What's the Deal?

Reports out today that Trump and China (may) have a deal.


A little hard to find details. Apparently this is “Phase One”, where the only thing agreed upon is China is going to buy some more food from the US and promise not to devalue their currency.

All in exchange for a promise not to raise tariffs (again).

Not a bad deal.

Thing is, by our measures, conditions in China are deteriorating.


Say what you will about home-brew indicators, but looking back, we’ve only seen things deteriorate this fast over 6m a handful of times since 1990:


Which might make you wonder, how are things deteriorating, and why?

When we break that conditions indicator into pieces, we get a story. One that jibes with our understanding of what’s been happening.

If you only focused on activity, then you’d think conditions in China weakened starting in the middle of last year, and pretty much been weak ever since.

What looked like strength in the beginning of last year, was the flow through from easier policy, and higher prices for commodities and financial assets.

As that stimulation has rolled off, and turned to tightness, so has strength in the prices financial assets and commodities.

Meaning, it looks like the Chinese policy easing passed through entirely to better conditions in prices in the financial sector, with little to no impact on real economic activity.


So why hasn’t real economic activity responded to the dual shock of stronger policy and strong prices?

Maybe it has something to do with the external conditions China faces. Both in terms of it’s weaker trade balance, and persistent capital outflows (in spite of many controls).

Trade War probably didn’t help either…


All of which leaves us reflecting on what that means for gold in China, if and when they promise to keep the peg.


At a minimum, if you expect furrther easing (which we do), you would expect bonds in China to do well. As policymakers lower rates and expand credit, both of which flow through to higher prices on bonds.

If you’re numbers inclined, you can also look at the math. And based on the historical relationship between deteriorating conditions and higher bond prices (aka lower bond yields), you’d also be bullish Chinese bonds (in local currency terms).


So to wrap up.

Conditions in China have deteriorated.

Usually when conditions in China deteriorate, you get easing.

The kind of easing that’s good for bonds and bad for the currency.

Which leaves us wondering, how can China really promise not the let the currency go? Especially, when it looks like they are going to need some easing soon?

And if they can’t make that promise, then what’s the deal?

The cost of gold

We've done pretty well on gold

because rates in the US are down

and the cost of gold

is not just the cost of the cash you spend to buy it

but the interest on that cash

you probably would have earned

and so your gold just sits there

earning nothing

while the yield of everything else makes money

your gold almost lazy

in it’s intransigence to yield

but what if that cash rate when negative?

and with it, your negative excess carry

cause now, you’re paid to own the thing,

compared to what you’d make sitting at Deutsche Bank,

waiting for the Brexit

in a race where everyone runs backwards

the winner just sits still

so imagine that world of negative rates

here, NYC, much closer to home

and now add in 1-3% inflation

and tell me where GLD is then?

Lucky Number 7

China’s yuan (as proxed by the USDCNH exchange rate) below 7 tonight.

Media having a hard time differentiating between whether it ‘fell’ or was ‘pegged’ lower.

Regardless of if it was market driven or pegging, once USDCNH got past 7, it kept running.


If you are reading this, you probably know what we think is behind this, and where it’s going.

We continue to remain long gold (and recommend those with the means hedge out the dollar on the other side of this trade by selling Chinese RMB against USD).


Big Ideas for the NewNew Deal - Transportation

At some point, we in the US are going to need to print some money to stimulate the economy.

Has anyone seen any of those ‘shovel ready’ projects mentioned back in the 2008 stimulus package? Me either.

So, with the goal of being constructive (it’s not all doom and gloom over here at BSC HQ) we’re starting a new series, called Big Ideas for the NewNew Deal.

In short, if you had to print and spend $3tr, where should it go?

Some of these ideas may sound a little zany, some of them are definitely half-baked. But the goal is to open the aperture, and hopefully help spur a more productive conversation about where all that money should go, when we open the fire-hose.

With that in mind, here’s Part 1: Transportation.

First step, let’s make all that cheap land in the East Bay accessible, through a functional transit system. When I first moved to SF I was shocked at how disconnected SF was from Oakland, owing to the fact you have basically one bridge connecting the two major metropolitan areas.

This is stupid, let’s fix it.


