Friday, December 25, 2015

Show Me The Growth!

GDP Is A Poor Indicator Of Growth
America and other countries have allowed numbers that mean "nothing" to seep into how the gross domestic product (GDP) is calculated in an effort to create the illusion of better growth. Decades ago America far out produced the rest of the world and manufactured goods that it exported across the seas, but today much of our economy is dominated by the service and retail sectors, this often translates into if you wash my windows, then I will mow your yard. Gross Domestic Product is defined as the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. Within that definition it appears those in power have discovered some wiggle room and even before that a debate exist as to what it really tells us.

Fraud Is Common In Our "Photoshop world"
We live in a "Photoshop world" and this means we should scrutinize everything, if not we risk we will be very surprised. The Bureau of Economic Analysis (BEA) has made a significant change on how they calculate the GDP and measuring our economic growth that went by unnoticed by many people when they changed how they classified and recorded expenditures for R&D and for entertainment, literary, and artistic originals. An announcement of this change was made by the BEA during February of 2013, this resulted in an increase in the GDP. This kind of "bump" means that a gain of 2% today is in reality less than a gain of 2% years ago. This means we are comparing apples to oranges. When delving deeper into all of this it is easy to see the GDP is a master illusion designed to filter down to both society and the Main Street economy.

The first comprehensive set of measures of national income was developed by economist Simon Kuznets who in 1934 told the U.S. Congress the formula was problematic, he said. "The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is contingent upon oversimplification."

In 1962 Kuznets again emphasized that we must keep in mind the difference between quantity and the quality of growth. He made it clear a distinction exist between cost and returns, and between the long and the short run. Kuznets went further to specify we needed goals concerning both growth "of what, and for what." Other economist have agreed that GDP is an empty abstraction with a very weak link to the real economy. The framework fails to reflect the difference between real wealth expansion or capital consumption. Kuznets used the example of the government building a pyramid that added nothing to the well-being of individuals, it would be viewed as economic growth, but in reality divert funding away from real wealth generating activities harms the generation of real wealth. Unfortunately, this is happening far too often.

What is not stated can be far more important than what is. The numbers we are often spoon fed and await with such glee has little to do with real growth but most likely mirrors or is merely a reflection of monetary pumping. The GDP number fails to highlight a slew of important factors that feed directly into our standard of living and the health of our economy, such as;

    * How wealth is distributed and inequality
    * Taxation and how it effects both the economy and society
    * Non- market transactions like volunteer and off book work
    * Underground economy, illegal trade and many cash transactions.
    * Asset value, meaning GDP ignores changes in what things are worth
    * The non-monetary part of the economy, bartering of goods and services
    * Distinguishing between production that is subsidized and that which is not
    * Quality improvements and new products
    * What is being produced, bombs or butter and a better educated populace
    * The sustainability of growth or misallocation of either capital or resources
    * Cross border parity and changes in currency value
    * External factors such as negative environmental effects or the health of the people

One way a country can kick their gross domestic product forward is to build a false economy based on infrastructure or war. When a country gorges at the trough of deficit spending it can easily manipulate a big temporary boost in its GDP. Some countries have even gone as far as to add things like prostitution and other illegal activities in a way to boost GDP and by doing so they can lower their ratio of GDP to government debt. In 2013 in advice to their government the UK's Natural Capital Committee highlighted some of the failures of GDP when they pointed out its focus on flows can allow an economy to run down its assets while recording high levels of GDP growth until a point is reached where this begins to impact future growth. They went on to make it clear the recorded GDP growth rate is prone to overstate the sustainable growth rate. This number as with most numbers once put out there is subject to full blown manipulation and spin.

Bottom-line in the words of its creator, "The GDP framework is more or less an empty abstraction devoid of any link to the real world." All economic growth is not created equal and quality is a critical factor that must not be ignored when it comes to the issue of growth. History shows that when you spend money and afterwards have little to show for it you have simply wasted your money. Sadly, much of the money America claims to invest in itself each year falls directly into this category. True economic growth is well directed and focused in a way that is both sustainable and yields long lasting benefits. The quality of growth directly effects its value to both the economy and eventually society, but sadly government shows little interest in a more honest reflection of economic growth. Proof of this is that absent in almost all government numbers is a reflection of how bankruptcies effect the economy and the fact many debts don't get paid off but are simply written off.

