The China Story of 2018 (Not What You Think)

Posted On Jan 16, 2018 By Dave Gonigam

  • If China is dumping Treasuries, does it really matter?
  • Forget the Treasury talk: Rickards spotlights the China-U.S. story of 2018
  • Shutdown? What shutdown? Here comes Dow 26,000
  • Bitcoin takes a spill below $12,000: Altucher weighs in
  • Are people fleeing high-tax states? Moving company has some answers
  • A British bankruptcy and black-swan risk… the new corporate tax rate reconsidered… an accusation of “deceptive advertising”… and more!

It was one of the big financial stories last week. And nearly everyone got the wrong idea.

Here’s how it appeared at the tip-top of the Drudge Report last Wednesday…

Drudge screenshot

We took note that day, briefly. We spotlighted the significance: China is the biggest foreign holder of U.S. Treasury debt.

The reaction was swift: Traders sold their Treasuries, pushing prices down. In the bond market, lower prices mean higher yields. Thus the yield on a 10-year T-note approached 2.6% for the first time since last March.

But it’s too easy to jump to the wrong conclusion — as many people did. “Pundits came out of the woodwork,” says our macroeconomic maven Jim Rickards, “to declare that the 35-year-old bull market in bonds was over and a new secular bear market had begun.”

The more doom-and-gloom minded took it a few steps further: YESSS! FINALLY THE CHINESE WILL DEAL A DEATH BLOW TO THE DOLLAR! NO ONE WILL WANT TO BUY TREASURY DEBT ANYMORE. TREASURY RATES WILL GO TO THE MOON, UNCLE SAM WILL GO BROKE AND THE SPENDTHRIFT POLITICIANS IN D.C. WILL HAVE TO FLEE TO PANAMA FOR THEIR SAFETY!

If your editor had a nickel for every time someone said the bond bull market was over these last five years… well, I wouldn’t be rich, but I’d have a substantial roll of nickels in my fist.

It’s true, the bond bull market is long in the tooth. Remember in the early 1980s, when you could get 17% on a CD at the bank? Bond yields were sky-high, and bond prices were lower than low. Interest rates have been climbing down steadily ever since… and in the post-2008 era it’s been almost impossible to get a respectable return on fixed-income investments.

Sooner or later, the tide’s gotta turn. But cycles in interest rates are a funny thing. The peaks don’t last long — those 17% CD rates in 1981 sure didn’t — but the valleys (like now) can last as long as 14 years. Check out this chart of the yield on a 10-year T-note going back to the early 1960s…

Sharp Peaks, Wide Valleys

Time and again there’ve been false alarms on the bottom of the current interest rate cycle — going back to mid-2012, when the 10-year yield fell to 1.4%.

In May 2013, Federal Reserve chairman Ben Bernanke told Congress for the first time the Fed was thinking about “tapering” back on its bond purchases, and the 10-year yield soared from 2% to 3% in the next seven months. (This was the infamous “taper tantrum.”)

But the so-called experts were wrong and the bond bull market wasn’t over: Rates started climbing back down, and kept doing so for 2½ years. In the aftermath of Great Britain’s “Brexit” vote in mid-2016, panic buying of Treasuries drove the 10-year rate even lower than the lows of mid-2012.

After Donald Trump was elected president later in 2016, interest rates began another steep climb like 2013. Yet again, the “experts” said there was nowhere to go but up. But rates stayed in a stubborn channel between 2.2–2.4% for much of 2017. Only last week did they start to challenge the post-election highs… and they still haven’t broken above that level.

Jim says the China freakout last week will prove another false alarm.

“There was less to this move than meets the eye,” he explains. “Chinese holdings of U.S. Treasuries have been nearly constant for about three years. China has been diversifying away from U.S. Treasuries for years, including increased allocations to gold, direct investments in private equity, hedge funds and high-quality euro-denominated debt. China is not about to dump Treasuries in a big way, although it might buy fewer in the future.