Come to think of it, why not invest in a real transit system for the entire Bay. One that connects Oakland as tightly to SF as Brooklyn and Queens are to Manhattan. Here’s a vision someone else cooked up.


Now let’s think a little bigger. America has always been a land of two coasts, even since the introduction of the Erie Canal connected the ocean coast of the east with the interior coasts of the great lakes.

Fifty years later came the intercontinental railroad, bringing the west to the east and the vision of a truly bi-coastal nation to life.


Fifty years after that, came the Panama Canal, another step forward in reducing the time and treasure required to move matter back and forth.


So why not bring that vision to the 21st century.

NYC to SF, via Detroit, Chicago and Colorado in ~10hrs, and no airport shenanigans.  Bit better than the almost 100hrs it takes currently…

NYC to SF, via Detroit, Chicago and Colorado in ~10hrs, and no airport shenanigans. Bit better than the almost 100hrs it takes currently…


Something tells me if you could get to downtown Chicago in 30 minutes by train, Detroit wouldn’t be in such a ghost town…

Waiting for the crash by waiting for inflation

As we have mentioned in the past, we believe the single biggest macro risk to the global economy is the precarious nature of the Chinese financial system.

For those that lend some credence to Modern Monetary Theory, one might be inclined to believe that the Chinese Debt Bubble will not create a Chinese Financial Crisis, as the vast majority of debt in china is denominated in domestic currency.

Those applying MMT to China are missing out on a key ingredient, the fact that the RMB remains essentially pegged to the dollar, and so while debt in China is notionally denominated in ‘domestic currency’, policymakers have essentially underwritten the value of that currency in the global reserve currency.

While steps taken over the past decade have opened up both the exchange rate and the capital account in China, the peg by and large remains, defended by the stock of assets accumulated during China's strong current account stage of development.

To the extent that the RMB is not the dollar, it stands to reason at some point policymakers will have to choose between exercising control over domestic monetary conditions, and the promise to maintain parity with the dollar.

Enter Baoshang and Bank of Jinzhou

With the failure of Baoshang last month, and Bank of Jinzhou today, the writing on the wall for the shadowy elements of the Chinese financial system. There will be bank failures/resolutions, and there will be losses, though at the moment, nothing on the scale of western bankruptcies has been permitted.

Chinese policymakers, aware of the problem, have been putting mechanisms in place to expedite the inevitable restructuring of the financial system. Debt for Asset swaps, NPL securitization auctions, and organizing bank takeovers.

While the news about these moves have been pervasive, the actual use of these mechanisms pale in comparison to the scale of the underlying problem. As written in our work almost a year ago, much talk of deleveraging, without any real change.

As reserves slowly dwindle, the time for reform grows shorter and shorter. Policymakers play a dangerous game, supporting the perpetual motion machine through providing ample liquidity to insolvent lenders, while trying to force credit creation through the system to the parts of the economy that still have productive uses for capital.

Meanwhile, the scope and complexity of the problem metastasizes. WMPs and trusts have turned into DAMPS and TBRs and the market has slowly caught on to the game. Banks use non-loan channels to fund the extension of credit that would normally fail the bank loan sniff test, and in doing so, fund long term credit with short term liquidity. Intermediation of liquidity from good banks to bad banks via interbank lending, a classic game. Then a loan becomes a bond, the bond becomes an investment receivable, which allows a small regional lender like Baoshang bank to gobble up assets that normally would fall afoul of regulatory guidelines around risk, concentration and liquidity.

“Many interbank institutions might have blocked Bank of Jinzhou as a counterparty, which will likely wear the bank down. Regulators hope that the market keeps on doing business with Bank of Jinzhou and helps it pull through. So, currently they are discussing measures to resolve its liquidity problem,”

All of which begs the question, when does the music stop, and why?

We see the game as a simple application of the classical international monetary triliemma.

Independent monetary policy

A pegged (or managed) currency

A closed capital account.

Your move PBOC. Choose two.

What's interesting is that this occurring precisely at the moment that western economies suffer through the deflationary hangover from the 2008 crisis.

The Chinese credit bubble is not an independent phenomena, it has been supported, and extended, by the creation of liquidity in the west.

Thus, the sword of Damocles to the Chinese financial system is not domestic tightness, but tightness in the currencies she is pegged to: aka the dollar.

