Thanks To The Central Banks, The Equity Bubble Is Getting Bigger

WASHINGTON – Imagine this. There are lots of chronically sick patients in the hospital. Many of them are deteriorating rapidly. The right therapies cannot be administered because of absurd delays caused by infighting within the Ministry of Health. 

Give them morphine 

The physicians in charge of the hospital know what is needed to take care of the patients. But they have no resources. The only thing they have got is morphine, lots of it.

Well, since we cannot cure the patients, at least let’s alleviate their severe pain. “Morphine for everybody!” orders the Director of the hospital. “But sir, this is no cure”, argues a young doctor. “What do we do when the effect of morphine wears off?”, he asks. “Well, we will give them some more. We have ample supply”, replies the Director.

Quantitative Easing is morphine

This may be a far-fetched analogy, but here it is. The patients are the sick economies in Europe, Japan, the US and now –in a major way– China. The Ministry of Health are the Governments incapable of tackling the structural issues of lack of productive investments, labor market rigidity and high public spending. The hospital Director are the Central Bankers. And the morphine is an ample supply is Quantitative Easing, (QE).

Central Bank left alone to manage the economies

The Western economies are really sick. There is too much leverage, low productivity, too much private debt and out of control public spending. But Governments do essentially nothing about any of this. They are paralyzed by ideological disputes and bogus arguments about austerity and income redistribution. The only institutions that can do “something” are the Central Banks. They have no real “cure” for any of this. But they can provide temporary relief by keeping interest rates close to zero, (here is the morphine, in the form of QE), thereby giving everybody the illusion that the situation, while difficult, is manageable. The patients are still very sick. But (thanks to ample doses of QE-morphine) they feel no pain; and so they are led to believe that they have been cured.

More QE, it is still party time!

This is totally absurd. But this is exactly what is happening. The European Central Bank, after having launched its own QE a while ago, just declared that the Eurozone economies need some more monetary easing. The Central Bank in China just announced some more easy money measures, in a country, mind you, that accumulated a monstrous amount of debt (much of it bad debt) in just a few years.

Watching all this unfold, Wall Street correctly concluded that in this environment where everybody is injecting even more liquidity there is no way that the US Federal Reserve will go against this powerful current and raise interest rates in 2015. With US rates still near zero, it still makes sense to put money in equities, since everything else will give you no financial reward.

Investors got the message. “It is still party time!” And so, Wall Street shot up on Thursday. The Dow Jones added 300 points. There was further growth on Friday. Has this optimism about equities got anything to do with the real economy? Not really.

Perverse incentives 

This is yet another Fed-induced rally. (By indirectly signalling that it will not raise rates in 2015, the Fed gave the green light). Needless to say, this is madness. Equity prices in developed economies now are largely disconnected from the fundamentals.

Even worse, thanks to QE governments in highly indebted countries, from Europe to the US, are under no pressure to reform their public finances, because they can keep borrowing at very low interest, this way creating and sustaining the insane delusion that more and more debt is a good way to finance chronic over spending.

Commodities took a dive 

In the meantime, though, emerging countries whose commodities fueled the crazy debt-driven Chinese construction investments binge are feeling the pain. As China could not sustain its own truly over sized madness, it stop buying stuff.

Therefore, commodity prices collapsed. As a result, Brazil, Australia, South Africa, Chile, Argentina, Zambia, and many others are suffering, in a major way. They built their budgets with the unwarranted assumption that commodity prices would stay in the stratosphere for ever. Now they have to go back to the drawing board.

In the meantime, their semi-impoverished people have no extra cash to buy new things, while their currencies are worth a lot less. This penury will further depress exports from industrial countries, this way further reinforcing the global downward spiral.

No incentives to engage in serious reforms 

So, here is the picture. The global economy is doing poorly, in large part because of minimal growth in the debt-burdened West where Governments still spend money on unaffordable entitlements instead of creating a business friendly environment that will encourage private investments in wealth-creating innovation.

Most emerging markets are in recession or close to it.

But at least in Europe, Japan, the US (and now China) the real extent of the problem is disguised. Developed countries enjoy a drug-induced financial markets buoyancy (QE is morphine) because the Central Banks keep pumping in liquidity, this way allowing the stock market bubbles to continue.

Another big bubble 

This is a gimmick. A dangerous gimmick. At some point it will have to stop. I am not sure when. But it cannot go on for ever. I do not even want to think about what will happen when this gigantic bubble will explode.

David Stockman: China’s Real Economic Figures Are Scary

WASHINGTON – Serious international economic and business media in the past used to quote official Chinese economic statistics indicating vigorous growth followed by even higher growth without any comments. But now something has changed.

Cooking the books 

Without saying so directly, the same media imply that the Chinese Government makes up its numbers. A recent WSJ story –even though not prominently placed– pointed out that it is hard to believe that the Chinese economy really grew at a 6.9% rate when all the indicators about manufacturing, consumption, exports and imports are significantly down.

Yes, official statistics released by the Chinese Government do not add up. Or, to put it differently, if you read between the lines, the truth is that Chinese authorities routinely and willfully cook their books in order to prove that their worn out investment-led growth model still works wonders.

True enough, Beijing conceded a while back that the country is experiencing an economic slow down. But they added that it is not a major one, while the Government has everything under control.

5% or less 

Well, several economists and forecasting firms believe instead that China’s official GDP growth numbers are inflated by at least 2%, may be even more. Which is to say that the Middle Kingdom is growing, but at 5%, not at 6.9%. Besides, the slower growth numbers hide even deeper troubles, since growth is financed by massive amounts of debt.

End of an era 

So, here is the thing: the Chinese economic miracle is over. What we see now is a (semi-desperate) political leadership that is trying to keep the wheels turning via some more debt-financed growth.

