Why Beijing Hates New Year’s Day

Every Chinese comrade can legally convert $50,000 worth of Yuan into a foreign currency each year. That quota resets on January 1st.

Year to date, the Yuan has weakened 6.33% against the USD. China’s FX reserves have “officially” tumbled to $3.052 trillion, the lowest in six years.

China’s FX reserves are a representation of the gift that exporters were granted at the expense of households. The PBOC could sell USD and purchase CNY, strengthening the Yuan. That would provide households with better purchasing power for imported goods. However, this would hobble the politically powerful export lobby, and diminish the riches of many government officials.

Due to the enormous amount of credit created with fewer and productive uses for it, the PBOC must export deflation abroad by weakening the Yuan. Many emerging countries have faced similar problems, and the weakening episode was volatile and chaotic. The FX reserves are the PBOC’s volatility smoothing tool. Until recently, China had capital controls imposed on the poor, but left the door wide open for the elites to cut loose. Rich Chinese were allowed to leave China, and levitate global property markets to unseen levels.

The elites recognise that the priorities of the Party have changed. To maintain a harmonious society, Beijing must favour poor and middle-class households over industrial barons. That means the doors are shut for capital leaving China, which is also the cause of Xi Jinping’s anti-corruption campaign.

If capital flees too quickly, the PBOC will not be able to devalue the Yuan in an orderly fashion. I have detailed in various past newsletters the popular capital fight avenues that are now closed. But the biggest risk now isn’t large chunky transactions, but instead a flurry of small legal ones.

A Thought Experiment

According to the CIA World Factbook, China has 1.084 billion people over the age of 18. If just 61 million people (5.63% of those eligible) converted $50,000 of CNY into USD, then that would exhaust the FX reserves.

According to Household Wealth in China (Yu Xie and Yongai Jin), the top 10% of Chinese households hold CNY692,000 of assets ($100,000 equivalent). Housing assets account for 70% of wealth, so let’s assume a household consists of two adults and have $30,000 equivalent of cash that could be converted. This means that 54.19 million households could theoretically convert their $30,000 of liquid assets.

Prior to August 2015, the CNY was strengthening, however the mood has changed and most Chinese want to move their depreciating cash out. Assume that in 2016 each household converted $15,000 of CNY into USD, and then will convert another $15,000 in 2017. On 1st January 2017, the FX reserves then could fall by another $813 billion legally.

Due to prior economic commitments such as China’s One Belt, One Road project, and Asian Development Bank contribution, if the FX reserves fall below $2 trillion they are basically broke.

A drawdown of $813 billion would bring the official tally to $2.239 trillion. That is very close to the red line.

The PBOC’s Options

As much as the PBOC would like to reduce the quota to zero, that action would signal something is dangerously amiss with China’s capital account.

A reduction of the quota, would signal it’s do or die time to convert CNY into a real asset or strong currency. China is a large place, Beijing’s control fades quickly as you move outward. Beijing will not be able to efficiently stop the flood of money leaving the country through more nefarious means.

Instead, the PBOC will make the conversion process very difficult. Banks will be instructed to invent convoluted tasks and superfluous forms that customers must complete. Failure to dot all the I’s and cross all the T’s, will result in “Cannot”. If you have lived in Asia long enough, you know it is futile to debate a customer service representative once they utter “Cannot”. You must go back to square one, and correctly complete the stated process, however ridiculous and illogical it may be.

While comrades are busy filling out forms and standing in lines, the PBOC will take a machete through the Yuan like a young Thai coconut. They must move fast before too much money leaves via legal means.

PBOC is Fed Up

The pace at which the Fed governors forecast rates to rise in 2017 surprised markets. According to the Dot Plot, Fed governors forecast three 0.25% hikes next year.

While the markets initially rejoiced at rate normalisation, too much of a good thing is not wanted. It seems traders finally believe in discount rates again. Convexity quickly consumes profits when you move from zero to highly positive interest rates.

Grandma Yellen’s expressed concern regarding a substantial increase in fiscal spending. She cautioned that because the US is at “full” employment, fiscal spending at this point in the business cycle could be highly inflationary. Add a spike in oil prices, and you have the recipe for aggressive rate normalisation. That is deadly for the PBOC.

“From The Side Mate”

Starting January 1st, the vice constricting the PBOC tightens. Comrades will rush to the bank to legally convert their shekels, and a surging USD will increase the speed at which the CNY must weaken.

Until now the markets have shrugged off a weakened Yuan while they fêted Trump. The honeymoon is over. Expect global market volatility to ingest Yuan weakness, and output violent gyrations. Bitcoin will benefit from a weaker Yuan and greater global instability.