With the shift to easing in the west following the sell off in assets in 2H18, the PBOC has been given the gift of time.

Low / negative interest rates in the west, and the printing of money by developed world central banks lends the luxury of time to Chinese policymakers by a) limiting the scope of dollar appreciation (which would force the PBOC to choose between the peg and domestic liquidity provision) and b) generating excess liquidity in financial markets, some of which finds it's way to China in search of yield, balancing the persistent capital outflows from nationals trying to get ahead of the inevitable depreciation / confiscation of capital upon a banking crisis.

The market, addicted to central bank stimulus, has now given central bankers an ultimatum. Cut interest rates *multiple times* in the face of record high stock prices and record low unemployment, because…because we can.

Because there’s no inflation.

A level deeper, we see the ultimate enabler of this easing as being persistently low and stable inflation.

Were the trend in inflation to reverse, markets would be forced to price in higher nominal rates.

When inflation is 1% you can get away with nominal rates at 2% or 1%, but were it to rise to 3% even, then markets and central bankers would be forced to consider a world where nominal (and real) rates return to levels seen for 200 years (roughly 2.5% inflation and 2.5% real).

This would be a disaster for the asset classes and investment strategies that, following fed guidance and support, have moved radically out the risk and duration curve.

Not to mention popular (and well meaning) investment strategies that have convinced portfolio managers to add levered bonds and ever more illiquid private and venture equity to their portfolio.

It is this narrative which has convinced us at Black Snow that the return of inflation as being the single biggest risk to both western and eastern portfolios.

Inflation that would force central bankers to engage in actual tightening would seriously damage portfolios with too much duration and too little protection.

This tightening would then flow through to dollar strength, forcing the PBOC into a “Sophie's choice” between saving the financial system and keeping the peg.

It is with that in mind that we have renewed our research push to look across time and economic trends to better understand the causal drivers behind falling inflation. To understand if, and when, that trend will reverse, and with it the dominant narrative of the last fifty years of financial history.

We’ll keep you posted.

Sugar In China

Over the past decade, conditions in China have become ever more important for the global economy and the markets that trade it. At the same time, the opacity of the political and market systems behind “Capitalism with Chinese Characteristics” has put western investors in the unenviable position of being ever more dependent on the outcomes from a system most do not understand. The chart below shows our current picture of conditions in China.

Indicator of China Conditions

Indicator of China Conditions

Last year we saw the consequences of that ‘tail wagging the dog’ phenomena. Dollar strength and policy tightening (in the US and China) led to deteriorating conditions in China which eventually flowed through to broad EM weakness and a sell-off in US markets. Midway through the year, Chinese policymakers shifted back to easing, which, when combined with a Q4 ‘pivot’ by the Fed, supported financial assets and economic activity.

Reacting to this policy easing, conditions in China have begun to improve, with prices for financial assets and commodities relatively strong and early indications of a bottom in real economic activity.


At the same time, the secular picture for the Chinese credit system remains ugly, with lots of noise about regulation, restructuring and reform, but no actual ‘deleveraging.’ With this in mind, we recommend investors take a bullish position in inflation-sensitive “soft” agricultural commodities (sugar, cocoa and coffee), hedged with a bearish position in the Hong Kong Dollar. This pairing represents a joint positive carry and positive convexity way to play both the inflationary upside of improving demand in China, as well as a world in which liquidity issues in the Chinese financial system result in a deflationary deleveraging and potential break in the peg to the USD.

There is a Credit Bubble In China

Two years ago at the Drobny Global Macro conference, we presented a framework for thinking about China in the context of the global cycle. This framework, detailed below, remains relevant amidst the noise of tit-for-tat tweets on sneakers and soybeans that populate our information channels these days.

1. There is a credit bubble in China.

2. The losses from this bubble will be large (and growing).

3. (Wise) Policymakers are aware of the problem, but have thus far been unwilling, or unable, to stop it.

Two years later, policymakers have made some progress curbing the worst excesses of an out of control shadow banking system without tackling the fundamental issues at play. Specifically, too much money which is leading to too much investment, therefore resulting in a domestic economy saddled with too much debt.

China Crisis Indicator

China Crisis Indicator

And in spite of years of talk of deleveraging, China and Hong Kong continue to top estimates of forward financial crisis risk.


