Original title: The Easy Button
Original author: Arthur Hayes
Original source: Medium
Compiled by: Lynn, MarsBit
The opinions contained below are solely those of the author and should not be used as a basis for investment decisions, nor should they be construed as advice or opinions on investment transactions.
The global elites have a wide array of policy tools to maintain the status quo that will cause pain now or in the future. I take the cynical view that the only goal of elected and unelected bureaucrats is to remain in power. Therefore, the easy buttons are always pushed first. The hard choices and strong medicines are best left to the next administration.
To fully explain why the USD/JPY exchange rate is the most important global economic variable would require an extremely lengthy series of articles. This is my third attempt to describe the chain of events that led us to the Valhalla Code. Rather than providing a complete and comprehensive picture first, I will do as they say. Give your readers the easy button. If policymakers abandon the use of this tool, then I know that longer, harder, and more prolonged course-correcting actions will come into play. At this point, I can provide you with a more comprehensive explanation of the sequence of monetary events and the relevant historical perspective.
A real “oh they are real fucked” moment occurred when I read two recent Solid Foundation newsletters written by Russell Napier about the lose-lose situations in which monetary union under Japan and the United States are both responsible. The latest newsletter, published on May 12, describes the easy buttons available to the Bank of Japan (BOJ), the Federal Reserve (Fed), and the U.S. Treasury.
Quite simply, the Fed, under the order of the Treasury Department, can legally swap unlimited amounts of dollars for yen with the Bank of Japan, as long as they wish. The Bank of Japan and the Ministry of Finance can use these dollars to manipulate the exchange rate by buying yen. By strengthening the yen in this way, it avoids the following:
The Bank of Japan raises interest rates and in the process forces regulated capital pools, such as banks, insurance companies and pension funds, to buy Japanese Government Bonds (JGBs) at high prices and low yields. In order to buy these overpriced JGBs, these capital pools will have to sell their US Treasury bonds (UST) to raise US dollars to buy yen and repatriate them.
The Treasury sells UST to raise dollars and buys yen.
If Japanese companies, as the largest holders of US Treasuries, do not become forced sellers, it helps the US Treasury continue to finance the profligate federal government at negative real interest rates. Otherwise, the Treasury will have to initiate yield curve control (YCC). This is the ultimate goal, but it must be prevented as long as possible due to the obvious inflationary and possible hyperinflationary effects.
Seppuku
Who is the biggest holder of Japanese government bonds? The Bank of Japan.
Who directs Japan's monetary policy? The Bank of Japan.
What happens to bonds when interest rates rise? Prices fall
Who loses the most money if interest rates rise? The Bank of Japan.
The Bank of Japan will commit hara-kiri if it raises interest rates. Given its strong self-preservation instinct, the institution will not raise interest rates unless it has a solution that spreads the losses to financial players other than itself.
If the Bank of Japan does not raise interest rates and the Federal Reserve does not cut interest rates, the interest rate differential between the US dollar and the yen will persist. As the US dollar yields higher than the yen, investors will continue to sell the yen.
To understand why a weaker yen raises geopolitical and economic issues, let's look to China.
China is not happy
China and Japan are direct export competitors. The quality of Chinese goods is comparable to that of Japanese goods in many industries. The only thing that matters is the price. If the RMB appreciates against the yen (yen depreciates, RMB appreciates), China's export competitiveness will be damaged.
China's President doesn't like this CNYJPY chart.
China is pinning its hopes of escaping deflation on manufacturing and exporting more goods.
Property = Bad
Manufacturing = Good
And that is exactly where cheap bank credit should go.
As you can see, China and Japan are neck and neck in the emerging passenger car export market. I use this as an example of global export competition. Given the number of cars purchased each year, this is probably the most important export market. In addition, the Global South is young and growing; they will add more cars per capita in the coming years.
If the yen continues to depreciate, China will respond by devaluing the yuan.
Since 1994, the People’s Bank of China (PBOC) has essentially pegged the RMB to the US dollar, with a slight bias toward strengthening. That’s what the USDCNY chart shows. That’s about to change.
China must devalue the RMB implicitly by creating more RMB credit onshore, and explicitly by a higher USD/RMB value, so that exports can outprice Japan. They must do this to fight deflation due to the bursting of the real estate bubble.
The GDP deflator converts nominal GDP to real GDP. A negative number means prices are falling, which is not good for an economy based on debt. Because when asset prices fall, banks extend credit against asset collateral, debt repayments are questioned, and its prices also fall. This is deadly, which is why China and every other global economy needs inflation to function.
It is easy to create the necessary inflation; just print more money. However, China’s money printing press is not working hard enough. Credit, as always, is created by the commercial banking system.
These BCA research charts clearly show a negative credit impulse, which suggests that there is not enough credit money creation.
Spending by local and central governments will also not be enough to end deflation.
