Alpha Report: How China and Japan Impact US Risk Assets
Crossboarder flows and geopolitical risk
Main Idea:
The structural shifts in supply chains, cross-border flows, and geopolitical tensions are shaping how relative consumption and production are being formed in Japan and China. These structural changes are reflected in HOW economic data is skewed on a cyclical basis. This results in a significant advantage for understanding how the PBoC and BoJ actions are transmitted through financial markets and thereby WHY positioning constraints exist for traders.
Review:
Before expanding on the ideas for alpha generation, please review the following articles:
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Podcast: How Interest Rates Shape The Rise And Fall Of Nations: I recorded the fundamental ideas you need to know about interest rates and the currency. This is critical regardless of the domain you are in or the asset you trade.
Alpha Report: Factor Moves and Interest Rates: The previous alpha report contextualized this week and the trades for the current macro regime.
Current Trades I am running:
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Structure Of Report:
The Mechanics of Market Flows: Understanding How Capital Moves
China and Japan’s Role in the Global Financial Landscape
PBoC and BoJ: Shaping Global Markets Through Monetary Policy
Strategic Constraints in Financial Market Positioning
The Mechanics of Market Flows: Understanding How Capital Moves
In balance of payments mechanics, the national accounts identity links consumption, production, and savings through the structure of GDP. Gross Domestic Product (GDP) can be expressed as the sum of consumption (C), investment (I), government spending (G), and net exports (NX), or GDP=C+I+G+(X−M), where X is exports and M is imports. The balance of payments ensures that the sum of the current account (trade balance) and financial account (capital flows) equals zero, meaning that any deficit in one must be matched by a surplus in the other. Savings in one country are deployed either domestically in investment or exported as capital flows to balance global imbalances. Countries with high domestic savings rates tend to have current account surpluses, while countries with low savings or high consumption patterns often run deficits.
For example, China’s high savings rate relative to consumption results in large trade surpluses. This surplus, a direct result of suppressed domestic consumption and high investment levels, leads to excess savings being exported abroad. China’s current account surpluses are matched by corresponding outflows of capital, mostly in the form of foreign exchange reserves managed by the People's Bank of China (PBoC). Germany similarly maintains a surplus due to weak domestic consumption relative to its production, causing persistent trade surpluses, with the resulting excess capital being exported via financial markets.
Chart: This is exemplified in consumption accounting for 56% of China's GDP (white line) while investment accounts for 42% of GDP (yellow line)
On the opposite side, the United States exemplifies the impact of high consumption and low savings. With a long-standing current account deficit, U.S. consumption exceeds its production, necessitating foreign capital inflows to finance this imbalance. U.S. financial markets attract these inflows, keeping the balance of payments in equilibrium. However, this structure makes the U.S. economy dependent on foreign savings and increases the sensitivity of its financial system to global capital movements.
Chart: This is exemplified in consumption accounting for 67% of US GDP (white line) while investment accounts for 26% of GDP (yellow line)
The US Dollar:
The U.S. dollar's status as the global reserve currency enables the U.S. to finance its persistent current account deficits by attracting foreign capital inflows, which fund domestic consumption beyond the country's production capacity. This dynamic allows the U.S. to absorb excess savings from surplus nations like China and Germany, which accumulate dollar-denominated assets to balance their trade surpluses. The high demand for U.S. financial assets, such as Treasury bonds, keeps borrowing costs low for the U.S., but also drives up the dollar's value, reducing the competitiveness of American exports and deepening trade deficits.
Resources:
The framework from Totem Macro is a great visualization of this geopolitical flow dynamic:
You can find the whole report here:
The book Trade Wars Are Class Wars is an exceptional resource on this as well: Link
China and Japan’s Role in the Global Financial Landscape:
The structure of Japan and its role in the global financial system has already been laid out in the Country Primer On Japan:
And the management of the impossible Trinity by China was touched on in the FX primers:
These Primers will contextualize how to think about China and Japan as they connect with financial markets and flows. I would also encourage everyone to follow and subscribe to
because his analysis of Japan is unparalleled.Keep reading with a 7-day free trial
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