During this time, banks have shifted to new lending from companies to households, who have in turn levered up to buy into ever more expensive real estate. While Chinese real estate data is notoriously sketchy, our best estimate is that real estate in second tier cities is now on par with that of developed nations like the US. Though with much lower household income levels to support those valuations.


Meanwhile, on the margin, the rest of the world has become ever more dependent on Chinese money creation, investment, and growth.


The way this story plays out will impact investors of every asset class. It is a well-established fact that Chinese conditions are a dominant driver of many energy and metal commodities markets. However, what we believe many investors are missing, is the degree to which the entire global economy is essentially long the Chinese credit bubble.

With the goal of understanding what’s going on in the Chinese economy today, we turn our attention to the notoriously sketchy data in China.

Answering the simplest questions with respect to growth conditions can be especially challenging in a country with scarce and unreliable data like China. Even in the best of circumstances, we would argue that GDP data is a poor measure of economic activity due to its low frequency, revisions, and lags. This is especially the case in China where Li Keqiang famously proclaimed that GDP statistics to be ‘man made’ and ‘for reference only’ while preferring rough proxies like electricity consumption, rail cargo volume and bank lending as a more accurate measure of cyclical momentum.

The Chinese Data Reliability Problem:

To solve this problem, we propose a theory fundamentally based on macro linkages.


In practice, the lines between these forces is much more blurry


And the reality, is that even after combing through thousands of time series and cleaning them up, you are left with something that looks like this.


There's signal in this noise though, and by applying our framework for thinking about the Chinese economy we can see how policy has been used as a tool to manage first prices, and ultimately economic activity. Going into the beginning of last year, activity and prices were hot, and the government was tightening policy too manged. After six months of deterioration, policy shifted dramatically easier, which has begun to flow through to improvements in first prices, and potentially activity.


Machine – What Would a Machine Say?

Other than thinking through the causal linkages (aka deductive logic), one can also rely on unsupervised machine learning techniques like principal component analysis (aka inductive logic) to break down the underlying economic structure of the Chinese economy.

We started by gathering all the data we could find (100+ time series) for China from various categories: 1) money & credit aggregates, 2) real economy (GDP & components), 3) government sector, 4) external sector, 5) financial market prices, 6) property market, 7) consumer and corporate surveys and 8) alternative data (e.g. satellite).

We then transformed and normalized (z-score) the data in order to run a PCA.

We found that the 3 first principal components explained over 60% of the total variance. The first principal component loaded highly on measures of economic activity (figure 1), the second principal component loaded highly on measures of financial conditions (figure 2), and the third principal component loaded highly on measures like the external balance (figure 3).


Interestingly, the machine learning approach corroborates the notion that financial conditions (policy + prices) and activity are the key moving parts in the Chinese economy (figure 4).


Although information content with respect to growth/activity can lead to better asset allocation decisions, we are more interested in which if any markets our indicators can trade. The tables below compare the buy and hold risk-adjusted returns of various betas and markets to those using a simple scaling rule conditioning on our policy impulse indicator using monthly data. The rule scales exposure long or short each market based on the indicator’s value (z-score) the previous month (t-1).


This testing results tell a pretty logical story. Understanding conditions in China is helpful to understanding the future returns of some, but not all, assets. In particular it looks like this model has edge in understanding commodities, particularly those linked to Chinese demand.

With that in mind, we propose investors allocate capital into a strategy that has positive exposure to a rebound in Chinese conditions, but a positive carry, positive convexity way to play the protect that view from the existential risks of a liquidity event in China.

Below, we show the expected value matrix of our preferred trade expressions: a long position in Sugar in HKD, or 1) long sugar and 2) long USDHKD.


The genesis for this trade was made through extensive research using the Rose platform. If you are interested in viewing the data in an interactive environment, then please click the link below and play around with our platform. In addition, we would love to hear any feedback that you have regarding Rose if you do use it.



Easing flowing through this week, weaker dollar, higher prices…

Everybody helping, rowing in the same direction.

Earning were strong for rich and growing tech empires. Pricing in more upside.

While the curve has no more tightening. Not a basis point to be seen.

So we bought inflation through the curve, and sold some fluffy tech.

