China’s Currency Crisis

There has been a lot of talk in the news lately about the relationship between the United States and China. You may have heard President Trump talk about China manipulating their currency, but I do not think a lot of people understand what this really means. So I am going to be breaking it all down for you in this video, because this is actually creating a very serious currency crisis that will affect all of you. WATCH NOW!

VIDEO SUMMARY

There is a lot of discussion right now about what is going on in America. There is complaints about handling the pandemic, the riots, and the actions of the Federal Reserve. I think part of this is because the US is fairly transparent and provides a lot of data. This gives people a lot to talk about and debate. It seems like America’s problems is all you are seeing in the news. However, if you take a step back and look at things from a global perspective, America’s problems are not the biggest financial issue that is facing the world right now. America’s problems are fixable. We have the data, we just need to make the hard decisions and fix them. There is another problem in the world that in my opinion is going to be much harder to fix. I am talking about China’s currency crisis. This is something that not enough people are talking about, or even know about. This is like a train engine barreling down a train track towards everyone, and no one is paying attention.

Let me start by saying, please do not take this video as any sort of negative feelings towards China. I have never been to China myself, but I have a number of friends who have lived and worked in China. And in general, you should know that most Americans love and respect the Chinese people and Chinese culture. But recent events have highlighted a big difference between Chinese and American values that has to do with free markets. America is a democracy, and China is communist, and this is a completely different way of thinking about free markets. This difference in values is showing up in China’s currency market. I believe it is important to understand this difference because America is not going to change its values when it comes to free markets.

Currencies are traded on markets. When you have normal currencies, like the US dollar, the Euro, or the British pound, these are constantly changing based on the productivity of these countries and the demand for the currency. However, China is a communist country. They actively control the value of their currency. This means, China’s currency is not based on what the market wants to pay for it, but what the central government wants it to be worth. China keeps their currency value artificially low. This benefits China, because it makes them more competitive as a manufacturing center. For instance, if China’s currency is cheaper than the Euro, it will make it cheaper to manufacture something in China than Europe. It is one thing if China wants to have communist policies for things within their own country. But when China uses communist policies to manage their currency, that impacts the whole world.

Let me show you what currency manipulation looks like. There are some people out there that argue that currency manipulation by China does not exist, but I think it is blatantly obvious it has been going on for a long time. The Chinese currency is called the Renminbi, or more commonly referred to as the Yuan. Here is what a typical financial chart looks like for currency conversion rates between the US dollar and the Euro. This is what a free floating currency should look like where rates are set by the market. This is the chart for the US dollar and the Chinese Yuan. I think it is obviously these rates are not being set by the market. There are clearly periods where the value is being forced to a certain level. Even a more recent chart of the last five days shows the same signs of manipulation. China is pegging their currency against the US dollar.

Now it is not unusual for countries to peg their currency against the US dollar. But it is unusual for a country as big as China to do it. Usually a country would peg their currency against the US dollar because they are a very small country, and they are doing it to stabilize their currency. That is not China’s situation. China’s GDP is the second largest in the world. Why are they pegging their currency against the US dollar?

This has been an issue that the financial community has talked about for a long time. You often hear about the Chinese government spending money in ways that are wasteful, because they are making decisions based on what the government wants instead of market forces. You have probably heard about “ghost cities” being built in China. These are massive cities where no one lives. You hear about the flooding going on right now with the Three Gorges Dam. The government is releasing the flood waters and destroying villages and everyone’s property that lives there. You hear about Chinese banks being loaded up with bad debt during the pandemic, and the government’s response is to relax accounting standards so no one has to report the bad debt. But it is still all there. (https://stockmarketnewsdottoday.wordpress.com/2020/02/28/china-makes-bad-loans-disappear-as-virus-pummels-banks/) How long can China make inefficient decisions without paying the economic price? But this has been going on for a long time.

The US first designated China as a currency manipulator in 1992. The designation was dropped in 1994, but people in the financial world have criticized China for this for almost 30 years. President Trump accused China again formally in 2019, but has dropped the charge in 2020 as part of the ongoing trade negotiations between the US and China. https://apnews.com/0c0897cfd101e269605fe1c3954e6b88 Here is what happened. In January 2020, President Trump signed Phase 1 of the US – China Trade deal. In Phase 1, China agreed to stop manipulating their currency. There were going to define a process to ensure this promise as part of Phase 2 of the trade negotiations. Now here we are today, 7 months later, and the trade deal has completely fallen apart, much of which is driven by frustration over the pandemic outbreak that started in China and spread to the world. At this point, even Phase 1 is off the table, because both the US and China have broken promises they made in the Phase 1 agreement. China broke their promise when they stopped buying US crop exports and US oil exports. The US broke their promise when they stopped recognizing the special status of Hong Kong due to China’s actions in Hong Kong.

