So let’s go back to that chart, because that’s
a shocking chart to me.
It’s assuming that there’s enormous amounts
capital flight going on.
And it’s not showing up in the currency market.
The one that shows illicit capital.
The diamonds obviously corroborates it.
And then we’ll show you also, one of the things
that when you think about how China operates,
when you understand that they’ve now gone
to current account negativity for the first
time in the first half of 2018, what is important
to China going forward?
It’s capital flows.
And so we put together this chart from SAFE
and CEIC’s database.
When you look at the green bars there, the
green bars are the current account building
that reserve balance that enables China to
just keep printing money on the other side
of their balance sheet, running their domestic
economy they want to do.
That turned negative in the first half of
So you see the green bars went negative.
The blue bars here are quote, “net errors
and omissions,” which is Chinese for illicit
So the only thing holding China up right now–
This hasn’t changed trend.
We still think that this is negative now,
going into 2019?
Well, I’ll say that– think about what happened
Crude oil dropped from $75 a barrel to, what
did it hit, like $43 a barrel?
That’s one of China’s biggest imports, is
So that will give them a brief reprieve on
the current account side of things.
But again, the question with that, is that
a secular or is that a cyclical phenomenon?
This is key to understand.
You see you see the dotted line?
That’s volume of crude importation by China,
using the right y-axis.
And this is the dollar value of imports.
So back in the end of 2014, early 2015, when
crude collapsed from 100 to 30, they got a
massive reprieve in their current account.
But if you look at the volume, does that line
look like equals y equals mx plus b?
It doesn’t look very cyclical.
The thing about this, they were importing
just under 300 million tons the beginning
The most recent number is 462 million tons.
Think about this.
They’re now importing 50% more crude in only
four years ago.
50% more today than they were importing four
So is this a secular or a cyclical phenomenon?
It is clearly secular, when you look at this
And now, energy prices will stabilize.
So you say, well, are they going to have a
positive current account or negative, this
And the fourth quarter’s probably positive,
because oil collapsed.
But in the long run, smoothed.
They have a secular problem where they, from
now on, will have a negative current account.
They’re starting to look more and more like
Argentina, and Turkey, and the other twin
Because what are they doing?
They’re running a negative current account,
they’re running a negative fiscal balance
of roughly 9% of GDP.
So they’re running twin deficits, their FX
reserves are dwindling, and they’re starting
to borrow a lot of dollars.
So how much of the FX reserves is liquid,
out of what’s left?
What’s the composition of that, now?
Well, first of all, if you remember when they
were led into the IMF SDR basket, they said
they would disclose the composition of their
reserves within two years.
That was a long time ago, and we haven’t seen
So again, look at what they do, not what they
say in China.
And clearly, they lied to everyone with that
But more importantly, I think, getting back
to your question, what does that composition
of reserves look like?
One thing we know for a fact is US treasury
tick data shows that they own a little bit
less than $1.2 trillion in treasuries.
So we think that their only liquidity that
they have any size of is our treasuries.
So they own a little bit of, call it yen,
But they mostly own treasuries.
We think the number is closer to $2 trillion,
instead of $3.2 trillion.
Which is dangerously below adequate levels.
Because it sounds like a huge sum, but for
the signs the economy and the potential capital
flows, that can go super quick.
So if we’re going to play large numbers here,
the broad measure of credit in the Chinese
financial system’s $48 trillion worth of RMB.
They only of $2 trillion of reserves.
Think about these numbers.
In their last banking crisis, which was between
’98 and 2002, the loss given defaults were
80% of loans that defaulted.
And at one point in time, they had 35% of
their entire system was non-paying.
But the counterargument always, for everybody,
is, it doesn’t matter.
But it’s China.
That’s always the thing.
They’ll smooth it.
Kyle’s being an alarmist.
Everyone’s being an alarmist.
You’re wrong, Raoul.
It’s not a trade through seven against the
All of this.
And those people sleep well at night, until
That’s the nickels in front of a steamroller
I think what brings this to a head is the
When the current account goes negative, and
the reserve balance is going the other way,
that the rubber meets the road then.
