By Ivan Martchev
December is when I write my favorite column of the year: my prediction for the coming year. Before giving you that call, let’s review my last three annual predictions.
2014: The year of the dollar
In December 2013, I wrote “2014: The year of the dollar” and what a year it was. The U.S. Dollar Index /zigman2/quotes/210598269/delayed DXY -0.0052% began to “run” in mid-year, rising from under 80 to 100 in nine months, by March 2015, when its largest component (the euro, at 57% of the index) traded a hair under $1.05. After the necessary consolidation phase, the DXY “broke out” above 100 after the U.S. presidential election, and we now look to have started another leg in this multi-year dollar rally (see chart ).
The euro /zigman2/quotes/210561242/realtime/sampled EURUSD +0.0088% is below $1.05 again and looks destined to test parity in 2017. I don't think parity will hold, as Brexit weakened Europe to the core, even though Britain is not a part of the eurozone.
It is ironic that an EU proponent like George Soros made sure in 1992 that Britons wouldn’t use euros by forcing the pound out of Europe’s Exchange Rate Mechanism (ERM) with one of his most spectacular trades, earning him the nickname “the man who broke the Bank of England.” It would not be far-fetched to say that Soros sowed the seeds of Brexit, as it would have been less likely for Britons to vote for Brexit if they were more integrated with Europe by using euros instead of British pounds.
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Looking forward, there is the added possibility that the EU may break up with Marine Le Pen in France and all sorts of euro-skeptics gaining the upper hand in a populist backlash against establishment structures. In addition to the clearly defined political risks for the euro, the Federal Reserve is trying to tighten while the European Central Bank and particularly the Bank of Japan are running aggressive quantitative-easing programs, making it is easy to see how the dollar is not done rallying. I would not be surprised if the Dollar Index ultimately reaches 120.
2015: A rough year for China
In January 2015, I wrote “Why 2015 could be rough for China,” and China didn’t disappoint. By the time I wrote the column, the Shanghai Composite /zigman2/quotes/210598127/delayed CN:SHCOMP +0.94% was already exhibiting signs of a classic bubble market similar to what we saw with the index in 2007 (see chart ). With the Chinese being notorious gamblers, their stock-market bubbles tend to be shorter but sharper in nature than the rest of the world. (Look at similar moves in the Hong Kong Hang Seng Index /zigman2/quotes/210598030/delayed HK:HSI -0.09% , which has a much longer history than the Shanghai Composite. The big difference is that in Hong Kong, GDP growth correlates to profit growth resulting in an upside bias of the Hang Seng Index. That isn’t necessarily the case in China, where the command-style economy does not often produce the same profit growth as GDP rises.)
My concern about China, often mentioned in this column, is not necessarily a prediction of serial stock-market bubbles, but the fact that China is in the middle of a much larger and much more dangerous (for China) credit bubble. As China’s GDP grew 11-fold since 2000, total credit in the economy grew over 40-fold, resulting in a total debt to GDP ratio rising from 100% to 400% (if one counts the infamous shadow banking system). This credit bubble has now burst, as evidenced by the crash in the stock market, the rolling crashes in local real estate markets, as well as the massive capital flight out of China.
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China's Xi Jinping is nearing the end of his first five-year term. After decades of collective leadership among top Communist Party officials, could Xi be shifting to a more rigidly autocratic model? Photo: Xinhua News Agency
For all intents and purposes, nearly $1 trillion has left China, with foreign-exchange reserves falling from $3.993 trillion in June of 2014 to $3.052 trillion at the end of November, marking the fifth straight month of decline and the lowest level of reserves since March 2011. Capital flight out of China is now re-accelerating after flattening out in mid-2016, declining by $70 billion in the latest reported month. In 2015 it wasn't uncommon to have a monthly run rate of $100 billion leaving China. This has put pressure on the PBOC and the Chinese yuan, which is being devalued in slow motion at the moment (see chart ).
I think the Chinese are headed for a hard landing and I am looking for a similar economic outcome to what happened in the Asian Crisis in 1997-1998. If capital flight continues to accelerate, we could see similar headlines out of China again as those we saw in 2015. The worst news from China is yet to come.