“This news is of no particular concern to the U.S. Treasury, as U.S. banks stand ready to pick up the slack if needed as buyers of last resort… Treasury yields should decline from here just as they did in 2014.”

But don’t get the wrong idea. The news from China was plenty meaningful, says Jim: “It’s best understood as a shot across the bow in what is shaping up as a new currency and trade war between the U.S. and China.

“The U.S. is preparing to slap tariffs and other trade sanctions on China, so China was warning Washington that such actions might be met with retaliation in the bond market.”

Even The Wall Street Journal says the consequences could be massive: “Global markets seem remarkably unprepared for what could turn into a clash of the titans,” says a report this morning. “Outside of North Korea’s nuclear threat, a U.S.-China trade war is the biggest potential economic spoiler of 2018.”

So no — China isn’t bankrupting the U.S. government yet. (Bummer, we know.) “For now,” Jim concludes, “what we’re seeing is bluster and the contours of a financial war rather than the end of the bull market in bonds.”

[Ed. note: As you might know, Jim recently “declassified” a project he first developed in his work with the CIA 15 years ago. It began as a way to sniff out anomalies in the financial markets that might tip off terrorist attacks. But the same tools also pointed the way to some immensely lucrative trades.

But as we said in a special note we sent while the markets were closed yesterday, the heat from Jim going public with this revelation is getting too intense. We’re pulling this presentation from the web tonight at midnight — give it a look while you still can.]

Hmmm… Dow 26,000 might have to wait another day or two.

It was only 12 days ago the Big Board crossed the 25,000 mark for the first time. It zoomed past 26,000 on the open this morning but has since pulled back to 25,952. That’s still 155 points higher than Friday’s close. The Dow is already up 4.9% in the first two weeks of 2018.

While the stock market was closed yesterday, the commodity and currency markets were open. The dollar tanked and gold jumped. Today some of that action is reversing; the dollar index rests at 90.7 and gold is $1,333.

Crude has pulled back below $64.

For the moment, traders remain oblivious to the possibility of a “partial government shutdown” come Friday night.

There’s still no sign of progress in Washington on a new budget, or the immigration matters that are tied up with a new budget. Not that a shutdown would be a death blow to the stock market, but it does make for a measure of “uncertainty” that markets don’t like.

As long as we’re looking out for financial black swans, there’s the collapse of Carillion — Great Britain’s second-biggest construction firm.

The government is taking over the company, promising that staff and contractors will continue to be paid. But the holders of Carillion’s debts might be another matter. Exactly who owns those bonds will come to light over the days and weeks ahead — maybe a major U.S. pension fund or insurance company? Events like these have spillover effects that don’t become obvious until after the fact…

For the first time in six weeks, bitcoin sits below $12,000.

The on-again-off-again rumors about a cryptocurrency crackdown in South Korea are on again. Finance Minister Kim Dong-yeon says in deciding how the government wants to regulate crypto, “the shutdown of virtual currency exchanges is still one of the options.”

South Korea accounts for almost 20% of all crypto trading. Thus, bitcoin is down 16% in 24 hours; many other cryptos have taken a bigger hit.

Meanwhile, rumors still abound from China about a crackdown on cryptocurrency mining; the Middle Kingdom accounts for 79% of global crypto mining, thanks to cheap subsidized electricity.

Our resident crypto-millionaire James Altucher is watching these developments with interest but not concern. “It shouldn’t impact the long-term trajectory for cryptos… This won’t be the last time regulators will attempt to step in and police this market.”

As the crypto market grows, James says, “Regulators will increasingly be tempted to protect their own interests and safeguard their citizens.”

But this temptation comes with a dilemma: “They can try to ban cryptocurrencies completely or they can work to develop solutions to accept the changing market landscape.”

James “expects them to try both.

“But as we’ve seen with alcohol prohibition, the war on drugs and digital music piracy,” James says, “the government has a terrible track record enforcing bans on goods and services that people want.”

So Asian attempts to regulate the crypto market — for now — amount to posturing, letting crypto investors know the government can interfere at any time. This certainly is keeping crypto on alert… but the market takes its lumps and bounces back. (Who still remembers China shutting down crypto exchanges last September?)