The implications of China’s loss of momentum are enormous. From Australia to Brazil, from Chile to Zambia, emerging economies that were doing well because of the China-driven commodities boom are now suffering, some (like Brazil) in a major way. Likewise, Germany and others will export fewer high technology products to China.

Not under control 

The Beijing cooked up notion (bought by many in the West) that the smart and wise Communist Party planners have all under control, while they steer the country away from investment-led growth to consumer-led growth, is a fantasy. China is in deep trouble, and we should be concerned.

In-depth analysis 

For a deeper and detailed analysis of China’s real economy, and what the end of its incredible growth era means for the rest of the world, I strongly recommend that you read a piece titled “Red Swan Descending” (reproduced below) by David Stockman, (Budget Director under Ronald Reagan). He wrote this on October 20 in his Contra Corner

Red Swan Descending  (by David Stockman)

“The proverbial peddlers of Florida swampland can now move over. They can’t hold a candle to the red suzerains of Beijing.

The latter had drawn a line in the sand at 7.0% GDP growth. Conveniently enough, the “consensus” estimate of so-called street economists was pegged at 6.8% for Q3, thereby giving authorities one thin decimal point through which to thread a “beat” at 6.9%. 

By golly they did it!

Even then, China’s Ministry of Truth had to fiddle down the GDP deflator to negative 0.5% (for the second time this year) in order to hit the bull’s eye. And that’s exactly the point.

No real world $10 trillion economy plagued with all of the turmoil evident in China’s whipsawing trade data or its volatile real estate development sector or its faltering rust belt and commodity-based industries can possibly deliver absolutely stable GDP numbers to the exact decimal point quarter after quarter.

In fact, the odds that these reports represent anything other than propaganda are so overwhelmingly high that they perforce raise another more important question.  Why does Wall Street and its servile financial press not issue a loud collective guffaw when they are released?

But no, the Wall Street Journal took it all very seriously, noting both the “beat” and China’s claim that the “miss” wasn’t a miss at all:

The better-than-expected result—a Wall Street Journal survey of 13 economists forecast a median 6.8% gain—is likely to renew debate over the accuracy of China’s growth statistics…….Speaking at an event to promote entrepreneurism in Beijing on Monday, Premier Li Keqiang said “even though it was 6.9%, it is still a growth rate of around 7%.”

Right. China’s #2 communist boss is out promoting the “enterprenurial spirit” while emitting central planning propaganda to the decimal point.

You might find the irony exceptionally rich, but there is a larger message. Namely, the true size of China’s economy is unknowable to the nearest trillion or even several trillions. But that does not prevent most of Wall Street from taking seriously each and every word of China’s self-evidently clueless statist rulers spouting growth rates to the decimal point. [Bold added]

In truth, Wall Street has become so intellectually addled from its addiction to central bank enabled gambling that it no longer has a clue about what really matters. That’s why the next crash will come as an even greater surprise than the Lehman meltdown, and will be far more brutal and uncontainable, as well.

Yet the evidence that a China-led crash is on its way is hiding in plain sight. And what is being blithely ignored is not merely the blatant inconsistencies in its economic numbers—–such as the fact that electricity consumption has grown at only a 1.3% rate over the past year——or that its commerce with the outside world has shrunk drastically, with imports down by 23% and exports off by 3-6% in recent months.

Instead, the evidence that China is a slow-motion train wreck lies in the very consistency of its Beijing-cooked numbers. Apparently, no one has told its credit-happy rulers that printing precise amounts of new GDP quarter after quarter by issuing credit at double the rate of nominal income growth will eventually result in the mother of all deflationary collapses.

Stated differently, if the pattern of debt versus GDP shown below is pursued long enough, the world’s greatest open air construction site will fall silent. Everything which can be built will have been delivered; any cash flow which can be encumbered with more debt will have been levered-up; any pretense that financial institutions are solvent will have given way too soaring defaults; and the Wall Street delusion that the primitive central planners of red capitalism had an iron grip on China’s runaway expansion will have been revealed as a snare and delusion.

Accordingly, the only thing that really counted in yesterday’s release was that credit is still growing at nearly 12% or at 2X the 6.2% gain in nominal GDP. And as is also evident in the chart, this massive and aberrational debt versus income gap has been underway as far back as the eye can see.

Indeed, its goes all the way back to Mr. Deng’s moment of enlightenment 25 years ago. That’s when he discovered a printing press in the basement of the PBOC and concluded that communist party power might better be preserved by running these presses red-hot than by Mao’s failed dictum that power descends from the white-hot barrel of a gun.

In any event, why in the world would anyone in their right mind think this crucial chart can be extended toward the right axis much longer. Assume 10 more years of 12% credit growth, for example, and China will have $90 trillion of total debt or 50% more than the already staggering amount carried by the US economy. [Bold added]

At the same time and given that China’s nominal GDP growth is descending in Gartman fashion from the upper left to the lower right, assume the very best outcome for nominal income. That is, posit that somehow China manages to achieve ten more years of this quarters’ 6% nominal growth. So doing, you get a mere $17 trillion of GDP.

Everywhere and always, however, a 5X total leverage ratio on an economy is a recipe for crushing deflation. In fact, it has never happened before in modern times except for Japan after 1990; and Japan at least had some semblance of functioning markets separate from the state and the rule of commercial law, contracts and bankruptcy.

By contrast, when China fully plunges into its inexorable deflationary spiral the rulers of red capitalism will have no choice except to resort to Mao’s preferred instruments of rule—–paddy wagons and machine guns—-in order to quell an outraged citizenry. After all, Mr. Deng told China’s newly ascendant capitalists that it is glorious to be rich, but did not explain that printing press prosperity ultimately results in a crack-up boom.

Stated differently, the recent 18-month rise and then overnight collapse of $5 trillion of phony market cap in the Chinese stock market gave rise to utter panic and mindless expediency in Beijing, including a de facto bailout of billionaires. China’s red rulers apparently feared that the 90 million angry stock market speculators would be no match for its 70 million party cadres——especially since most of the latter were foremost among the former.