The real interest rate is positive. The growth in the quantity of money is falling, but its price is rising. Very bad.
China has to create more credit, either through government spending or more loans to businesses. So far, China has not launched a bazooka-style stimulus program like it did in 2009 and 2015. I think this is because there are well-founded concerns that these domestic money creation policies will have a negative impact on the currency, and at least for now, they want to keep it stable against the dollar.
To create the above chart, I divided China’s M2 (RMB money supply) by reported foreign exchange reserves. At its 2008 high, the RMB was 30% backed by foreign exchange reserves, mostly US Treasuries and other dollar assets. Currently, the RMB is only 8% backed by foreign exchange reserves, the lowest level since the data was published.
If China ramps up credit creation, the money supply will grow further. This adds pressure on the dirty yuan to be pegged to the dollar. I think China wants to keep the dollar-yuan exchange rate stable for domestic and international political reasons.
Domestically, China does not want to exacerbate capital flight by devaluing the CNY too much. This also increases import costs. China imports food and energy. When these costs rise too fast, social chaos is not far away. The lesson any Marxist, especially a Chinese Marxist, has learned from revolutionary history is to never let food and energy price increases get out of control.
The key factor that China is concerned about is how Pax Americana responds to a weaker CNY. I will get to this later, but a weak RMB makes Chinese-origin goods cheaper. This reduces the incentive for Americans to move manufacturing capacity overseas. Why would they build expensive factories and employ expensive skilled labor (if they can find it) when their final products are still not price competitive with Chinese products? Unless the US government provides massive corporate welfare, American manufacturing companies will continue to make their products abroad.
Rust Belt doesn't like
Slow Joe is being crushed in states where the manufacturing base moved to China over the last 30 years. If China lets the yuan devalue, jobs will continue to be lost. If Biden doesn't carry these states, he will lose the election. Trump's 2016 victory was on the margins due to victories in the Rust Belt states with anti-China rhetoric.
Some readers might say that Biden’s handlers have finally figured it out; the Biden administration’s anti-China rhetoric and actions have intensified. In fact, Biden just announced another increase in tariffs on a variety of Chinese goods, including electric vehicles.
My take is that Chinese goods don't always come directly from China. If the product is cheap enough, China will export it to a US friendly country first before it ends up in the US. The goods are then considered to be from another country, not China.
Here is a chart of Chinese exports to Mexico (white), Vietnam (yellow), and the United States (green). Trump's rule began in 2017, which is the starting date for the index at a value of 100. Trade between China and Mexico increased by 154%, and trade between China and Vietnam increased by 203%, but trade with the United States increased by only 8%. Obviously, trade with the United States is much higher than trade with Mexico and Vietnam, but it is clear that China is using these two countries as transit points for goods to evade tariffs.
If the goods are good and cheap, they will come to the United States. While politicians will make a big fuss about combating "dumping" with punitive tariffs, China can easily change the destination of its exports. Countries like Vietnam and Mexico hope to earn a small commission by allowing goods to pass through their borders into the United States.
Biden must win these battleground states to keep the Orange at bay. Biden cannot allow the yuan to devalue before the election. The Chinese will use this fear of losing the election to their advantage.
China's response
If I were a member of the Standing Committee of the Chinese Communist Party advising President Xi, this is what I would advise.
China conveyed the following threats to Biden followers visiting Beijing. In the past few quarters, Secretary Blinkin and Yellen have visited Beijing many times. I think the real content of the conversation revolved around the threat of China.
If the United States cannot get Japan to strengthen its yen, China will respond by devaluing its currency against the dollar and exporting deflation to the world through mass-produced, cheap goods.
China is also pressuring Yellen to implement a weak dollar policy by doing whatever is necessary to increase the global supply of dollars. This allows China to deploy bazooka stimulus again, as the pace of RMB credit creation will match that of the dollar in relative terms.
In return, China would keep the dollar-yuan exchange rate stable. The yuan would not depreciate against the dollar. Perhaps China would even agree to limit the amount of products shipped to the United States to help American companies move production overseas.
If Yellen and Blinken balk at this threat, I would follow up with the nuclear currency option.
It is estimated that China has stored over 31,000 tons of gold. This is government and private holdings combined. The Party technically owns everything in China, so I added government and private holdings together. This gold is worth about $2.34 trillion at today's prices. The RMB is implicitly backed by 6% in gold. I divided China's reported RMB money supply by the value of all the gold China holds.
As I mentioned, China's FX reserves/M2 is 8%. The dollar and gold support the yuan roughly equally.
My threat would be to declare a dirty peg of the yuan to gold. Here is how China could achieve that outcome:
Sell UST for gold ASAP. At some point the US may freeze Chinese assets or restrict China's ability to sell its approximately $1 trillion worth of US Treasuries. But I believe China will be able to quickly sell hundreds of billions of dollars worth of US Treasuries at fire sale prices before US politicians pick up the pieces.