Footnote;  The article below titled. "Building A False Economy On Infrastructure Or War" explores how countries can create short-term prosperity.

Friday, December 18, 2015

Strong Dollar Acts As A Magnet

Earlier this year I wrote a piece that indicated a great deal of wealth would be flowing into America seeking protection from the ravages fostered upon it. This is driven by policies that have been even worse than those America's leaders have chosen to pursue. The strong dollar acts like a magnet pulling wealth towards America and it may soon get much stronger. Throughout history, strong currencies have attracted wealth and this means money and wealth from all over the world are headed towards our shores. The money coming into America is flowing into both bonds and stocks. This creates a self-feeding loop that supports lower interest rates and drives the stock market ever higher. Those of you who have read other articles I have written know I think the market is overvalued and the bond market is a bubble ready to pop, but as long as we remain the best and safest place to hide money do not discount the dollar.

Drawing Money Like A Magnet
While America has been described recently as the cleanest dirty shirt in the closet, or the best house in a bad neighborhood, both place it as the least worse option. The reality is other options fail to pass the smell test. This means what is coming to America is wealth and money seeking a "safer" place to take refuge from the coming storm. Today America has become a money magnet, Lady Liberty the symbol of America that stands in the harbor of New York while a bit tarnished is still giving people hope even if Washington is not overwhelming us with the same glowing feeling.

Do not underestimate the power of cross-border money traveling into the country as a driving economic force. Another thing you should not underestimate is the advantage our currency has because of its role as the world reserve currency. This makes it the "default currency" and by the size of its market, float, and liquidity the currency by which all others are weighed, measured, and often pegged. The chickens are coming home to roost for countries that face growing debt and policies that make them uncompetitive. Some of these countries are increasing looking at ways to confiscate the wealth of their citizens, it is only logical that as people begin to realize the dead end path of their homelands they take action to move their money to a safer place. 

A Very Important Chart In Understanding The Dollar
The chart to the left is very important. Today four major currencies dominate the world stage, they are the pound, the euro, the yen, and of course the dollar. The remaining currencies remain small bit players in the overall scheme of things. John Maynard Keynes said, By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. As the central banks print like crazy to control interest rates on bonds they devalue the currency. While there are not many Bond Vigilantes there is a slew of  Currency Vigilantes and they are ready to make their presence known.

The yen and the euro are in trouble, with the pound being very vulnerable to contagion. Weakness in the value of the Yen, Pound, and Euro must not go unnoticed as they are a precursor to the wealth fleeing the countries that use them in everyday life. What is occurring in the currency markets and the huge shift in wealth are not uncommon. History has shown countries can steal wealth by way of various Trojan horse methods such as monetizing debt through printing massive amounts of new currency or new taxes. If you look close you will see the currency markets are beginning to reflect diminished confidence in the system central banks have created and as the currency games continue to ratchet ever higher it is becoming more apparent that much of the world financial structure is built on shifting sand.

The schemes bankers have used for years to hide and transfer debt are coming under attack, if they crumble under the assault it will culminate in a reset of the economic system across the globe. If  people all over the world try to get out of their home currencies a surge in the value of the dollar is logical. In the end, this will not be the salvation of America or its economy but it sure does help create a bit of a lift that we would be wise to take advantage of.  As things turn ugly across the world it is only expected that as in Neil Diamond's patriotic song the wealth of the world like its people just wants to be free. Like the people Diamond sings about it seems wealth also appears to have legs and as the people, everywhere around the world the money is coming to America! Yes, it is coming to America, today, today!

Footnote; For fun, if you haven' heard if in a while the link for the song "Coming To America" is below. It comes complete with some very good visuals, enjoy.

Footnote #2; Last night the yen took a blip up based on a surprise move by the BOJ that was interpreted as not easing enough, I'm short the yen and see such blips as expected. Note the yen often jumps on bad news from China, I feel this has to do with money leaving Chine via Japan, it then moves its way into the dollar.

Wednesday, December 16, 2015

Writing Off The Rising Amount Of Bad Dept!