Yet what will happen when China’s hideously inflated real estate and land values succumb to the deflationary wringer?  And hideous is not too strong a word: in many urban areas housing prices have reached 15-30X the median income.

Well, there are 65 million drastically over-priced, empty apartments in China because its rulers told speculators and the rising middle class that housing prices could never fall——that they were the next best thing to a piggy bank. Accordingly, the last phase of China’s madcap construction boom is likely to be a manic spurt of prison building to accommodate the millions of irate citizens who are destined to experience China’s turbo-charged version of 1929. [Bold added]

The other number in the Q3 release that has been drastically misinterpreted is the reported 10.6% growth of fixed asset investment. Needless to say, this was described as “disappointing” when it is actually a screaming symptom of China’s terminally deformed economy. If it had any hope of avoiding a crash landing, fixed investment in its fantastically overbuilt public facilities and industrial capacity would be sharply negative, not still growing in double digits.

Owing to the cardinal error embodied in Wall Street’s self-serving rendition of Keynesian economics, however, China’s fatal dependence on erecting economic white elephants and what amount to public pyramids in the form of unused airports, train stations, highways and bridges, is given hardly a passing nod. That’s because it is assumed that some way or another China will make the transition to a services and consumption based economy just like the good old shop-till-they-drop US of A.

Let’s see. When China finally stops its borrowing binge, these putative shoppers will need to finance their purchases out of current incomes. Yet is not the overwhelming share of household income in China currently earned from the supply chain for fixed asset investment and construction and from the export of cheap goods to already saturated and debt-besotted DM markets? [Bold added]

Just consider the fantastical reality that China’s 2 billion ton cement industry produced more in three years than did the US industry during the entire 20th century. When they finally stop building roads, apartments and factories, therefore, it is not just the cement kilns which will shutdown, but a whole network of gravel haulers, chemical plants, cement truck fleets, construction equipment suppliers, work site service vendors and much more reaching deep into the interstices of China’s hothouse economy. [Bold added]

Likewise, when rebar and other construction steel demand collapses and the rest of the world throws up barriers to China’s surging steel exports, as it surely will and is already doing, the ricochet effects on China massively overbuilt 1.1 billion ton steel industry will be far-reaching. The incomes of coal barons and blast furnaces workers alike have already taken a pasting, and the downward spiral is just getting started.

And wait until China’s newly minted auto dealer lots become backed-up with unsold cars as far as the eye can see. Then its 25 million unit auto industry will tumble into a depression unlike anything since 1929 when Detroit’s production plunged from 6 million cars/year to less than 2 million.

All of those suddenly unemployed auto, steel, rubber, glass, upholstery etc. workers did, in fact, economically “drop”. But it wasn’t from an excess of shopping!

In short, the affliction of Keynesian economics brought many ills to the modern world, but repeal of Say’s Law was not among them. You can have a one-time credit party, but when it inevitably ends, consumption spending defaults to that which can be financed from current incomes. Consumption is the consequence of production and income, not its cause.

Yet crack-up booms eventually destroy the bloated and unsustainable incomes generated in the raw materials, capital goods and consumer durable sectors during the boom phase. Accordingly, even the red suzerains of Beijing can not get from here to there. The phantom incomes that resulted from paving nearly half of the Asian continent occupied by 20% of the world’s population must inevitably shrink, meaning that China’s consumption and service spending will falter, too.

Stated differently, China’s red capitalism is the new black swan. There is nothing rational, stable or sustainable about it. Moreover, the consequence of its pending collapse will be literally earth shattering.

That’s because in recent years it has accounted for a lot more than the one-third of global GDP growth conventionally cited. The latter is just a measure of border-to-border economic statistics.

But the second and third order effects are equally large. From the bowels of Australia’s iron ore mines to the top of Dubai’s pointless 100 story office towers, the entire warp and woof of the global economy has been distorted and bloated by the central bank money printing spree of the last two decades, led by the red credit machines of Beijing. Everywhere economies have succumbed to over-building, over-consumption, over-financialization and endless dangerous, unstable speculation.

So forget the cleanest dirty shirt meme or the preposterous Wall Street nostrum that the US economy has been “decoupled” from the rest of the world. That’s unadulterated hogwash, and its means that the stock market and risk assets are heading for a thundering crash.”




Chinese Communist Party Instructs Media To Stress “Superiority of China’s System”

WASHINGTONThe Financial Times reports that the Chinese Communist Party gave detailed directives to all Chinese media about how they will have to report economic news.

Bright future 

Here is the story they must tell, in the aftermath of the Shanghai stock market crash and other bad developments, regarding the overall economic slow down in China: “The focus for the month of September will be strengthening economic propaganda and…promoting the discourse on China’s bright economic future and the superiority of China’s system”.


Got that? A dramatic loss of momentum becomes “China’s bright economic future”. A mercantilist model that run its course is in fact “a superior economic system”.

Look, these efforts to manipulate the message are not shocking revelations. The Communist Party runs China and in a broad sense it “owns” the economy. There is no question that a large part of the party’s prestige and overall legitimacy rests on its reputation as competent economic steward.

Therefore, it is no surprise that, confronted with a sustained bad economic trend, the party orders all media to publish only “happy news”. The point is to preserve the party’s image. Negative news hurt politically. They tarnish the party’s prestige.

Most official data is fake 

That said, all this active effort at manipulation tell us at least one thing. Most likely, the real situation in the Chinese economy, (data about growth, unemployment, and bad debt), is worse than what we think. Based on this revelation, we can count on the facts that all official statistics are routinely doctored, so that things will appear far better than they are.