Santa granted my two Christmas wishes. All hail Bitcoin $1,000.

Quarterly Me Surprised

This Friday 16 December at 08:00 UTC, BitMEX will launch the 31 March 2017 Bitcoin / USD (XBTH17) and Bitcoin / CNY (XBCH17) futures contracts. Given the recent highs that Bitcoin has reached in terms of price and market cap, there is excitement building surrounding the launch.

The premium traders will pay to go long for three months represents the cost of unsecured USD, counterparty risk, and the bullishness of the market. There are several trading strategies that can be employed.

Cash and Carry

The simplest strategy, is to buy spot and sell futures to earn the basis. Remember, basis is the difference between the futures and spot price. Basis represents the cost of funds to buy Bitcoin using leverage. Arbitrageurs utilising this strategy effectively lend USD to speculators.

Capital is finite. Unless you plan to trade the basis, once the trade has been put on, it must be kept until expiry to earn the basis. The trick is to predict when during the life of the contract the outright basis will be the highest.

The above is a time series chart of the outright % basis between the Bitcoin / USD futures contract, XBTZ16, and spot. XBTZ16 was listed on 26 October 2016. Observing the chart, putting on the trade closer to the listing date, meaning when it has the greatest time value, generally gives the greatest outright returns. There are spikes during periods of high volatility, and when the price is rising.

Of the capital allocated to this strategy, use 50% within the first month of listing. Divide the remaining 50% into two tranches, and opportunistically employ the strategy during aggressive price spikes.

If the past is any guide, an outright rate above 5% is to be expected. If the rate rises above 6%, consider that a good opportunity to deploy any dry powder.

Fixed vs. Floating

More sophisticated traders can play the curvature of the term structure. The XBTUSD swap charges a funding rate to longs or shorts every 8 hours. This is a variable interest rate which depends on whether the swap trades at a premium or discount to spot. Longs pay shorts if the swap is at a premium, shorts pay longs if it is at a discount.

Traders who believe the XBTH17 basis is underpriced, can employ a curve steepening trade. They would buy XBTH17 futures vs. sell XBTUSD swaps. The Bitcoin / USD risk is eliminated, and what remains is a pure curve trade. If the XBTH17 basis increase is larger than the net funding being paid to a long XBTUSD swap holder, then the trade is profitable.

Traders who believe the XBTH17 basis is overpriced, can employ a curve flattening trade. They would sell XBTH17 futures vs. buy XBTUSD swaps. If the XBTH17 basis decline is larger than the net funding being paid to a short XBTUSD swap holder, then the trade is profitable.

As a point of reference, cumulatively since the May 2016 launch of XBTUSD, longs have paid shorts 30.74% outright (51.96% annualised). Assume from now until expiry of XBTH17, XBTUSD will have the same annualised variable funding rate. That would mean a break even outright basis of 14.95% would need to be earned by shorting XBTH17.

China Bitcoin Premium

The PBOC is expected to accelerate the devaluation of the Yuan in response to the Fed’s more hawkish tone. In the past, this lead to an expansion of the premium between XBT/CNY and XBT/USD.

The devaluation process will not happen overnight. The Bitcoin market will not fully price in a substantially weaker Yuan until it actually happens. When XBTH17 (Bitcoin / USD) and XBCH17 (Bitcoin / CNY) open, a suitable trade would be to go long the China Bitcoin premium.

To go long the premium, go long XBCH17 vs. short XBTH17. The Bitcoin risk is eliminated. What remains is a pure China Bitcoin premium play.

ETCWin and the ongoing Battle Between ETH and ETC

On the 5th December, BitMEX launched its first ETCWin token derivatives contract, WINZ16. It currently trades approximately 74% higher than its listing price. On the back of this successful launch, a number of traders are asking “What is ETCWin?” and “why the FOMO?”.

In a nutshell, ETCWin is a China-based Digital Currency Exchange Platform, built primarily for Ethereum Classic (ETC) trading. The exchange aims to list ETC pairs against XBT, LTC, XMR, and ZEC. The exchange will also allow trading of smart contract digital tokens, such as the ETCWin token (WIN). ETCWin also operates 91pool, an ETC mining pool with over 10% market share.

The exchange ran a successful ICO between 17th October to 23rd November, raising over 1,022,500 ETC. In return, the investors will receive 21% to 49% of project income and voting rights in the form of WIN tokens, which are based on the ETC protocol.