Instruct any state-owned enterprises that hold US stocks or UST to also sell and buy gold.
In December, the RMB will be pegged to gold, which means that the RMB will depreciate by 20% to 30% from its current level. The price of gold in RMB terms will rise (XAUCNY rises).
Gold trades at a premium between the Shanghai Futures Exchange (SFE) and the London Bullion Market Association (LBMA) fixed price. This leads traders to arbitrage prices by taking delivery of gold in London via long futures contracts and delivering it to Shanghai via short futures contracts. This causes gold to flow from the West to the East.
As the global gold price rises, the value of physical gold in the stockpiles of LBMA member countries decreases, and one or more major Western financial institutions go bankrupt due to lack of physical gold. There have been constant rumors of Western financial institutions nakedly shorting gold in the paper derivatives market. This would be a GameStop on steroids, as it could destroy the entire Western financial system, as there is a lot of leverage embedded in the system.
The Fed was forced to print money to save the banking system, which increased the supply of dollars. This helped the yuan strengthen against the dollar.
After reading these hypothetical scenarios, the reader may wonder why I think the United States can dictate Japan's monetary policy. The key assumption is that by threatening the United States, China can convince the United States to instruct Japan to strengthen the yen.
Japan frequently agreed in the 1970s and 1980s to strengthen the yen in order to make its exports less competitive to the United States and Western Europe, primarily Germany.
Above is the USDJPY chart. USDJPY started at 350 in the 1970s, imagine how cheap Japanese goods were to Americans at that time.
Yellen is well placed to politely advise Japanese businesses to strengthen the yen this time around to prevent Chinese retaliation.
If the Japanese were playing ball, what would they do? Let me explain why Japan cannot strengthen the yen by instructing the Bank of Japan to raise interest rates and end quantitative easing.
Japanese Bond Math
I want to quickly explain why the Bank of Japan would crumble faster than Sam Bankman-Fried would on the witness stand if they raised rates.
The Bank of Japan owns over 50% of all outstanding JGBs. In reality, they price all bonds with a maturity of 10 years or less, and what they really care about is the 10-year JGB rate, as that is the reference rate for many fixed income products (corporate loans, mortgages, etc.). Let's assume their entire portfolio consists of 10-year JGBs.
Currently, the running 10-year JGB#374is worth $98.682 and yields 0.954%. Assume the BoJ raises its policy rate to a point that the yield matches the current US Treasury 10-year yield of 4.48%. The JGB is now worth $70.951, a 28% drop (I used Bloomberg's bond pricing function) <YAS>. Assuming the BoJ holds 585.2 trillion yen worth of bonds and the USD/JPY exchange rate is 156, the mark-to-market loss is $1.05 trillion.
Losing that much money is game over for the BoJ’s fraud against yen holders. The BoJ holds just $32.25 billion worth of equity capital. Even the crypto exit trades are not as leveraged as the BoJ. Seeing these losses, what would you do if you held yen or yen-denominated assets? Dump them or hedge them. Regardless, USD/JPY will escape 200 times faster than Suju and Kyle Davis could escape from the BVI court-appointed liquidators.
If the BoJ really had to raise rates to narrow the dollar-yen interest rate differential, they would first force domestic regulatory capital (banks, insurance companies, and pension funds) to buy Japanese government bonds. To do this, these entities would sell their dollar-denominated foreign assets, primarily US Treasury bonds and US Treasuries, use those dollars to buy yen, and then buy the high-priced Japanese government bonds with negative real yields from the BoJ.
From an accounting perspective, as long as these institutions hold them to maturity, they won’t have to mark to market their JGB portfolios and report huge losses. However, their clients, the funds they manage, will be financially constrained to bail out the BOJ.
This is a bad outcome from a Pax Americana perspective, as the Japanese private sector will be selling trillions of dollars worth of U.S. Treasuries and U.S. stocks.
No matter what plan Yellen proposes to strengthen the yen, it cannot require the Bank of Japan to raise interest rates.
Simple Button
As mentioned above, there is a way to weaken the dollar, enable China to revive its economy, and strengthen the yen without having to sell any UST. I will discuss how unlimited USD-JPY currency swaps can solve this problem.
To weaken the dollar, its supply must increase. Imagine that Japan would need $1 trillion worth of firepower to increase the yen from 156 to 100 yen overnight. The Fed swaps $1 trillion for an equal amount of yen. The Fed prints dollars and the Bank of Japan prints yen. There is no cost to central banks to do this because they have their own national currency printing presses.
These dollars exit the BoJ's balance sheet because the Ministry of Finance has to pay for the yen on the open market. The Fed has no use for the yen, so it stays on the Fed's balance sheet. When a currency is created but remains on a central bank's balance sheet, it is sterilized. The Fed sterilizes the yen, but the BoJ releases $1 trillion into global money markets. So as the supply of dollars increases, the dollar weakens against all other currencies.
