World View: Monday’s Stock Market Rout Blamed on China’s Foreign Currency Selloffs

This morning’s key headlines from GenerationalDynamics.com

• Bangladesh covers up Tibetan art after China threat
• Desperate China official rapidly selling off foreign currency reserves
• Monday’s stock market plunge blamed on China and on weak earnings
• Hong Kong experiences worst violence in years

Bangladesh covers up Tibetan art after China threat

Dhaka Art Summit is the biggest art show in Bangladesh with about 300 South Asian artists participating

Bangladesh’s biggest art show, the Dhaka Arts Summit, was forced to cover up an exhibit by Tibetan artists, due to threats from China’s ambassador. The exhibit page homage to 149 Tibetans who had self-immolated (burned themselves to death) to protest China’s policies. The exhibit displays five letters written by Tibetan protesters before they burned themselves.

According to the artist:

They had to be covered because the Chinese ambassador to Bangladesh (Ma Mingqiang) found the works offensive, during a visit to the summit on Saturday.

We were told by the curator (Diana Campbell Betancourt) that he exploded as soon as he saw it and asked the works to be removed immediately or face consequences.

The nature of the “consequences” was not explained.

China heavily censors art displays within China, and now is censoring art displays in other countries. AFP and Indian Express

Desperate China official rapidly selling off foreign currency reserves

People used to say that the U.S. was so deeply in debt to China that China could blackmail the U.S. by simply threatening to sell off all the Treasury bonds that it owns. In those days, the U.S. was importing so much from China that China had to buy U.S. Treasuries to help the balance of payments between the two countries.

Those days are long gone now, with the American dollar steadily strengthening and China’s economy steadily weakening.

For a number of months, China’s economy has been weakening, and the government has had to battle a stock market rout, slowing factory production and falling exports last year, and causing China’s renminbi (yuan) currency to weaken. The People’s Bank of China (PBoC) central bank has responded by selling its holdings of foreign currencies (dollars, yen, euros) in order to buy up yuan on the international markets, thereby increasing the demand for yuan and preventing it from weakening further. The PBoC fears that there could be an international run on yuan currency, causing a rapid devaluation, and destabilizing China’s economy.

So it still came as a surprise that China’s foreign currency reserves plunged $99.5 billion in January. In other words, China sold off almost $100 billion in dollars, yen and euros in order to purchase yuan, to prevent a devaluation.

At $3.23 trillion, China still has the world’s biggest reserve of foreign currency holdings. But that has declined by $420 billion in just the last six months, and is now at the lowest level since May 2012.

According to one analyst, “While the remaining reserves still represent a substantial war chest, the mathematics around this rapid pace of depletion in recent months is simply unsustainable for any length of time.”

That means that the yuan is continuing to lose value, and analysts are expecting the PBoC to devalue the yuan by substantial further amounts in the next few months.

Already, the yuan has declined 1.24% against the dollar so far this year.

In fact, the yuan may be in a vicious deflationary spiral. Forex (foreign exchange) investors see that that the yuan is going to be devalued so they are selling yuan to purchase dollar-denominate assets, the exact opposite of what the PBoC is doing. Investors selling yuan will cause the yuan to devalue further, causing investors to sell even more.

According to this analyst: “Domestic private investors and global currency traders see a one-way bet against the currency. This has resulted in large-scale private capital outflows since early 2015 as expectations mount that the PBoC will eventually be forced to capitulate once its reserves are sufficiently depleted.”

Devaluing a currency makes the country’s products cheaper on the international markets, and so makes the country more competitive, increasing exports. That is what China would like.

But there are many emerging market countries, especially China’s neighbors in Asia, whose economies depend heavily on trade with China, and so they are devaluing their own currencies in sympathy with China. The concern is that this will be a different kind of vicious cycle, as countries compete with each other to “race to the bottom,” with devaluations in one country triggering further devaluations in other countries.

A “race to the bottom” among Asian and emerging market currencies could have a substantial effect on the U.S. economy, since the dollar is expected to strengthen substantially in this scenario, making American goods extremely expensive on world markets. This could dramatically reduce exports, reducing earnings, and causing the stock market to tumble, which is part of the explanation for what happened on Monday. BBC and Bloomberg and International Business Times

Monday’s stock market plunge blamed on China and on weak earnings

S&P 500 Price/Earnings ratio at 21.40 on February 5, indicating a huge stock market bubble (WSJ)

Monday was another dramatic day on Wall Street, as the day began with a 400+ point drop on the Dow Jones Industrial Average (DJIA), with oil prices falling once again below $30 per barrel. By the end of the day, the stock market recovered to “only” a 178 point loss. Analysts are mostly confused about why the stock market has been falling recently, and I frequently see them on TV scratching their heads wondering why such a “small economy” like China’s is having such a big effect on Wall Street.

As regular readers know, Generational Dynamics predicts that we are headed for a global financial panic and crisis. According to Friday’s Wall Street Journal, the S&P 500 Price/Earnings index (stock valuations index) on Friday morning (February 5) was at an astronomically high 21.40. This is far above the historical average of 14, indicating that the stock market is in a huge bubble that could burst at any time. Generational Dynamics predicts that the P/E ratio will fall to the 5-6 range or lower, which is where it was as recently as 1982, resulting in a Dow Jones Industrial Average of 3000 or lower.

If you compare stock price and P/E ratio changes in the last month, there are some interesting observations. Last week, on the moring of February 5, the Dow was at 16417 and the S&P 500 P/E ratio was at 21.40.

A month ago, on the morning of January 8, stock prices were higher, but the P/E ratio was lower. Specifically, the Dow was at 16514, and the P/E ratio was 21.03.

Now, that should be impossible. The P/E ratio is, well, a ratio of stock prices to earnings, and so if stock prices fall, then the P/E ratio should fall as well.

But of course, that is not always true, because the earnings may change as well. What has been happening is that fourth quarter (4Q2015) earnings have been coming out in the last month,

In fact, 63% of S&P 500 companies reported results as of Friday morning, and Q4 earnings are on track to decline 4.1%. This is even worse than the 3.7% decline that analysts had been predicting at the beginning of January.

The 4.1% decline in Q4 earnings would be the biggest drop in six years, and it follows a 0.8% decline in Q3. Revenue figures followed the same path, with revenue falling 3.5% in Q4, after falling 4.4% in Q3.

And so, the reason that the P/E ratio increased in the last month, despite the fact that stock prices have fallen, is that earnings have fallen even more.

If earnings decline two quarters in a row, then it is called an “earnings recession.” We won’t know for several months whether the GDP also fell for two quarters in a row, which would be the definition of an “economic recession.”

The stock market has been in a bubble for several years. Although analysts are always claiming that “this time it’s different,” the fact is that it’s never different, and Generational Dynamics is predicting a stock market panic and crash, with the Dow falling to 3000 or lower. USA Today and Barrons and Investors Business Daily

Hong Kong experiences worst violence in years

Dozens of people, including several Hong Kong policemen, were injured in some of the worst Hong Kong violence in years.

With the Lunar New Year celebrations in progress, police were called in to shut down illegal food stalls and food hawkers in the main shopping district. “Pro-democracy” activists had been prepared for the arrival of the police. Around 100 protesters began throwing missiles, including paving stones, bricks, bottles and plant pots at officers. They also set fires and blocked roads, while the police fired warning shots over the crowd. Coconuts Hong Kong

KEYS: Generational Dynamics, Bangladesh, Dhaka Art Summit, China, People’s Bank of China, PBoC, foreign exchange reserves, S&P 500 Price/Earnings ratio
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