Again, nothing too surprising here. With all its years of reforms and partial liberalization, China remains an autocracy. Those in power must be depicted as capable and wise. They make no mistakes. They steer the country in the right direction, and at the appropriate speed.

We bought the story 

The problem is that Western policy-makers and media bought this fake story. They swallowed this propaganda as if it were legitimate news. They bought the exaggerated growth statistics.

So, what do we make of all this? Even if we discount the fluff created by the “happy news” ordered by the authorities, in the end, China is not a disaster. Far from it. We are talking about a loss of momentum, not about an economic collapse. With its immense cash reserves, China will pull through.

The glitter is gone 

However, the glitter is gone. A debt-driven growth model based on ever-growing exports, and a never-ending construction boom, has run its course. Most likely for good. China still has impressive resources. It will continue to grow, probably at a respectable 4% to 5% rate.

But it will soon become clear to the entire world that China’s leaders did not invent “a superior economic system”. Far from it. And, in the long run, this fall to earth will hurt them politically. They built themselves up as invincible economic geniuses. It turns out they are not.

Defensive battle

Yes, the party propaganda machine will do its best to force Chinese media to tell a different story. But this is a defensive battle, damage limitation.

Again, the glitter is gone.

China’s Economy “Worse Than You Think”

WASHINGTON – A few years ago, Jim Chanos of Kynicos Associates made news because he had the temerity to call a spade a spade by telling the world that China’s construction-driven economic growth was in fact a big bubble.

A bubble economy 

Chanos argument was that China’s construction frenzy was not led by real demand. Soon enough this enormous property boom driven by speculation, and by the political need to show consistent GDP growth, would cause huge problems.

And he argued that the crunch would be felt first among the international companies that supply the raw materials that feed the Chinese construction industry. He argued that the Australians, the Brazilians and other commodities exporters would get hit first.


At the time Chanos looked like a really odd character who really did not understand China. China was doing very well, fueling the almost universal expectation that its super successful “New Economic Growth Model” would allow it to surpass America, thereby affirming that there is indeed something better than capitalism.


Now we see 

Well, fast forward to today, and it is quite a different story. Now Chanos looks like a prophet.

Indeed, with all the bad news about China’s economic slow down, smaller exports, lower industrial production, huge over capacity funded by mountains of debt, the Shanghai Stock Exchange implosion, and –yes– the real estate disaster, it is hard to challenge his negative forecasts.

When Chanos speaks, now people listen to him. So, how bad is the Chinese economy? “It’s worse than you think”, replied Chanos in a CNBC interview. “Whatever you might think, it’s worse”.

Got that? It is bad beyond imagination. Well, this assessment is certainly not very detailed. But you get the idea. Underneath a relatively calm, in fact almost airbrushed, surface, there is a badly mismanaged country.


But how is this possible? We thought that the Chinese meritocracy only promoted the super smart. We were told that China is run by carefully trained technocrats.

Well, may be not. “People are beginning to realize the Chinese government is not omnipotent and omniscient,” Chanos said to CNBC. “In fact, like many of us, sometimes they don’t have a clue.”

There you go: “Clueless China”. 

How Bad Is The Chinese Economy?

WASHINGTON – There is no way to tell which way the Shanghai Stock Market is headed. However, it is clear that the July 27 8.5% loss is not just an ugly day in a period of unusual volatility that will eventually come to an end.

A bad day in Shanghai

The fact is that this collapse, the worst one day decline in many years, took place despite highly publicized and very costly ($ 200 billion) government-led counter measures aimed at stabilizing the markets, after a massive rout in early July.

Counter measures 

The Beijing authorities watched (probably in horror) a precipitous share prices decline, day after day. They got really worried that a true stock market collapse would ruin millions of retail investors, this way creating a political problem for the national leadership.

And so they rapidly concocted a series of massive interventions to support share prices. They suspended trading. They ordered brokerage houses to buy selected stocks. They made public funds available to execute these trades.

And, sure enough, the $ 200 billion medication worked, at least for a while. For a few days the markets calmed down. On account of the government administered shock therapy, share prices stabilized. In fact, there was some recovery from the huge dip that had taken place in early July.

No real confidence

But on Monday there has been another major collapse, despite the massive intervention aimed at restoring investors’ confidence. And this is truly worrisome, because it means that millions of Chinese investors deep down do not believe that the government has either the ability or the staying power to stabilize the markets, this way saving their investments.

That said, despite this set back, the Beijing government cannot stop intervening. It simply cannot take a chance and allow a market led by millions of scared investors who would love to run for the exit to find its natural bottom. This bottom may be much, much lower then the lows experienced in early July.

What’s really going on? 

And this is only half the story. Forget for a moment about manipulated and therefore meaningless share prices. The fact is that most of China’s economy is manipulated. Therefore, it is next to impossible to determine its real health conditions, in the midst of signs that indicate a slow down.

Unfortunately, many Western observers keep forgetting that a large chunk of China’s economy is controlled by the state through State Owned Enterprises (SOEs), always funded by state controlled Banks. These large corporations do not follow market rules as we understand them. You can rest assured that government appointed managers will hide losses, while highlighting bright prospects. You see, the government cannot fail.

What we know

Still, despite this fog, we know a few things, none of them reassuring. We know that, thanks to an ill-advised gigantic stimulus plan aimed at facing the 2008 international financial crisis, in the last few years there has been an unprecedented, in fact grotesque, overbuilding of “everything” in China.

We also know that, in order to support its gigantic construction projects, China added an enormous amount of capacity to every industrial sector supporting it: steel, cement, glass, copper, appliances, furniture, and so on. Taken together, these sectors amount to anywhere between 25 and 30% of GDP.

We know that, on account of this construction frenzy, overall supply of commercial and residential properties now vastly exceeds demand. There are way too many vacant villas, apartments and half empty shopping malls.