The WIN subscription price was 1 to 1.1 ETC, depending on the amount invested. Each WIN token represents 1 vote. Token holders can vote on development proposals 1 week in advance. A proposal that garners 60% of voters will be approved.

Why the Price Rise?

ETCWin has forecasted a dividend schedule based off approximately 3,000 XBT daily turnover. They predict a YTM of 54% in the 1st year, 153% in the 2nd, and 380% in the 3rd year. In addition, they proposed a buy-back schedule where they guarantee to buy back at 1 ETC per WIN.

They also have large backers and important members of the community behind them such as Chandler Guo, Roy Zou (CEO of Bitkio and a Core team member of ETC), and Feng Han (Blockchain Asia DACA Chief Secretary).

ETC is becoming more and more relevant in China as large miners and exchanges adopt it as the currency of choice given its immutability, and their ability to participate in discussions surrounding the future, compared to Ethereum (ETH) where the Foundation rules with an iron fork.

Both ETH and ETC have been on a one way trip against the King of Crypto that is Bitcoin, however ETC has reached 10% of the market capitalisation of ETH and remains a serious contender. Given the amount of investors and institutions backing ETH, it was easy to classify ETC as a pipedream.

China is the key to a future pump in the ETC price. It is telling that BTCC chose to list ETC trading before that of ETH. Many influential Chinese traders and miners vocally do not support ETH and the Ethereum Foundation. This angst lays the foundation for an ETC to ETH parity rally.

Want to Get Rich? Become an Indian Tax Agent

Indian Prime Minister Modi’s demonetisation drive has hit a major snag. He sold the program on the premise that tax evaders would be unable to wash their money through the banking system. That didn’t happen. Instead over 80% of all old bills were deposited into the banking system.

Businesses and individuals instead of producing value, were busy scheming on how to turn black money white. There were so many loopholes, that Modi was caught flat footed.

Indian’s love of gold was shown to be prudent. There is a reason why brides in India are decked in gold. It is a wealth transfer of massive proportions. Many believed that a bride’s gold was sacrosanct due to cultral factors, and no politician would dare strip brides of their lucre.

As predicted, Modi had to address Indian gold ownership for the digital currency drive to succeed. He recently decreed that gold is now subject to ex-post tax. Tax agents are raiding homes demanding owners poney up. Gold cannot be seized if it falls under certain thresholds. Married women are allowed 500 grams of jewellery, unmarried women 250 grams, and males 100 grams.

The most alarming facet of the “Raid Raj” is this tidbit: “Also, the ‘officer conducting [the] search has discretion to not seize [an] even higher quantity of gold jewelry.'” [Bloomberg] By giving tax agents’ discretion, Modi licensed theft. The tax man will demand a cut of your assets, otherwise he can legally confiscate them. As most people living in India know, just about every interaction with a civil servant involves some sort of bribe.

I am waiting for news reports about record numbers of applications for any open positions in the tax collection agency. Often times, the reason many people enter the government or civil service is to enrich themselves through bribery. Otherwise, why take a boring job that pays less than what can be earned in the private sector.

Bill and Hillary Clinton are role models. They admittedly left the White House “dead broke”. [PolitiFact] Since 2000, they have amassed a $100 million fortune. Their primary sources of income are speaking fees and income from their shady foundation.

After Hillary lost the presidential election, Australia ceased donating to the Clinton Foundation. The country had “donated” $88 million over the past 10 years. [News.com.au] Surely poor children in Africa still need help. I guess these “donations” were given for different reasons.

The India Blueprint

Savers globally should study how Modi has stolen from his subjects. First he banned the use of physical cash in an economy where 90% of transactions use that payment mechanism. While the salaried middle and upper-classes were unaffected because they are banked, the majority of the working poor now had two problems.

First, they had to waste precious time queuing at banks to deposit their money. Second, it became much harder for them to accept payment for their goods and services.

Gresham’s law dictates that bad money will be spent, and good money hoarded. Modi had to attack gold, the widely held form of good money. By unleashing corrupt tax agents onto the populace, Modi has effectively killed the free ownership of gold.

In 1933, FDR signed executive order 6102, “forbidding the Hoarding of gold coin, gold bullion, and gold certificates within the continental United States”. [Wikipedia] Owners had to sell gold to the Federal Reserve at $20.67 per oz., or face criminal charges.

China recently curtailed the ability of some banks to import gold.

Some banks with licences have recently had difficulty obtaining approval to import gold, they said — a move tied to China’s attempts to stop a weakening renminbi by tightening outflows of dollars, the banks added.

