The Inflation Fight and Dollar Dominance War See New Action

China takes desperate action against the dollar to prop its wounded yuan, only to see its action backfire.

China’s terra cotta army rises from the crypt| Photo by Aaron Greenwood on Unsplash

New jobs added this week in ADP’s payroll report blew the doors off expectations, beating them by double. So much good news for the economy, of course, also blew up the stock market because it screams of the high probability of tougher Fed fighting to come in the Inflation Wars. That, of course, was a foregone conclusion for thinking people; but investors are more of the feeling type, betting the stock market up based solely on what their greed hopes for. As a result, many investors have continued to fantasize that the Fed would be retreating soon from its inflation fight.

As an example of how subtle that bias can be, I read one analyst today who mentioned the Fed’s “halt” on interest-rate hikes. It’s not a halt or a hold. Powell even had a little trouble with calling it a pause. It is a slowing. Now that rate increases have hit what is normally the smallest increment the Fed makes (0.25%), it makes more sense, if the goal is to slow the rate of increases even more, to start making those 0.25% hikes every other meeting, rather than try to do almost meaningless 0.125% hikes at each meeting.

Powell tried to make it clear that the Fed is not taking a break; it is simply slowing the pace to allow more time for lagging data to start to show how effective the increases are; but the market refused to hear his words, once again, because investors, and especially their advisors, want to sift out all the hope they can find to feed their foolish rally.

One article today points out why we are actually more likely to see intensified inflation fighting because inflation is probably going rise again this year, which is what I predicted at the start of the year, though we haven’t seen that happen so far. The article says that inflation wars happen as a play in three acts. First comes the big inflation and the Fed goes to war. Naturally, in the second act, the war makes a difference so that inflation starts to drop and, so, the Fed slows. In the third act, latent forces for inflation emerge — the sticky stuff (as reflected in today’s surging jobs report) — and inflation finds an easy environment to rise in because people have gotten used to accepting price increases as a fact of life and demanding wages to compensate and because the Fed has slowed its advances against inflation, so the Fed has to stuff inflation down harder in an even bloodier battle that drives the economy into recession, which finally kills the inflation.

Today’s glorious job numbers woke the stock market up to that latent reality. They also woke up slumbering bond investors, who rose this morning to realize the inflation fight is not so likely over as they thought. The 10-year Treasury spiked out of bed, going 4% for the first time since March (and only third time this year), while the 2-year bolted above 5% for the first time since March, which is only its second time this year.

In this week’s Deeper Dive, which I’m now working on for paying subscribers, I’ll be plunging into the headlines from this week that I didn’t cover in these editorials, which foreshadow serious economic decline, contrary to the job indicators in this morning’s news. While those job indicators may not mean future economic recovery, they do mean current pressures of wage inflation are not going to cut the Fed a break. As Dallas Reserve Bank President Lorie Logan said this morning, the jobs report just shows the Fed is going to have to make another rate hike at its next meeting, as it said was nearly certain at its last meeting.

In another war that is far from over on the other side of the sea, China, once again, tried to save its wounded yuan. The currency war has been a slaughter for China this year, but the People’s Bank of China dealt a vicious blow against the dollar when it closed down dollar trade in Hong Kong this week, one of the world’s largest currency markets.

Financial Secretary of China's Hong Kong Special Administrative Region government Paul Chan said on Sunday that to limit U.S. dollar trading in Hong Kong will in return damage global confidence in the U.S. dollar and U.S. financial assets.

Extreme measures, such as restricting Hong Kong using the U.S. dollar or the settlement system, are also highly risky to the United States itself, the Hong Kong finance chief wrote in an online article in response to concerns over threatened sanctions by the United States.

While the move is intended to cripple the US dollar, it is actually a desperate move by China to prop up its withering yuan (again!), but it backfired to be as crippling in some ways for the yuan as it is intended to be for the dollar.

Chinese investors are rushing offshore to make dollar deposits and buy Hong Kong insurance in a signal domestic confidence is languishing and that the ailing yuan faces more pressure.

The outflows highlight deep-seated concern about the state of China's economy as its much-awaited pandemic recovery stalls. Consumer spending is flagging, the property market and stock markets are in the doldrums and cash is piling up in savings.

Brokers say individuals are responsible for the surge and it shows no sign of letting up, which analysts warn could put further pressure on the yuan as it teeters at eight-month lows.

So, the war between the US dollar for dominance and the Chinese yuan as its presumptive replacement continues with the dollar only being promised future hurt from China’s move while the move pistol-whacked the yuan on the back of its retreating head. It exhibited China’s desperation to prop the yuan. We can see why it is desperate from other Chinese news today where China’s plummeting property market, which had shown signs of a rebound just like the US housing market recently showed, fell off an unexpected cliff.

(Headlines covering today’s editorial are in boldface in the section that follows for paid subscribers.)