James’ takeaway? “All of this uncertainty represents tremendous opportunity.” Opportunity to buy bitcoin on dips, he says… because the crypto market’s not going anywhere.

The folks at United Van Lines ask the question: Where did Americans move in 2017?

The moving giant keeps track of customers’ moves in the U.S. and releases the data every year.

According to the Tax Foundation: “By comparing the number of inbound moves to the number of outbound moves, United Van Lines data gives us early insights into annual interstate migration, available much sooner than government data sources.”

So which state was the numero uno relocation destination? The answer might surprise you: the Green Mountain State, Vermont. And — of course — the next question is which state was dead last on the list? Well, among the contiguous states, Illinois is the last-place holder.

Moving Day in America - 2017

By the way, United didn’t measure Alaska or Hawaii…

“Individuals move for a variety of factors,” the Tax Foundation’s Nicole Kaeding says. “Climate, job opportunities, family, among others, impact the decision to relocate.

“Taxes can influence the decision too.” Umm… yeah.

Look at the top states Americans “quit” in 2017 — Illinois, New Jersey, New York, Connecticut and Kansas — high-tax states all, except Kansas, which is a special case the limitations of our 5 Min. clock don’t allow for today. (Just in case any Jayhawkers are offended: Let the record show your editor spent two contented years of young adulthood in Wichita.)

Now for the states Americans are moving to: Vermont, Oregon, Idaho, Nevada and South Dakota. Traditionally, low-tax states. Interesting….

“There are many ways that states can compete with one another for residents, and tax rates and structures should certainly be part of the conversation for states looking to attract new residents.”

To the mailbag, and some unfinished business from last week:

“Isn’t Zach Scheidt being overly simplistic in his illustration of how corporations will (presumably) benefit from the reduction of the tax rate from 35 to 21%?

“The effective tax rate for each corporation is highly variable depending upon deductions. How can we be certain that this will translate to the 21% Zach estimates, or any similar figure?”

The 5: To be sure — and we’ve pointed it out before — few corporations actually paid a 35% tax rate under the old system.

Zach’s only point is that conventional wisdom on Wall Street is underestimating the tax bill’s impact on corporate earnings. Look for many companies to “guide higher” for the year ahead during their quarterly conference calls these next few weeks…

“Deceptive advertising,” reads the subject line of our next entry.

Referring to the ad at the top of Friday’s 5, he writes, “You lied about this video being less than one minute long. What else are you lying about in your newsletters, advertising and promos?”

The 5: It was an honest mistake — the space ad we ran linked to the wrong sales promo.

I brought the matter to the attention of our marketing folks this morning to ensure it won’t happen again. Thanks for writing in and keeping us on our toes.

“As a long-time subscriber, I’m fascinated by the feedback thread,” a reader writes with some more unfinished business from last week.

“I remember when The 5 started with Addison Wiggin at the helm and how it continued in the same vein as the early iterations of The Daily Reckoning and The Rude Awakening. You have stayed true to the concept of timed topics to a roughly right five-minute read with just enough wit and sarcasm to keep it fun.

“The players and contributors have changed over the years but you have managed to maintain the plot. Readers that expect a daily missive like The 5 (or any of the free e-letters, for that matter) with wide distribution to provide a flow of specific picks that turn $100 into a million just don’t get it. We readers should be looking for insight, not guidance. The former provides input to performing our own final analysis and decision making. We pack our own investing parachutes.

“So thanks for the years of insight and here’s to many more. Please stay irreverent and chase the stories that we would never see if there were no 5.”

“How I yearn,” writes our final correspondent, “for the days when the mailbag was full of stimulating topics like how long it takes to read The 5.”

The 5: Heh. Don’t worry, it still comes up every six months or so…

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

P.S. Last chance: Access to Jim Rickards’ most controversial project to date closes down at midnight tonight. Here’s your final chance to review it and decide if it’s right for you.


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