Two world’s, and while one can’t know which, you gotta buy those tails.

Which then bring’s up that fateful question, of how to fund the carry.

So hold your nose, and buy that beta. Maybe even sell a little vol.

Just try not get caught, in one of those “2x1”s.

Those guys never end well.


We’ve been doing a lot of research on bubbles lately.

People talk a lot about the financial bubbles, the one’s that manifest in particular asset prices, or individual securities.


Then there’s your thematic/macro bubbles, the bubbles that follow technological innovations. The bubbles of the canal, the railroad, the telephone, the internet, and the handheld.


Each technological bubble, backed by the full faith and credit of the financial markets those very technologies have enabled. The bubbles of the company, the bond, the stock, the derivative, and the fund.


Step back and bit, and you start to see the bubbles that work on systems, the one’s that manifest in the push and pull of different models of civilization. The kind that inevitably resolve themselves in war, of one form of other...

The war/s of the central planner vs the wisdom of the crowd (starting in the Cold War and ….)

The wars of the nation vs the other (initiated by Napoleon and Bismark, and terminated by Mussolini, Hirohito and you know who)

The wars of the king vs the republic (with two false starts in Alexander, and Caesar, both trying to take democracy east, both falling prey to the egoism of empire).

And it reverberates down, each conflict of a kind, each essentially a conflict over and about culture. Each of these conflicts, a kind of bubble about culture. Each of these conflicts about the two-thousand year trend of the individual consistently taking more and more liberty out the hands of the state.

And if we’re being honest, we don’t know if this is a bubble.


Mostly because that chart doesn’t look that much different if you sub in a blue line of US money supply.

Maybe your answer to whether that’s a bubble or not just boils down to where you fall on the spectrum, the one that weighs the interests of the individual vs the interest in the community.

And maybe we’re wrong, not only about how the direction it plays out, but the why.

I guess we’ll see.

Log Scale

Log Scale

The Dollar

Some of us live in a world of dollars.

As opposed to pounds, or yen, or deutschemarks, we experience the everyday prices for goods and services in units of dollars.

Everything from our morning coffee, to rent, to our retirement savings is priced in terms of “how many dollar bills is this thing worth?”

Most of us don’t spend time thinking about the fact that a dollar bill is itself a commodity. It’s just one of those helpful abstractions that comes from thinking that a dollar bill is ‘money.’

This abstraction tends to unravel when, like this week, famous investors make public predictions that

“The Federal Reserve…will have to print more money to make up for the deficit, have to monetize more and…You easily could have a 30 percent depreciation in the dollar”

At Black Snow, while we don’t disagree with Ray’s logic that:

Fed Easing > Lower Interest Rates -> Debt Monetization -> Weaker Dollar

We do disagree with the timeline and path that the dollar may take.

Given that the Fed is currently tightening (and most other major central banks are easing), the first order pressure on the dollar aught be to strengthen. It’s hard to see the dollar selling off that much in a world where a bank account in New York gets you 2% (and rising) more than a bank account in London, Tokyo or Frankfurt.

Rates and returns.PNG

Further, when you think about what the world would need to look like to get the Fed to switch from tightening:

Everything is fine -> Raise Interest Rates -> Shrink the Fed Balance Sheet

To easing:

Everything is doomed -> Lower Interest Rates -> Buy Assets/Print Money

You need a mechanism by which global demand contracts and prompts a change in policy.

What’s the most likely cause of a contraction in global demand?


Yes, deficits in the US are large and unsustainable.

But it’s not like the US is the only one that needs to get it’s fiscal house in order.


Yes, in the next downturn, the Fed will likely return to printing money.

But when put in context of money printing in the rest of the world, it’s not like the US is the one that stands out.

*Central Bank Balance Sheets for Japan and China are ex-foreign currency reserves

*Central Bank Balance Sheets for Japan and China are ex-foreign currency reserves

Further, if you are worried about an unsustainable expansion in money, the US doesn’t seem like a prime candidate for worry.


So yes, we think it likely that in the next downturn, major central banks will print money to buy assets.

In the meantime, our view is that the relatively tight monetary policy by the Fed will lead to an appreciation in the dollar against most major currencies. That this stronger dollar will lead to the next downturn in the global credit cycle, as tightening in the reserve currency traditionally has.