As long as that balance is increasing annually,
along with GDP, in RMB terms, they can keep
But as soon as those balances go– now, their
fiscal balance is negative 10, negative 9.5.
Their current account balance goes negative,
and it’s a secular negativity, then they have
more money leaving than coming in.
They have to desperately borrow.
And now, they’re changing their laws.
They say, you know what?
Now, Westerners can own more than half of
our banks, not a problem.
Please invest more in Chinese equity.
They have to get rid of all the shit they
So please invest more in Chinese equities.
So when you look at capital flows, this is
a really important chart.
This is from CEIC and SAFE.
The red bar and the striped bar is just portfolio
investment and FDI.
So without Western capital flowing into China,
China can’t hold this all together.
Literally, we are providing them–
Which is Turkey and Argentina, right?
That’s the only way that–
–they were supported.
But what’s interesting about China is this
gives them– first of all, their economy has
given them the confidence globally to be more
geopolitically assertive in their dealings.
It’s given their military the ability to be
much more assertive in the South China Sea.
And it’s given Xi an aura that he’s made the
west think that, somehow, his economy, his
economic model is superior to that of Western
And it’s all a facade.
The whole thing is a mirage.
The whole thing is made up with the printing
press, keeping a closed capital account, and
hoping the world doesn’t notice it.
But can they get away with it?
Can they do a smooth, Japanese-style decline,
20, 30 years of below-trend growth or growth
of trends lower, and just kind of work out
the bad debt?
Because Japan’s surprised everybody of how
they actually managed it.
Now, it’s a different economy, because they
have a bunch of surpluses.
But, can they do it?
I don’t have the chart in here.
I didn’t bring it with me.
But the other thing that Japan has, that China
doesn’t, if you look at the net international
FX reserve position abroad– so it’s the investments
of Japan, Inc. abroad, both from a sovereign
perspective and from a savings perspective
of the population.
Japan’s net international effects position
is 250% percent of their GDP.
China’s is 18% of GDP.
And most of China’s are the state.
It’s the left side of the PBOC’s balance sheet.
Lending to ports in Sri Lanka, buying the
port in Greece, owning a Ugandan copper mine
in Congo, for lithium, and things like that.
Those are things they are not going to monetize
and bring home.
So China doesn’t have that net international
FX position that Japan can really rely upon,
to keep its dream alive.
Now, Japan still runs a positive current account.
And Japan has a quadrillion yen of debt, right?
They also have a quadrillion yen of net international
savings, where China doesn’t.
So Japan is a completely different animal.
So there’s two things I want to put into this.
One of the things that I’ve been talking about,
I think the probability of a global recession
is reasonably high, at this point.
What do you think it is?
Yeah, I agree with you.
It’s very high, and all the data I look at
looks like it’s coming.
Could it be 2016 again?
Well, we kind of avoid it, because the Chinese
got us out of it.
I don’t think that’s coming.
We saw that a fiscal stimulus in the US lost
It’s not going to help.
So we’re running out of something.
We’re running out of ability to get around
Looks like Australia is about to go into the
All of this is starting to happen.
So let’s assume ceteris paribus in China,
they don’t anything different, but the world
goes into recession.
They’re screwed, right?
Because they can’t sell goods.
And then so their current account–
Goes more negative.
Because that offsets the oil thing, because
the fact is– because we saw a similar kind
of thing happened when oil fell last time.
It’s because, well, trade fell, as well.
And if Chinese cannot sell enough goods, then
that’s the end of the game.
I think the writing’s on the wall, when you
look at– everything that you look at.
You look at Australia, you look at Southeast
But look at Italy just entered a recession
a week ago.
If you look at the subcomponents of Germany’s
industrial production, it’s actually tracking,
right this minute, as bad as it was when Lehman
And you know what it’s highly correlated to?
But that’s my point.
Germany’s headed into recession.
The US numbers look really good right now.
It’s because we just stimulated at full employment.
That’s stimulus– I think peak stimulus is