You might be asking at this point, “Why is this such a big deal?” If China has been manipulating their currency for 30 years, nothing bad has happened during that time, so what is the problem. The way China is able to ignore market forces is because China’s central government has so much control over their economy, that if there were ever any issues, they would be able to work through them. So the question is, can China engage in economic activity against market forces for three decades without any economic consequences? Something that I continue to discuss on this channel is that economics always wins in the end. If we look at business history, that is the lesson we learn. You can only ignore economics for so long, and at some point, you are going to have to pay the price. For China, that time is now.

It is helpful to understand how currency manipulation works. Consider the relationship between the United States and China. China’s economy is largely based in manufacturing. The United States purchases items that are manufactured in China. US dollars flow into China, and Chinese goods are shipped to America. The Chinese central bank holds large amounts of US dollars while printing large amounts of Chinese currency. China is purposely causing inflation in Chinese currency in order to make it cheap and attractive to manufacture goods in China. For instance, if a company is deciding whether to manufacture in Europe or China, they can look at how much they can buy with the currencies in each region. China will obviously be more attractive because of the weaker currency. What should be happening, is currencies should be valued off supply and demand which is driven by the productivity of the country. But in China’s case, if they let their currency float at market rates, manufacturing business would dry up, creating massive unemployment across China. (https://www.investopedia.com/articles/investing/040115/reasons-why-china-buys-us-treasury-bonds.asp#:~:text=China%20has%20steadily%20accumulated%20U.S.,than%20any%20other%20foreign%20country.)

One of the fears at this point is that China holds so much US Debt. As of June, it is estimated the Chinese central bank holds around $3T in US dollars. (https://www.reuters.com/article/china-economy-forex-reserves/update-1-chinas-june-forex-reserves-rise-less-than-expected-on-buoyant-yuan-idUSL4N2ED1EL) China holds $1T in US debt as of May 2020. (https://ticdata.treasury.gov/Publish/mfh.txt) China and Japan are both the largest debt holders at roughly 5% of US debt each. https://www.marketwatch.com/story/heres-who-owns-a-record-2121-trillion-of-us-debt-2018-08-21

One fear is that China could dump all US dollars on the currency markets, causing massive inflation in the dollar and damaging the US economy. This would be very harmful to the US economy, but no one thinks China would actually do that, because it would hurt China more than it would hurt the US. If China ever dumped its US dollars, all they would have left is their own currency, which is not worth much after decades of forced inflation. China would face massive unemployment and social unrest.

But the real problem for China, is that America holds all the cards. America has a lot of different countries where it is possible to do manufacturing. Since the pandemic, a lot of American companies are already pulling manufacturing out of China. The NY Times reported last week that Samsung, Hasbro, Apple, Nintendo, and GoPro are all moving their factories out of China to countries where costs are even lower. Imports into the US from Taiwan, Mexico, and Vietnam are on the rise. (https://www.nytimes.com/2020/07/22/business/companies-may-move-supply-chains-out-of-china-but-not-necessarily-to-the-us.html#:~:text=Many%20companies%20that%20are%20moving,Vietnam%2C%20Taiwan%20and%20Mexico%20swelled.)

So the real question we have to look at right now is “what happens if the flow of US dollars into China stops?” To understand this, I want to explain an old accounting concept. There is a type of accounting fraud called lapping. This is one of the oldest accounting frauds having to do with recording revenue.

The way lapping works is that someone steals money when it comes in the door, and covers up the missing funds, by replacing it with money that comes in from customers the following month. If your company is growing, you can steal a little bit more each month, because you will always have more money coming in to cover it up. If you are manipulating your financial data, you can cover this up forever, as long as your business keeps growing. It is called lapping, because it is like you are running around a track, constantly covering up your crime with future money. But as soon as you hit a month where revenue stops, you do not have the money to cover up the crime any more, and the fraud becomes revealed because you cannot pay any of your bills.

What I think is happening in China is essentially lapping, except it is on the scale of an entire country. China has experienced massive growth for Thirty years. They have been artificially manipulating their currency, which has always been possible, because any economic holes can be covered up with more money in the future, because their economy keeps growing. But when the money stops coming in, you can no longer cover the missing funds, and then all the problems get revealed. And when frauds end, they can result in a very painful crash.

China has never had a problem in 30 years. Why do I think this is a problem now? Here is a chart of China’s GDP from the World Bank. It has stopped growing. It has gone from regular double digit growth to nothing, because of the global pandemic. Exports to the US have decreased. The flow of US dollars has stopped. This is the sign that China is in trouble. They are not going to be able to keep their currency manipulation going. Before, the growth always enabled China to keep the manipulation going, but they cannot keep it up any more.