As a result of this property glut, construction –the main driver of China’s economic growth– had to slow down, dragging down not just unlucky developers but also a huge part of the economy. We know that factory utilization is down to 70%, a pretty bad number.

Debt-financed investments 

Given all of the above, we can conclude that most of China’s recent growth is based on debt-financed excessive investments in unneeded capacity. The stimulus policy aimed at countering the ill effects of the 2008 international financial crisis led to a colossal level of malinvestment.

Still plenty of cash 

The Chinese Government does not have to pull the plug, right now. It still has plenty of cash reserves (trillions of dollars) to fuel this madness a little longer. But how much longer? How much more good money can they throw at zombie companies, in order to prolong the illusion that they are viable? How much more cash will they use to support shares that investors would love to unload?

It is a political issue 

In the end, this is not an economic policy issue. This is a political issue. In a true free market, the state would not massively intervene in the economy. It would allow private companies to compete, while allowing foreign investors to participate on an equal base. This way, without state interference, markets would eventually re-balance demand and supply.

But it is hard to see how China can get from here to there. Hard to believe that the national leadership will liberalize the economy right now, when things are slowing down. There are just too many risks.

Without the recent massive interventions, the Shanghai Stock Market might have collapsed, this way ruining tens of millions of small investors. Likewise, forcing zombie firms to shut down may be good for the future health of the Chinese economy; but it would cause short term misery for millions of workers, suddenly without a job.

The instinct is to control 

I just cannot believe that a political leadership that can claim legitimacy mostly on the basis of a long (past) record of impressive growth would accept a most serious retrenchment of the Chinese economy. Their instinct is to intervene, extend credit, mask problems, and prop up failing companies.

Of course, this means burning cash for no good economic purpose. But this is the only way to survive politically, at least for a while.


China Dumping Excess Steel

WASHINGTON – In a “normal” capitalistic country, when supply expansion strategies in any given industry exceed market demand, the companies operating in that sector pay the price. In order to realign demand and supply, they have to cut production, fire workers, sometimes close down entire production facilities. And, of course, the weakest players go bankrupt. Invested capital goes up in smoke, share holders are wiped out. This is painful. But it has to be done, simply because nobody can afford the luxury to keep making stuff that cannot be sold at a profit. And you cannot have any functioning capitalism without profits.

In China market rules do not apply

Well, move over to China and you see that these elementary rules do not apply –at least not now. Here is the story. In the go-go reckless years in which all local Chinese governments went into heavy debt in order to finance more and more construction projects, (construction was the easiest way to jack up GDP numbers), China built up gigantic steel, copper, cement, and glass capacity. All this was necessary, or so it seemed at the time, in order to supply the extraordinary construction boom.

Yes, except that the boom is over. China now is fantastically overbuilt. Brand new developments sit empty. There is too much of everything: luxury condos, shopping malls, office buildings.

Factories will not be closed

Needless to say, this is having and will have an impact on the supercharged sectors that were beefed up in order to support construction, steel first and foremost.

Well, according to the old-fashioned “demand and supply” capitalistic logic, China would have to cut down steel production. And we are not talking about trimming. We are talking about shutting down dozens of steel mills, since shrinking demand generated by a cooling economy will not even remotely match the existing, gigantic over-supply in the years to come. This would be most unpleasant. At a time of diminishing economic expectations, when projected growth rates are constantly adjusted down by the Beijing authorities, closing state-owned steel plants, while creating unemployment by firing thousands of workers would be politically complicated.

Political jobs

But, no worries. China operates in its own world –a world in which normal laws of the business cycle do not apply, for now. You see, in China most large steel mills are state-owned corporations. They will not go bankrupt on account of this over capacity and over production crisis because the state will give them easy credit, no matter what. It is politically important (forget about economics) that the mills stay open, and that they keep all their workers employed.

Dumping is the answer

And what about the excess steel they keep making for which there is no domestic market? Very simple! They will dump it abroad. In fact, they are already doing this.(Dumping means selling a product below cost, an illicit trade practice). As the WSJ reports, Chinese steel exports to the US have already jumped 40% in January 2015 from a year before, while US domestic prices have collapsed, creating a huge problem for US steel producers already hit by lower demand from the energy sector.

It is illegal

But wait. Isn’t dumping against the WTO rules? Isn’t Chinese behavior prohibited? Of course it is. But you have to make a case: provide the evidence, bring the whole thing to the WTO in Geneva, wait for a ruling, plan countermeasures, etc. All this takes time. Meanwhile, the Chinese keep dumping gigantic amounts of excess steel all over the world: Europe, the USA, India, and South Korea, bringing about economic ruin to hundreds of companies and thousands of workers.

How much excess capacity?

And how big is this excess capacity? Extremely big. As David Stockman put it in his Contra Corner: “China’s steel exports are now running at a 110 million ton annual rate compared to just 50 million in 2013. What’s worse, China has in excess of 1.1 billion tons of capacity and after nearly tripling production to satisfy its construction binge, its current 750 million tons of domestic demand has nowhere to go except down.” Got that? That’s 350 million tons of steel produced annually beyond what the Chinese market can absorb. All this will be dumped all over the world.

If private sector capitalism is bad, state-run corporations are worse

Capitalism is a crisis prone, wasteful and lousy system. We know that. But if you think that a country running huge state monopolies that are (at least for a while) immune from market forces is any better, just look at China.

I am confident that the oversold Chinese economic miracle will be soon deflated, along with its bubble economy. But, in the meantime, this anomaly that passes for “superior economic system” will be a source of disruption for the rest of a world economy that is trying to create and live by some rules of good conduct.

Mountains of Debt in Greece…And In China

WASHINGTON – There is nothing promising in the outcome of the “European Tour” taken by Greek Prime Minister Alexis Tsipras and Yanis Varoufakis, his Finance Minister. Winning an election on the basis of a populist plan to resist Brussels’ mean spirited austerity is one thing, negotiating real debt relief when you are poor and weak is quite another.