The hit to gold imports comes as China tightens restrictions on overseas deals by state-owned companies in an effort to limit capital outflows that has seen the renminbi fall to its lowest against the dollar in eight years. [FT]

Gold is the most trusted and liquid form of non-government issued money. Time and again it has been proven that physical commodity money has one major drawback. It is physical, so confiscating it from citizens is quite easy. It is tough to transport and store large amounts of gold without government knowledge.

Cryptographic Money

Bitcoin is the most liquid form of cryptographic money. Because it is not physical, it is harder for governments to know you own it and subsequently confiscate it under the implicit threat of legal violence.

Rarely does the economic “ism” your country subscribes to guarantee economic freedom. Governments need control, and if gold ownership threatens their objectives it will be taken.

The challenge for Indians and other financially repressed people is how to acquire Bitcoin and other forms of cryptographic money.

It is harder to buy Bitcoin in American than it is in China. Circle, one of the largest VC funded payments / digital money startups, was initially founded with a vision to help people buy, store, and use Bitcoin. Due to oppressive financial regulations and harassment from state and government regulators, they cried uncle.

Circle will not longer help Americans buy Bitcoin. To their credit, Circle had one of the best customer experiences for buying Bitcoin. It is sad to see what happens in the Home of the Brave, and Land of the Free.

Contrast that to China, where you can deposit CNY through bank ATMs to fund your Bitcoin exchange account in minutes. There is ample liquidity, and no fees to trade Bitcoin.

There will not be a natural supply of Bitcoin in India until it is mined there. The 11% premium of Bitcoin in India will encourage entrepreneurs to start mining. Additional supply will come from businesses that can convert INR into USD and wire abroad. They will begin importing Bitcoin to sell at a generous markup.

The Day the World Stood Still

While president-elect Trump believes himself to be a BSD, the real commander in chief of humanity resides at The Marriner S. Eccles Building. One year after the first historic Federal Funds hike, Grandma Yellen will raise again.

The US Dollar is the king of all fiat currencies. Regardless of how many commentators warn of the impending doom for the USD, it is and will remain for some time, the global funding currency. Equities, commodities, and debt are all priced in some way off of the USD.

Trump’s inflationary intended fiscal policies are the cover Yellen needs to continue rate normalisation. Luckily for Yellen, the hubris of equity investors globally remains. They pay no heed to the future higher cost of funds; they believe the free money party will last forever. Even in the face of a steadily depreciating Chinese Yuan, the S&P 500 and Dow Jones continue to hit new highs.


As always, the real concern is China. Leading up to the Fed meeting Wednesday December 14th, the PBOC has steadily sliced the Yuan. Usually this creates panic in global markets; however, Trump stopped all that. The Make America Great Again president-elect will go on a debt binge that his Republican compatriots in charge of Congress fully support.

The market cannot get enough of the government spending more of other people’s money it doesn’t have. Look at how China’s fiscal spending levitated global markets in the wake of the Global Financial Crisis of 2008.

China’s inability to spook Yellen meant that it went into overdrive closing the most egregious capital flight thoroughfares. Chinese companies completing offshore M&A deals must now receive approval. Shady Chinese insurance companies will think twice before buying hotel chains.

Chinese who make the Haj to Macau will face more scrutiny. Macau may require pilgrims to declare cash in excess of $15,000. Macau gaming stocks got hammered in Hong Kong when that announcement surfaced on December 2nd. [Bloomberg] China could choose to raise domestic interest rates to make holding CNY more attractive. However, corporate and local governments would be forced to pay higher costs to roll over debt. And more importantly, financing rates for property companies and punters would skyrocket, collapsing the one asset class performing well in China.

Desperate comrades stung from the 2015 stock market collapse, and unable to afford or purchase additional properties, then turned to the commodities market. Speculators flooded the futures exchanges causing sharp rises in industrial commodities. Beijing shut that down as well. Exchanges were instructed to raise margin requirements and fees to deter speculators. It worked. Volumes and prices crashed across the board.

A recent Quartz article highlighted the plight of retail speculators. They interviewed several punters who have recently started trading Bitcoin. They like the 24/7 markets and high volatility. Some grasp the technological and economic genius of Bitcoin, but most just want a new, volatile, and non-governmentally controlled asset to punt.

China Bitcoin Premium

During the recent Bitcoin rally, the China Bitcoin premium rose to 4.50%. As the rally stalls, the premium is contracting. The premium will continue to contract leading up to the Fed meeting.

This week, BitMEX launched a 100x leveraged Bitcoin / CNY futures contract, XBCZ16. Combining XBCZ16 and XBTZ16 (Bitcoin / USD underlying), traders can directly trade the premium without Bitcoin price risk.