As the dollar weakens, China can create more onshore RMB credit to combat the harmful effects of deflation. If China wants to keep the USD/CNY exchange rate unchanged at 7.22, it can create an additional RMB 7.22 trillion ($1 trillion * $7.22) of domestic credit.
The CNY/JPY exchange rate falls, and from China's perspective, the CNY/JPY exchange rate is weakening, and from Japan's perspective, the CNY/JPY exchange rate is strengthening. The global supply of CNY has increased, while the amount of JPY has decreased, because the Japanese Ministry of Finance buys JPY with USD. Now, the JPY is reasonably valued against the CNY in terms of purchasing power parity.
Any dollar-based asset will go up in price. This is good for the US stock market and ultimately for the US government, which imposes capital gains taxes on profits. This is good for Japanese companies, as they collectively own over $3 trillion worth of dollar assets. Cryptocurrencies prosper because there is more dollar and yuan liquidity in the system.
Domestic inflation in Japan is lower due to a stronger yen, which reduces the cost of imported energy. However, exports will suffer due to the stronger currency.
Those who make mistakes will get something, some more than others, but this helps keep the global dollar system intact ahead of the U.S. presidential election. No country should have to make painful choices that would negatively affect its domestic political standing.
To understand the risks of the United States engaging in this behavior, first, I need to draw an equation between YCC and this dollar-yen swap.
Same but different
What is YCC?
This refers to the central bank's willingness to print unlimited amounts of money to buy bonds to keep prices and yields fixed for political expediency. Due to YCC, the money supply increases, resulting in a weaker currency.
What is this dollar-yen swap arrangement?
The Fed is prepared to print unlimited amounts of dollars so that the Bank of Japan can preemptively raise interest rates, leading to a sell-off in US Treasuries.
The two policies are equivalent in outcome; that is, UST yields less than the other policies. In addition, the dollar will weaken as supply increases.
Swap lines are better politically because they happen in the shadows. Most commoners and even nobles don’t understand how these tools work or where they are hidden on the Fed’s balance sheet. It also doesn’t require consultation with the U.S. Congress because the Fed was given these powers decades ago.
The YCC is more visible and will surely draw attention from the voices of engaged and angry citizens.
risk
The risk is that the dollar depreciates too much. Once the market equates the dollar-yen swap line with YCC, the dollar will commit suicide and sink to the bottom of the sea. When the swap agreement is finally unwound, it will mean the end of the dollar reserve system.
A politician concerned about gaining support would support an expansion of dollar-yen swap lines today, given that it would take years for markets to force such an easing.
Watch out
How can you supervise whether I am right or wrong?
Watching the USD/JPY exchange rate is much closer than the Solana developers monitor the exchange rate. Closer, in fact…
The problem of the interest rate differential between the dollar and the yen has not been solved. Therefore, the yen will continue to weaken regardless of intervention or not. After each intervention, open this page and monitor the size of the USD/JPY swap lines. On Bloomberg, monitor the FESLTOTL index. If it starts to increase substantially, and I mean billions of dollars, then you know this is the path chosen by the elites.
At this point, add the size of the USD swap line to your handy USD liquidity index. Sit back and watch crypto move higher against fiat currencies.
Wrong.com
I could be wrong on two counts.
The Bank of Japan is changing its weak yen policy, raising interest rates sharply and saying it will continue to do so. When I say "sharply," I mean 2% or more. A mere 0.25% rate hike will not erode the 5.4% interest rate differential between the dollar and the yen.
The yen continues to depreciate, the United States and Japan do nothing, and China retaliates by devaluing the yuan against the dollar or pegging it to gold.
If any of the above happens, it will eventually succumb to the US YCC in some form, but the path to the YCC is complicated. I have a theory about the sequence of events from here to there, and if necessary I will publish a series of posts about the journey.
Timing is everything
The market knows that the yen is too weak. I think the pace of yen depreciation will accelerate in the fall. This will put pressure on the United States, Japan and China to act. The US election is a key motivating factor for the Biden administration to come up with a solution.
I think a surge to $200 USD/JPY would be enough to play out the Chemical Brothers and “Push the Button.”
This is why all crypto traders must constantly monitor USDJPY. I am sure that the clown team in charge of American peace will take the easy way out. It just makes political sense.
If my theory comes to pass, it would be trivial for any institutional investor to buy a US listed Bitcoin ETF. Bitcoin is the best performing asset in a global fiat currency debasement scenario, and they know it. When the issue of yen weakness is resolved, I will mathematically estimate how the inflows into the Bitcoin complex will push the price to $1 million, or even higher. Keep your imagination, stay foolish, now is not the time to be a fool.