Greece is ruined

We could discuss all sorts of possible options. But I see no workable solution that will satisfy both Greece and its creditors. The fact is that Greece is ruined. In part because of its idiotic policies, and in part because of counterproductive EU-imposed medicine, Greek output declined by 25% in the years since the troika-engineered (EU-IMF-ECB) rescue. As its GDP sank, its debt to (real) GDP ballooned. It is now at 175% of GDP. This is far worse than Italy at 130%.

Now you tell me how can a small, non competitive, unproductive economy get out of this mess. And keep in mind that Greece is surviving only thanks to the bailout provided mostly by its EU “partners”. That’s $ 286 billion obtained at favorable conditions, in exchange for a promise to implement structural reforms that would reduce public spending, privatize assets, and more.

No more austerity?

However, now the Syriza leaders want to stop, and in fact reverse, the EU-imposed austerity. They want to increase public jobs, (all this implies increased public spending), give everybody in Greece a raise, and renegotiate the terms of their gigantic loans.

This is impossible. But it is also unrealistic for the rest of Europe to believe that the Greeks –with this government in charge– will be disciplined and pay back little by little all what they owe, according to plan.

Greece will never pay back

Greece will never pay back this debt. Especially since now its elected leaders tell the people that it is not really the nation’s fault. Greece was somehow tricked by rapacious foreigners. It is all a big conspiracy, you see.

The fact is that Greece is essentially bankrupt. The bailout obtained from its EU partners has now become an inflammatory political issue. It is impossible that this anti-austerity, far left, populist government will forget all its campaign promises and enforce the existing –extremely unpopular– agreements.

Will Greece literally go bankrupt? Will it be forced to get out of the Eurozone? Will it voluntarily leave? I have no idea. But I find it hard to believe that this far left government in Athens and the rest of Europe will find a mutually acceptable, workable agreement that will allow creditors to be paid and the Greeks to be happy.

China is worse

Well, if Greece is bad news, give a look at China. Its fantastic GDP growth in the last few years was driven in large measure by an unprecedented construction boom financed entirely by debt. And this building frenzy, totally disconnected from real demand, led to “ghost cities” with no people, empty shopping malls, and plenty of under utilized infrastructure. This is “malinvestment” on a colossal scale. Yes, it made GDP go up. But none of this is real.

Fake growth

As bad as Greece is, China is certainly far worse. In only 14 years, China accumulated $ 26 trillion in new debt in order to get mostly fake growth. As David Stockman observes in his Contra Corner, (China’s Monumental Debt Trap—-Why It Will Rock The Global Economy, February 5, 2015), China’s GDP doubled since 2007. Its growth expanded by $ 5 trillion in just 7 years. Yes, but in order to get there, it increased its debt by $ 21 trillion. In other words, for every $ 1 dollar of new growth, China added $ 4 of new debt.

This is not going to end well. Here is how Stockman sees it:

“In any event, China’s $10 trillion of GDP is exactly at the Greek bulge stage. It’s not replicable and sustainable unless the bosses in Beijing truly do intend to pave the entire country.”

“In fact, the Chinese economy is addicted to construction, and its rulers can’t seem to let go—-even as they recognize they are heading straight toward the wall. At the present time, nearly 50% of GDP is accounted for by fixed asset investment—–that is, housing, commercial real estate, industry and public infrastructure. This ratio is so far off the historical and comparative charts as to be in a freakish class all of its own. Even during the peak “take-off” phase of economic development in Japan and South Korea this ratio never exceeded 30% and did not dwell there for long, either.”  [bold added]

“So China is caught in a monumental debt trap. Its rulers fear social upheaval unless they keep pumping GDP—and the associated rise of jobs, incomes and financial asset values—-with more credit and construction. Even then, they know better and have therefore hop-scotched from credit restraint to credit curtailment almost on alternate days of the week.”

“But now the edifice is beginning to roll over. Housing prices are falling and new footage put under construction has dropped by 30% over the last three months—something which has not even remotely happened during the last 15 years. At the same time, the consequent cooling of demand for construction materials and equipment is evident in China’s faltering industrial production numbers and the global commodity deflation that has resulted from its vast excess capacity in steel, shipbuilding, cement, aluminum, copper fabrication and all the rest.”

Economic growth is a political mandate 

Yes, the trap is that China’s unelected leaders need to deliver sustained economic growth in order to legitimize themselves. But since it is impossible to generate genuine 7% growth (let alone the 10% we were used to see in China) year after year, they faked it. Local governments borrowed in order to finance more jobs-creating construction. The unprecedented construction boom in turn generated a boom in steel, cement, copper, you name it.

How long can this crazy act last?

The End Of China’s Boom

WASHINGTON – The China story has changed, quite a bit. Yesterday it was about relentless growth. Today it is about the slow down. In fact, it is worse. Today it is becoming the story about “what went wrong”. Today’s story is about massive industrial overcapacity, newly built cities with no people, and environmental disasters. All this is coming out while China’s growth numbers, while still incredibly high, are less impressive. From 10% we got down to 7.4%.

Industrial machine 

For many years we were used to the gigantic Chinese industrial machine powering on, gobbling more and more export markets. We were used to old Chinese cities made over at incredible speed. We saw pictures of brand new airports, new highways, super fast trains, and glittering shopping malls.

At the same time, literally hundreds of millions of Chinese had graduated to the middle class. They owned cars, apartments and started traveling abroad, while the very rich sent their kids to expensive, elite Western universities.

America down, China up

After the disastrous 2009 US recession, the contrast appeared even more stark. America was in decline, General Motors was bankrupt; while China gained even more ground. The biggest trading nation also became the world’s number 2 economy, leaving Japan behind.