Trade Recommendation

Go long XBTZ16 vs. short XBCZ16 between now and the Fed meeting December 14th. If the Fed raises rates as most expect, reverse the trade, go long the premium by shorting XBTZ16 vs. going long XBCZ16. The trade thesis is that the PBOC will devalue the CNY to 7.00 against the USD. This will lead to an aggressive premium expansion.

A December to Remember

On December 4th, an Italian constitutional referendum and the Austrian presidential election will be held. Should Italians vote No, and Eurosceptic Norbert Hofer achieve victory, say hello to risk-off with a vengeance.

Bunga Bunga

Prime Minister Renzi stated that he will resign if the new constitution is not approved. Like most governments, needless complexity is created to confuse, distract, and discourage normal citizens from challenging their overlords. The Washington Post provides an excellent summary of what Italians will vote on:

Why Is There a Referendum?

The highly contested bill finally passed through parliament earlier this year, but it didn’t receive the qualified two-thirds majority of votes needed to change the constitution. So, Renzi had to seek a referendum. [WP]

The Issue in a Nutshell

There are other aspects of the proposal that are also important, however. One major one would attempt to clarify the balance of power between the regions and the central government, largely granting the former more control. Then there’s also the separate, but deeply intertwined, issue of Italicum, Renzi’s new electoral system for the Chamber of Deputies. [WP]

Italicum Huh?

The system effectively means that a party will be able to hold a majority in the Chamber of Deputies without winning a majority of seats. It seems designed to create a true two party system, like that of the United States or Britain. [WP]


Renzi is tired of minority parties causing trouble for his government. He is stripping them of power by reducing the threshold needed to capture and hold a government, and increasing the power of the Federal government at the expense of more autonomous regions and states. It is understandable that many voters are chafing at the possibility that their voice in any government will be sharply curtailed.

Why Are the Markets Spooked?

Renzi went for broke by declaring he will resign if the referendum fails. Bebbe Grillo’s Five Star Movement (5SM) is waiting in the wings. 5SM’s popularity has surged since 2012 on the back of virulently anti-establishment and anti-EU rhetoric. If elected into power, Grillo plans to force a vote on Italy’s EU membership.

As always, the problem leads back to Italian banks. They are broke. The willingness of the private capital markets to keep them afloat is wearing thin. Absent a bail-out from the ECB, which must be voted on by the governing council, a bail-in will happen.

A bail-in consists of senior debt holders or depositors taking a haircut. Both means of capital replenishment will cause harm to small retail investors and or savers. This is political suicide, and will commence an Italian and European bank run.

Europeans looked the other way when wealthy Russians lost their Euros in Cypriot banks, and when their feta eating brothers and sisters were pick pocketed. But if Italian savers get bagle’d, it will be impossible for Europeans not to run for the exits. The bail-in rules not only apply to Italy, but to every EU country.

Italian sovereign credit spreads blew out, and Italian bank equity prices are collapsing. If Renzi is not at the helm to appropriately fluff Draghi, then all bets are off. Super Mario and Frau Merkel will punish Italy for electing an anti-EU party by denying the country the funds it needs to fix its banks.

Hofer vs. Van der Bellen

Norbert Hofer is described as a far-right Eurosceptic candidate. Alexander Van der Bellen is a centric Euro-friendly candidate. Hofer narrowly lost to Van der Bellen in a presidential run-off earlier this year. However, the results were annulled due to voting irregularities.

Polls indicate that Hofer will take the prize. He is widely known for his stance that Austria should leave the EU. Post Brexit he walked back his rhetoric when it appeared that many Austrians were not so pleased that Britain vacated the sacred union.

EU bureaucrats are terrified that Hofer will call a referendum on Austria’s continued membership in the EU. European president Drunker Junker, known for his vino consumption habits, voiced grave concerns about a Austrian EU membership vote.

Jean-Claude Juncker has urged EU leaders not to hold referendums on their membership of the bloc because he fears their voters will also choose to leave. The European Commission president said giving people a vote would be ‘unwise’ as they could seek to replicate Brexit. [ZH]

After Brexit, another chink in the armour from a continental European country exiting could prove fatal for the EU. When the future of the EU is questioned, all eyes turn to the member banks. Bond holders fear redenomination of their debt assets into greatly depreciated national currencies.

Le Pineapple Pen

The French presidential election is not until 23 April 2017. The two front runners are Eurosceptic Marine Le Pen, and former Prime Minister under Nicolas Sarkozy, François Fillon.