Thus, we remain long dollars.

This downturn will likely see a broad depreciation of all paper currencies relative to real assets, as policymakers inject liquidity to local credit markets by printing money.

At that point, it will be less a story about dollar weakness in particular, and more a story of ‘which one’, ‘how much’ and ‘against what’….

We recommend gold (denominated in RMB) as a natural hedge for this eventually outcome.


The Machine

At Black Snow, we believe it pays not only to study history, but to form mental models of the systems that guide history.  That the creation and refinement of these models not only help us understand the world, but help us trade markets.

This post is about the high-level system we see guiding the allocation of resources in and across three distinct domains of human affairs.   It is the system that defines how capital, in its broadest sense, evolves and defines our day to day life.

We call it #theMachine.

The Machine has three parts. 

Each part representing a form of capital that guides human affairs in a particular domain.  Each with existing internal feedback loops.  Each with defined (but constantly evolving) ways of interacting with the other domains.



Cultural capital can can be thought of as the ability to mobilize financial and technological resources purely through personal or institutional clout. 

As culture is the domain of purely human affairs, cultural capital represents standing and power amongst humans.

The ability of a politician's tweet to move markets, or of a celebrity endorsement to change opinions is a manifestation of the cultural capital those individuals posses.  Though this clout is recorded not in any balance sheet or hard drive, it exists nonetheless.

We take a broad definition of culture here, one that contains both the explicit (politics) and implicit (class) hierarchical structure that we as social apes spend our days in.



Simply put, technological capital is the ability to do more, with less.

It can be thought of as the ability of an individual, organization or society, to design, implement and maintain systems.

Some of those systems, create, store and transport physical goods and services, be they a barrel of oil or a iPhone.

Some of those systems deal with non-physical objects, be they streaming movies or search results.

In some sense less, tech capital isn't as immediately apparent than the other two forms of capital, as its primary impact is to the reduce the financial and cultural cost of doing business.   




Financial capital is the domain of money, wealth, and obligation.  Of assets and liabilities.  Equity and Debt.  Inflows and Outflows.  

Finance can be thought of as the great book of accounts in the sky.  That which records who owe's whom what, and the prevailing market prices by which those debits and credits were exchanged.

While this system has evolved significantly since Hummurabi's slab was used to make the first recorded insurance contracts, it's relationship with the other two forms of capital remains relatively constant.  

Financial capital is the ability to make change in that great distributed ledger, and in doing so, mobilize change in the domains of culture (humans) and technology (systems).


The goal of this post was to lay out the three forms of capital as we see them.  

In subsequent posts, we will go a level deeper, and walk through how the three forms of capital function, interact, and evolve.  

In this work, we'll attempt to provide the logic (backed up with data) behind the three charts in this post. 

For example, how can the US (and by association the UK and it's former colonies) be the source of so much of the world's technological and cultural capital, whilst simultaneously owing everyone else so much money? 

Once you start to see the world in these terms, it becomes hard to stop. 


Someone I respect a great deal taught me that setting goals was a pretty important part of the process of getting what you want out of life.

Since seeing this, I have become rather obsessed with thinking about goals. I found that much of what could be called regret came down to sloppy thinking on my part about what my goals actually were, and what a good process towards reaching those goals looked like.

The power of this heuristic then extended to knowing and understanding the goals of others.  It has reached the point where pretty much my first conversation with any potential business associate is a frank discussion about our mutual goals.  I find it becomes much easier to build flexibility into a relationship when all parties have mutually consistent goals, because everyone knows everyone is essentially rowing in the same direction.

Anyway, the throat-clearing here is to provide some context for why this first post is about goals.

The goals of this blog are simple:

1. Use publishing on this blog as a forcing function to structure some of our thinking about markets and investing.

2. Socialize that thinking such that others can engage with that thinking, by asking questions, pushing back, and holding us accountable.

3. Through that process, increase the rate at which we learn about the world and, in doing so, create value for our investors.

With those goals in mind, we plan to prioritize transparency and the asking of questions in this blog vs coming up with high-confidence, specific answers to specific questions.  

We accept that we might be wrong, that at times we will be wrong, and we look forward to figuring out which is which, with you.