Now we have to be cautious about GDP data from China. There is always a discussion in the financial community about whether we can trust the data from China. There is an understanding about Chinese ethics that it is more important to maintain the power of the central government than to have accurate financial data. But even if this GDP data is manipulated, it still looks really bad for China.

I need to emphasize this point, because I do not think a lot of people understand this. Accounting in America is approached very differently than accounting in China in terms of ethics. An example of this approach to financial data is all the recent fraud in Chinese companies that has been revealed. There has been a lot. This was made known in a 2017 documentary that reported 200 Chinese companies had been delisted by the SEC as fraudulent due to poor accounting and the State Secrecy Laws of China. This resulted in a loss to investors of $500B. The most recent example of this was four months ago when the stock of a Chinese company called Luckin Coffee, a Chinese coffee chain was removed from the stock exchange. It was disclosed that the COO of Luckin Coffee fabricated $310M of sales. https://www.cnbc.com/2020/07/06/investing-fraud-at-china-luckin-coffee-fraud-case-warning-for-investors.html#:~:text=Menu-,Fraud%20at%20China’s%20Luckin%20is%20a%20’great,tale’%20for%20investors%2C%20says%20analyst&text=Chinese%20coffee%20chain%20Luckin%20Coffee,It’s%20a%20great%20morality%20tale Donut There have been so many examples in Chinese companies of manipulating revenue. A lot of American’s have lost a lot of money by investing in Chinese companies, when it turned out there accounting data was not correct. There is an attitude with these companies that it is okay to pad the revenue numbers a little bit. And this is something that people in the financial community talk about. If you are going to invest in a Chinese company, you need to take the revenue numbers with a grain of salt. But it is not that surprising if the Chinese government itself is manipulating the currency.  What is the harm with manipulating a little revenue? In China, it is more important to maintain the power of the central government than to have accurate financial data. That is the difference between the American values of the free market, versus the Chinese values of Communism.

So what happens if there is a China currency collapse? Well something similar has happened in history before with another Communist country. We had the Russian currency collapse in 1998 and it devastated the US economy. Russia’s central bank was doing the same types of things with manipulating their currency. A China currency collapse would be even bigger and impact the entire world. According to the Bank of International Settlements, trading in China’s currency is the 8th largest global currency by average daily turnover, accounting for 4.3% of global currencies. We are talking about big numbers.

There are some other signs I think this is happening right now. You have to put yourself in the mindset of the Chinese leadership. When you talk about ethics, you have to look at the tone at the top. We have already talked about how there is an attitude that it is okay to manipulate the data. When you have someone unethical at the top, who wants to stay in power, when the fraud is about to unravel, their only option is to do something more unethical. They are going to take the money from somewhere else.

China is in the middle of a currency crisis and they have two options: Invade another country and take their money, and identify a minority within their own country and seize their assets. China has done both of these things, and have given indications that they are going to do even more. China has seized control of Hong Kong. China has attacked and killed Indian soldiers in a skirmish at their border with India. Even more depressing is China’s treatment of the Uighur minorities in their own county. The Uighur’s are a Muslim minority group that lives primarily in Northwest China. There is video footage, you can find it online (https://www.youtube.com/watch?v=ijkvNiYcwFA), of the Chinese government rounding up Uighurs and putting them on train boxcars and taking them to concentration camps.

China is committing genocide. They take the women, abort their babies and sterilize them. This was reported by the Associated Press in June. I do not understand why more people are not talking about this. China has identified an ethnic group, they are putting them on train boxcars, taking them to concentration camps and committing genocide. I do not want to come off as self-righteous here. But I think we have to clearly point out the differences between American and Chinese ethics on human rights. There is a difference. This is all being driven because of China’s currency crisis. The Uighur’s live in Northwest China which is rich in oil and minerals. China is seizing their assets. It is because of the money. This is now a problem that effects all of us. If China’s currency fails, it will impact the entire world.

This is a textbook example of how a tyranny deals with a currency crisis. If we go back in history to Germany before World War II, there are remarkable similarities. Germany was dealing with a currency crisis with massive inflation. Germany invaded Poland to seize their assets. Germany seized assets from Jews and sent them to concentration camps committing genocide. I am not saying China is the same as Germany, but there are shocking similarities.

In my opinion, China’s actions tell me that they are past the point of no return. This has been building up for 30 years, and for the first time China has had a year of no growth. They are seizing whatever assets they can inside and outside their country to keep their situation stable. I am not going to talk about the solutions in this video, because at this point, all of the potential outcomes here are horrible. And this is going to affect everyone in the world. I think this is the greatest threat to global markets today, and I think a lot of people are not even aware of it. I just hope to shed some more light on these issues and help people understand them better. Thank you.

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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.

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