Le Pen is adamant that France should not be an EU member. She advocates a return to the Franc, and pursuit of nationalistic economic and immigration policies. Many elites regard her and her daddy as soft-core Nazis. However, her brand of French nationalism continues to gain adherents.

A rejection of the Italian referendum and a win by Hofer, will increase Le Pen’s chances of victory. After Brexit, France is the second largest economy in the EU. It is obvious to see why its exit would be catastrophic for European risk assets.

Let’s Trade

The obvious trade is to take a position long or short on the Euro. After the SNB debacle, retail FX brokers learned their lesson. Spreads and fees will rise on Friday night before FX markets close for the weekend.

Bitcoin is the only asset that trades 24/7. During the weekend Greek votes in the summer of 2015, Bitcoin reacted in real-time as Greece inched closer to leaving the Euro. The events set in motion by an Italian No vote, and or a Hofer win are positive for market volatility and instability. Bitcoin thrives in these situations. As such, expect Bitcoin to creep and then explode higher if one or two of these events occur. My upside target price is $800.

Should Italy affirm the new constitution and Hofer lose, expect Bitcoin to dip. A test of $700 and then $680 is warranted as a portion of risk-off premia vacates the Bitcoin price.

Hong Kong Bitcoin Derivatives Arbitrage Seminar

I will be leading a 90-minute seminar on the basics of arbitrage using Bitcoin and cryptocurrency derivatives. This seminar is geared towards financial services professionals who want to learn how to apply standard arbitrage techniques to the cryptocurrency markets.

When: Wednesday, 7 December 2016, 6:30pm – 8:00pm
Where: Metta, 21/F California Tower, 30-32 D’Aguilar St, Central, Hong Kong
Cost: Free

Please signup here.

After the seminar, please join us at the Bitcoin Association of Hong Kong’s Blockchain Holiday Party sponsored by BitMEX at the same location. I hope to see some of you there.

The China Capital Control Chronicles

China’s economy is in trouble and has been the running theme in a number of our blog posts over the previous year. For those coming out of their election-bunkers, let us recap these issues and provide evidence for a forthcoming tipping point:

  • China’s debt is the largest it has ever been at nearly $5.5 trillion, which has rapidly risen the government and household debt to GDP. A large part of this credit was misallocated, and the bill is coming due.
  • After the 2015 stock market collapse, Beijing has pushed desperate savers back into property. The property market contributes a large percentage of economic growth. Prices have become unaffordable for all but the very rich. Bejing’s attempts to prick the bubble might cause a financial crisis.
  • In an effort to increase the Party’s power, Xi Jinping embarked on an anti-corruption drive. Many business people and government officials now fear for the safety of their loot and their hides.
  • If credit growth stalls, the party is over. As a result, the PBOC is forcing state owned banks to lend to state owned companies.
  • A stronger CNY decreases China’s competitiveness on exports. In recent years, China’s export growth has dropped from 31% to a dismal 8% while Vietnam, Cambodia, Laos and Myanmar have been picking up the slack, increasing the growth in their exports by over 20% annually. With a stronger greenback on the cards, further depreciation is needed to remain in the export game.
  • If enough capital flees China before the CNY can be meaningfully devalued, China’s capital account will bear the losses instead of domestic savers.

Cognizant of these facts, comrades are devising more and more cunning ways to export capital outside of the Middle Kingdom. The current annual $50,000 limit is insufficient for the amount of CNY that wants to leave.

Last month, China’s foreign exchange reserves dropped by the fastest amount seen since January by $45.7 billion to $3.12 trillion. [Bloomberg] However, some economists point to this figure as being milder than expected given the depreciation against the greenback. Regardless, FX reserves are down from $4 trillion in June of last year.

How are locals actually getting their cash out? There are legal and obviously illegal methods. Illegal (and unusual) methods involve the following:

  • Underground Banking: “Underground banks” take CNY onshore, and deposit HKD into the client’s offshore bank account.
  • Money Mules: Some pay “trustworthy” individuals to strap loads of notes onto themselves ducking and dodging through customs.

However with recent crackdowns resulting in busts up to $148 billion [Bloomberg], these methods have become increasingly risky. Given this, we were not surprised when we heard (although unconfirmed) reports of underground FX dealers charging rates 14% over spot (effectively a USDCNY exchange rate of 7.8).