The secret of success

Of course, at the time, everybody wanted to know the secret. Many believed that the special ingredient was superior leadership. The Chinese Communist Party had successfully morphed into a super qualified technocratic elite that could steer China in the right direction, crafting smart growth policies that were able to create a unique and super optimized blend of state-run and private corporations.

Not so

Well, guess what, it was not so. Not by a long shot. And we are beginning to see the truth. China did extremely well exploiting its cheap labor advantage. China did manage to become the workshop of the world simply because its workers received wages that were a fraction of what Western workers normally got.

Cheap labor

This basic cheap labor factor made China the primary destination of outsourced manufacturing. Granted, the Chinese were also quite skilled in creating the supply and logistics chains that factories and foreign customers depend on. Indeed, beyond the new factories, the Chinese also built the railways, the highways and the ports that made it possible to move enormous quantities of goods reliably and efficiently. This is no small accomplishment. (If you look at India, well, no comparison. India could theoretically exploit a cheap labor advantage. But forget about efficient logistics. India is a gigantic mess).

With all this manufacturing base and infrastructure coming to life, it made perfect sense for thousands of  Western companies to move all or most of their manufacturing to China.

Because of this, while big chunks of America’s middle class disappeared, along with the shuttered factories, China put to work millions of people.

The end of the export boom

But this export-led boom is over. Not that we Westerners will stop buying made in China products. We simply will not buy them at the same rate. Most markets are saturated. Leaving aside any speculation about the resurgence of manufacturing in America or Europe, it is simply impossible to grow export markets by 10% a year, every year –for ever. China will remain a major exporter. But GDP growth cannot depend on growing exports the way it used to.

Construction boom is over

Add to this the end of the fantastic construction boom. Well, much of it was bad speculation financed by (now bad) debt. Much of it was driven by local governments trying to “look good” by showing nice growth numbers. The problem is that these local leaders got into heavy debt in order to finance easy development to be achieved through construction projects.

And the net result of this collective insanity is a monstrous property glut. In the so-called second or third tier Chinese cities, (from 500,000 to a few million people), one can see entire blocks of empty high-rise buildings. Very simply, the Chinese created an enormous, debt-financed property bubble.

Worse yet, the unprecedented construction frenzy fueled the creation of massive over capacity in all industrial sectors that support construction: steel, cement, glass, copper. Add to this the oversized growth of all the industries that supply the housing market: major domestic appliances, furniture, bathroom fixtures, you name it. Too much capacity in all these sectors.

The stimulus led to waste

And then you must add to this mix unwise policy choices. In order to avoid the ill winds of the 2008-2009 recession created in America, China launched a massive stimulus program. Well, guess what: a large amount of that money was wasted on bad projects that added to the overcapacity mentioned above, while saddling the financial system with a huge number of bad loans.

Environmental disasters

And I forgot to mention that during the go-go years of massive industrial expansion, the Chinese couldn’t care less about environmental safeguards. As a result, at the end of this incredible 30 year run, tens of millions in China live in cities where the air is not safe and most of the water is polluted. Not to mention soil contaminated by toxic and poisonous substances. How do you fix that?

Growth still high

Well, let’s fast forward to the present. China just announced that in 2014 its economy grew “only” 7.4%. Of course this is still a fantastic rate. (Europe is lucky to have 1%. America seems like a giant within the West because it moved up to about 3%). But China is trending down.

Of course, there could be a good way forward. Having exhausted its major comparative advantage –cheap labor– China should move upmarket. It should become an “innovation society”.

Innovation society?

But, you see, innovation usually requires plenty of innovators, original thinkers. People willing to think outside the box. People who go against the grain. People who are willing to experiment, and try new things.

The Chinese are very good at making products following the specifications provided by the Western companies that actually design them. But this has little to do with innovation. Innovation requires a different set of skills. And China is not the ideal breeding ground for their development.

The fact is that China, with all its incredibly rapid modernization, is still a hierarchical country run by a small unelected elite that is extremely aware that it needs to control society in order to stay in power.

This de facto “top down” control in which discipline and uniformity are not just encouraged but often imposed does not strike me as the ideal, decentralized, multi-polar eco-system that will breed many future innovators.

You see, innovators thrive in free societies.


Fiscal Stimulus Does Not Work –Yet We Keep Applying It

WASHINGTON “If economic troubles are approaching, put together a big stimulus package”. This is the universally accepted prevention/remedy therapy to save any country from the storms of recession or the chills of stagnation.

A good idea?

In principle it sounds like a good idea. If demand is falling, the government will create it through major public spending programs, (infrastructure is a big favorite), and by injecting more liquidity into the financial sector, this way encouraging banks to lend more money.

Well, guess what, it does not work.


In most cases the money spent by governments becomes “malinvestment”. Many new loans become bad loans because, in the rush to promote more economic activities, undeserving, sub par projects get funded. So, when the dust settles, precious capital has been wasted, growth has not increased, while deficits and debt have grown.

If you want a more detailed account of this sad tale of dashed expectations, read How Spending Sapped the Global Recovery, an interesting WSJ op-ed piece, (January, 16, 2015), by Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management.

China’s stimulus did not work

For instance, China, in order to forestall any major contamination spreading from the devastating 2009 US financial crisis, launched a mega stimulus program (12% of GDP)to protect its economy. The problem is that these new funds have often been poorly allocated.

State banks gave money to badly managed State Owned Enterprises, (SOEs). This led, (among other things), to the creation of massive overcapacity in the steel industry that was beefed up in order to produce the material needed to fuel an absurd construction spree.

And now, after all that spending, empty apartment buildings, under-utilized airports and half-occupied shopping malls dotting many Chinese cities provide painful evidence of bad allocation of capital. In the meantime, China did not manage to avoid an economic slow down.

The spectacular failure of China’s stimulus plan should serve as a lesson.

But no. We learn nothing.

