Hedge Fund CIO: “Today, The Chinese Are Trapped… And The Box Keeps Shrinking”

Submitted by Eric Peters, CIO Of One River Asset Management

V-Day

“America built the global trading system, but we don’t really need it,” said the strategist. “We defend it, but we don’t require it.” For all the free-trade talk, the US is the most closed of all major economies. “When you include Canada and Mexico – basically vassal states – you could cut off trade with every other country and America would run just fine.” Plus we haven’t even started fracking south of the border. “We built the trading system to support our allies during the Cold War. We subsidized them for so long we forgot why we were doing it. But the war is over.”

“The US pays for the security that underpins world trade,” continued the strategist. “And we provide the excess demand that allows the world’s mercantilists to function.” No large nation/block is willing to run a current account deficit like we do. “The Bushes and Clintons kept it going. Obama too. They kept the Cold War alive. And it was great for Wall Street, multi-nationals, their executives.” But it wasn’t great for most workers. “The rearrangement we see today was inevitable. It just needed a leader strong-willed enough to defy the establishment.”

“Neither Democrats nor Republican leaders wanted this change,” explained the strategist. “But almost overnight, voters have woken to the notion that China is not our friend. It’s a strategic rival.” This genie will not return to the bottle. “Neoliberalists assured us that welcoming China in the WTO would yield a win-win.” It certainly helped them get rich. “A strong China is not really a win for the US. It’s not a win for Vietnam either.” Or anyone within 1,000 miles of Beijing. “This change is generational. And the impact on China will be terminal.”

Dead Presidents

“Read McKinley’s speeches, they were very interesting,” said our President. So I did. “He talked about how we won’t allow the outsider to come in and take our wealth from us without having to pay,” continued Trump. The 38%-50% McKinley Tariff passed in 1890, before William became President in 1897. McKinley introduced the term “reciprocal trade” and as President, threatened additional tariffs to lower foreign barriers. The economy flourished in his 1st term. He won a 2nd, warmed up to more open trade, then got shot. Teddy came next.

Anecdote: 

“There are two types of macro traders,” said the macro trader.

“The first makes money when what’s supposed to happen actually happens,” he continued. “They tend to own emerging markets, the S&P 500. They buy high yield and anything that rolls down a curve.” These strategies are implicitly short volatility; usually a winning proposition.

“The second type of macro trader looks for situations where policy makers have found themselves trapped in a box. And to escape, they need to pay you.” These opportunities are less frequent.  “The more acute the policy dilemma and the more advanced the corresponding stress or euphoria, the better. As the box gets smaller and the exits narrow it becomes easier to game out how they’ll ultimately act.” The most famous example was Soros’s bet against the Bank of England in 1992; the BOE’s only viable escape was a sterling devaluation.

“I made a lot of money in 2014 as the European economy struggled and the Euro soared. The ECB was boxed. They either needed to ease and devalue the currency, or their banking system was going to implode.” Draghi made the ‘whatever it takes’ speech in 2012 but had not yet adopted QE. “There was no other way out of the box. So you could short European stocks against the S&P 500 and short the Euro versus the dollar.” In every plausible outcome, you were going to win.

“Today, the Chinese are trapped. They need to keep policy easy to prevent implosion of their crazy-levered economy, but easing pressures their currency, which induces capital flight. So far, they’ve sidestepped this dilemma through capital controls and portfolio inflows (the latter a result of co-opting global asset managers and bureaucrats by getting included into global benchmarks and the SDR basket). But these are just delaying tactics.” As the box keeps shrinking.

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