Other traditional methods include:

  • Overseas Real Estate: Chinese people bought over $100 billion worth of US real estate between 2010-2015. [FT]
  • Alternative Assets: Buying gold, rare coins, or even internet domain names to be resold to an overseas owned company has become popular. [ZH]
  • Fake Trade Invoices: Companies overstate the value of imports into China or understate the value of exports. The invoice is submitted to the bank, and then the company is allowed to conduce a foreign exchange transaction. Over the past two years, the Hong Kong Monetary Authority (HKMA) has cracked down on this practice.

Here are two of the more creative schemes we have heard of:

  1. A Chinese company reportedly approached a law firm to represent it in a fake arbitrationcase against a US domiciled company they actually owned. If the Chinese company lost, the damages would have to be sent from China to the US. The amount in question was over $3.5 million. [China Law Blog]
  2. In a March blog post, “200 swipes: A New Way Chinese Avoid Capital Controls”, we mentioned how it became popular for local Chinese to buy insurance products in Hong Kong. The government attempted to stop this practice by limiting each transaction on UnionPay cards to $5,000. However, that didn’t stop some users from swiping their UnionPay card more than 200 times, bringing a new meaning to “jimmy hands”.

Furthermore, even when comrades try to do the right thing, they encounter obstacles.

There have been reports that locals are having trouble legally converting their CNY to USD. The common theme heard by many is that the bank would avoid paying dollars. Banks are offering various excuses. Some say they don’t have dollars, some reverse previously approved transfers, and others flat out refuse if the foreign entity receiving dollars has a Chinese owner [Above The Law].

The American EB-5 investor program is a popular route to spirit your capital and family out of a hostile China. For a minimum investment of $500,000, a green card can be granted. Companies have sprung up to consult eager Chinese expatriates. Some are now reporting their qualified clients are having trouble moving the necessary capital out of China.

In fact, some of these companies are seriously considering Bitcoin as a means of moving their client’s money into the US for investment. We’ve been told these customers are willing to pay up to 3%. I suspect with further depreciation and the uncertainty surrounding President-elect Trump’s immigration policies [Forbes], they would be willing to pay much higher costs to get through the door before January 20, 2017.

Bitcoin, up to a certain CNY premium, remains a viable option to liberate modest amounts of capital in China. Given that all major Chinese exchanges conduct thorough KYC, those moving large or illicit sums will not choose the Bitcoin route. This is probably why the PBOC hasn’t stomped on Chinese exchanges.

With a surging dollar and whiffs of American trade protectionism, Beijing cannot forestall the hard economic choices any longer. If Beijing cannot politically force the credit misallocation costs onto large industrial companies and the rich, then a disorderly devaluation looms large in the near future.


Faces of REKT

Hillary Clinton was supposed to don red, white, and blue pantsuits and cruise to victory over the clownish Donald Trump. Unfortunately Clinton is not a closer. In the past 8 years she was the heavy favourite to defeat Barack Obama and now Donald Trump in her runs for president. In both cases, she fumbled on the goal line.

Clinton’s sobbing supporters now must make peace with The Donald. Faces of REKT is an apt description of the despair witnessed at any pro-Clinton rally.

Now that the circus is over, what does Trump mean for Bitcoin? Trump and his Republican party captured both the House of Representatives and Senate. He has a unique opportunity to deliver on his campaign economic promises.

Trump promised to reduce personal and corporate tax rates, eliminate burdensome regulation, and increase infrastructure spending. These nationalistic economic goals will crown The Donald as The Strong Dollar President.

America-first economic policies will have profound implications for the USD, Europe, and China.

USD Still King

Will Grandma Yellen raise rates on December 14th? Fed rate-hike odds tumbled below 50% initially as Trump ascended to victory. After the market realised that Trump’s policies will allow the Fed to raise, the odds surged above 80%. [CME]

Central banks globally have lamented the lack of fiscal spending to help revive economies globally. With Trump and a Republican controlled congress committed to fiscal spending, the Fed can normalise rates. This fact was not lost on the market. 10yr and 30yr Treasury yields spiked higher.

Trump plans to reinvigorate corporate America through tax cuts and the elimination of regulation. He also plans to punish corporates who offshore production through high tariffs. The net result of these policies is more investment and production onshore. This is USD positive.

Santa was kind to me with a Trump victory, and it appears my second wish for a Fed rate hike is still in play.

Say Bye Bye to the European Union

The Brexit and Trump victories represent a continuation of economic nationalism. This goes directly against the system EU bureaucrats created. Southern European nations suffer high unemployment and low to no growth due to their inability to correct EU economic imbalances through monetary policy. The suffering plebes have had enough.