We learn nothing

Confronted with stalled economies and frozen political systems that are incapable of promoting the creation of new competitive enterprises, unimaginative government go back to the same, tried and discredited Keynesian medicine: more stimulus.

Abenomics in Japan did not work. But wait, politically victorious Prime Minister Shinzo Abe has the magic powder. How about a brand new $ 29 billion stimulus program? Yes, it sounds like a great idea. In a country with a debt to GDP ratio of 240%, creating more debt seems like a good way to grow out of debt.

And what about Europe? Same story. In this scenario the savior is going to the European Central Bank. The ECB will do the heavy lifting, by buying bonds, this way supposedly revving up the financial sector, by making it easier for (often semi-comatose) European corporations to obtain new commercial loans.

It is amazing how we keep doing the same old stuff, even when the evidence shows that it does not work.

Real growth

Real growth in mature economies is about R&D that produces commercially viable innovation. In time, innovation will translate into increased workers’ productivity and growing standards of living. Of course, we all want economic, fiscal and monetary policies that will not create obstacles to the growth of new enterprises.

But here we have instead the childish belief that propitious monetary and fiscal policies –by themselves– will create innovation and vigorous enterprises. It would be nice if it worked this way. But it does not. Capitalism requires real entrepreneurs. And no, financial manipulations and government mandated investments do not produce solid, wealth-generating corporations.

As Agustin Carstens, the President of Mexicos’ Central Bank, told Sharma, (the author of the WSJ piece referenced above), “fiscal and monetary policy cannot create growth”.

Indeed, they cannot.

Overall, stimulative policies most of the time amount to bad allocation of capital and malinvestment, higher deficits and a larger debt.

Is Wall Street Going To Crash?

WASHINGTON – If you believe that US stocks are priced fairly, then the current sharp dip experienced by Wall Street is an opportunity to buy good assets at a discount. But if you believe instead that we are experiencing the bursting of a bubble induced by an unprecedented period of Fed-induced zero interests and by a parallel gigantic increase of the Fed’s balance sheet, then you have ground to be scared.

High stock prices, modest economic growth

Here is the picture. After the end of the bad 2008-2009 recession, the US stock market kept going up and up, while the US economy was growing –but only modestly, at about 2% a year. At the same time, Washington did not make even an attempt to cut persistent and absurdly high Federal Budget deficits. Yes, Uncle Sam is virtually broke. But the whole world keeps buying US Bonds, because they are supposed to be a truly safe investment.

Europe is sick

Looking at the global picture, notwithstanding many attempts engineered by the European Central Bank, the Eurozone is really in bad shape. And the broader European Union is not doing much better. Most states carry too much debt. Their economies are at a standstill, or in recession, while unemployment is above 10%.

Does this concern America? Yes, it does, because Europe is still our main trading partner. Most US multinational corporations make more money abroad than at home. If Europe keeps doing so poorly, expect General Electric, United Technologies and Caterpillar to suffer.

China not doing so well

And what about China? With China one never knows exactly, because of unreliable official statistics. But we know that the era of 10% growth, year after year, is over –for good. Now the real question is whether the cooked up figures –officially growth is above 7%– are in truth closer to 5% or 4%.

Add to this the incredible industrial overcapacity created by unwise “stimulative” economic policies in China. Steel production capacity reached absurd levels, even as the construction boom had ended. While Chinese state banks for the time being will keep supporting virtually bankrupt corporations, they cannot do this for ever.

China’s economic future will be at best a mixed bag. Expect lots of non recoverable bad loans and plant closings. Do not expect China to be the locomotive that will pull ahead global growth.

Japan is in decline

Japan, still the number three world economy, has its own problems. Prime Minister Shinzo Abe is engaged in a heroic, if futile, effort to reignite sustained economic growth.

But Japan has stupendous macro-economic problems. Its public debt is now 240% of GDP. The phasing in of a new sales tax aimed at increasing revenues has frozen purchases, and this has depressed economic activities. Add to the mix a steady population decline and you can figure out that Japan’s long-term economic growth prospects are not that good.

Energy stocks hit by low oil prices

Last but not least, the US and global energy sector is now significantly down because Saudi Arabia decided that this would be a good time to flood the market with plenty of oil at discounted prices. This may be a temporary phenomenon. But nobody really knows when this downward pressure on oil prices –and therefore on the profitability of oil companies– will end.

Of course, this is great news for consumers in the US and elsewhere. But it is horrible news for Exxon and other energy companies that have seen the value of their reserves reduced on account of sharply lower crude prices. Their stock prices are down, significantly.

For all of the above, this new low prices trend is horrible news for all the investors who believed that energy stocks were “safe”. If you are holding Exxon, Chevron, BP, Shell, Halliburton or Schlumberger stocks, you are not happy.

Is this a stock market bubble?

All in all, if you agree that Wall Street’s recent high valuations were  largely the result of a bubble created by years of Fed-induced low interest rates, you have reasons for serious concerns. Those high stock prices cannot be sustained, especially in the light of weak global demand caused by Europe’s endless stagnation and China’s loss of altitude.

No help from the Fed

To make things a lot worse, as noted by David Stockman and other analysts, unlike 2007-2008 the Federal Reserve today has no more ammunition to fight a new financial crisis. Interest rates are at zero, while the Fed has already increased its asset purchases to unprecedented levels.

In this environment of seriously limited monetary policy options, no “soft landing” scenario, in case of a crisis. No bail out. Not even thinkable.

In the past, there was the semi-guarantee that the US Government had to intervene to save the “too big to fail” financial institutions. This is what happened in 2008. The Federal Government stepped in, in a massive way, and prevented a global collapse.

Now, it is different. The over leveraged Wall Street guys should know that this time they are on their own. Hence the likelihood that, if and when some will start rushing towards the exit, we may see a real stampede.

In other words, if the US stock market took a real dive, hard to see where the floor might be.