British and American citizens will now pursue national interests over global ones. This will fire up Greek, Italian, Spanish, Portuguese, and French people. If these oppressed nations followed their own interests, they would repudiate the economic diktats handed down by Germany and the ECB. That entails the return of national currencies and independent monetary policy.

December 4th, The Beginning of the End

December 4th might be the day that ushers in a violent risk-off period due to the Italian constitutional referendum and Austrian presidential election.

Prime Minister Renzi stated he will resign if the referendum is defeated. The referendum will be a prelude to national elections where Mr. Grillo’s 5-Star Party, which is anti-EU, is slated to win.

“Austrians will vote in a presidential election that could see Norbert Hofer of the Freedom Party become the first far-right head of state to be freely elected in western Europe since 1945.”[Zerohedge] He certainly will not be welcomed by the usual coterie of EU bureacrats.

Feta, Frogs, and Sauerkraut

During the various debt renegotiation talks happening in the months to come, the Greeks might finally discover their backbone. This opens the door for the Greeks say bye bye to the EU and Euro.

French presidential elections will be held in the summer of 2017. Marine Le Pen, who would exit the EU if elected, is polling better and better. Polls still place her behind front-runner Alain Juppe. That could change quickly as other like-minded politicians take the helm of neighboring countries.

The granddaddy of all European elections occurs in the fall of 2017. Frau Merkel is facing a revolt at home over her controversial immigration policies, and her continuation of bailouts for Germany’s lazy European neighbors. The Alternative for Germany party continues to gain momentum. They also plan to exit the EU if voted into power.

Don’t Forget About Deutsche Bank

Before any of these elections cause any choas, a European banking crises precipitated by a banking crisis is more likely to intensify the strain on the EU project. Deutsche Bank has still not raised equity capital or received a lighter penalty from the US Department of Justice. Italian banks are still insolvent, but a national bailout is not permitted under EU rules.

These banks must be recapitalised. A bail-in or bail-out will occur. A depositor bail-in will spark bank runs accross Europe. A bail-out will be deeply unpopular and most likely require printing billions of Euros. Pick your poinson Draghi.

While in America the yield curve is steepening, the ECB has shown no interest in allowing long-end rates to rise. The ECB is killing its member banks.

While the market forgot Europe’s troubles in the lead up to the US elections, expect renewed focus on its broke banks.

Yuan Hits New Lows

As I have repeatedly stated, the PBOC doesn’t desire a rising USD. The PBOC is forced to devalue the Yuan as the USD rises. USDCNH in the Trump victory aftermath hit fresh highs of 6.83.

The PBOC will not be measured in its devaluation of the CNY if the Fed doesn’t get the message and hikes in December. Unable stem the creation of credit by China’s banks due to politics, the PBOC will have to export this Yuan liquidity through a weaker currency. A stronger USD makes this process more chaotic as capital outflows will intensify.

Trump’s economic nationalism will fuel the USD rally. This spells trouble for Europe and China. With two of the three largest trading blocs likely to experience currency and banking crisis, Bitcoin will shine. Time and again Bitcoin has proven to be a safe haven asset during times of market volatility.

Imagine what Bitcoin will do when Europe and China’s SARS chickuns arise and come home to roost. I reiterate my $1,000 price target for Bitcoin by year end.

Make Bitcoin Great Again

As Bitcoin roars back to life for various reasons, traders are rotating out of altcoins back into the crypto reserve currency. The above chart shows the performance of Bitcoin against that of a number of altcoins over the past two weeks.

What is abundantly clear is Bitcoin up, altcoins down. Furthermore, the performance of Bitcoin and altcoins is negatively correlated (see the table below). Finally, altcoin prices move more violently than Bitcoin.

XBTUSD -91% -65% -67% -86% -77%

There are a few reasons to explain the above results. China’s devaluation of the CNY, the release of Segwit, and a flight to safety during market volatility that resuscitated Bitcoin.

As traders close their positions in altcoins to ride the Bitcoin wave, altcoins are kicked to the gutter without enough liquidity to cushion the fall.

Cryptocurrency Market Cap %
Bitcoin $11,440,078,705
Ethereum $911,356,507 7.97%
Litecoin $185,283,515 1.62%
Monero $82,886,148 0.72%
Ether Classic $77,732,113 0.68%
Factom $20,638,427 0.18%

The above table shows the currency market capitalisations of the above coins. Cryptocurrency traders should keep these numbers in mind when evaluating trading and market impact costs. The market impact or liquidity cost is often ignored by novice traders. When everyone rushes for the exit, the lack of liquidity leads to exaggerated moves and erosion of paper profits.