Debt Defaults Are A Transfer Of Wealth
Writing off bad debt will be a painful process and I don't mean for the debtor but for the creditor the person, business, or institution that holds the paper. It generally constitutes an unplanned and involuntary financial adjustment. While it appears much of the financial community is relatively unfazed by the mountains of debt growing throughout the world we as individuals should be concerned as to the many ways it might spillover and affect our lives. Clever sounding terms like "transitory" are often used to mask growing problems and to inject a bit of sophistication to this problem while trying to brush reality aside. Sometimes a person presenting the case growing debt is under control will even go so far as to explain that some of it is good debt or boast how we are enjoying the positive effects of the loose lending standards.

Debt Hangs Above Us Ready To Explode!
We should remember debt takes many forms and shapes, it is not contained in auto and student loans. With low-interest rates many companies have borrowed a great deal of money to buy back stock, this has been one of the forces driving the market ever higher. A comment from a reader several months ago highlights this and why it might be a big problem when he wrote;  It is fairly obvious that not all IOU's are deemed as trustworthy, and as trust drains from this over-indebted system, shakiest issuers' debt will lose value fastest. Junk debt is thus a Hindenburg in search of a spark all its own. Wait until corporations discover how difficult it may be to roll over all this share-buyback debt of the last few years.

Artificially low-interest rates tend to skew all markets especially the credit and debt markets. This creates a debt explosion that extends into everything including consumer spending and the statistics surrounding their effects on the economy. A great deal of what is being seen as deflation flows from a loop being created from lower interest payments on things like autos, sadly this is a one-off and only goes to mask deeper trends developing under the surface. The fact is debt that cannot be repaid tends to be hidden away and corrupts the true worth of those owed what often amounts to non-collectible sums. Even now we are hearing calls by many people to write off and forgive student debt without any real understanding of the implications such a policy would entail.

Again, I caution those who think this writing off of debt will be an orderly and even process. By that, I'm saying not all debt is created equal. One major difference is whether it is backed by assets or collateral. Many other factors affect the strength or impact of defaults. One example of this is when it becomes payable, some debt is stretched over decades while other obligations are short-term and paid with a balloon payment or all at one time.  Also, debt is computed at different interest rates and this can affect its long-term impact. Another often forgotten issue is whom the debt is owed to and the impact default will have on their ability to honor their current and long-term obligations. I have seen several businesses forced into bankruptcy when a large customer defaults and cannot pay its bills.

It is important to consider how this will all play out or shakedown, this is yet to be determined but the ramifications remain powerful. Often unpaid debt shifts the pain or obligation to another party and acts as a wealth transfer, usually, this is not a voluntary act unless the note is being forgiven by the holder. I see bad debts on the rise and the effect to both the economy and the lives of many will be massive and undeniable in coming years. It will show its ugly side by pensions being cut, inflation edging higher, or simply lowering our overall standard of living. The fact is some way or form the piper must be paid and we will be reminded that there is no such thing as a free lunch.

The Reality Is We Have Not Deleveraged!
The world of bankruptcy and unpaid debt has become a complicated place where protection for one party can leave another totally exposed. We have seen things like "clawbacks" or the government making an exception and changing the rules as in the case of shafting the bondholders of General Motors during the bailout. Yes, writing off debt can be a slippery slope. The debt that is written off takes something with it when it leaves this world and that is the wealth of someone else! In today's low-interest rate easy money environment it is much easier to hide under-performing assets and the inability to repay debt. Low-Interest rates tend to foster an extend and pretend attitude that becomes apparent and crystal clear only after rates climb and put stress on the system.

Several other bad things also happen such as increased speculation that propels the creation of leverage or carry trades that multiple risks. It also tends to move demand forward and cause an increase in the improper allocation of capital, both of these activities have a way of causing problems that linger for years. Across the globe, since 2008 the central banks and governments of the world have played a giant game of hide the debt, much of it disguised by transferring obligations from the banks and people onto the backs of their populations and into a growing pile of public debt. The problem is massive debt still hangs above our heads as a Hindenburg in search of a spark.

Footnote; This post dovetails with many of my recent writings. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged. The two article below delve into some of the things we should of learned by now and how bad debt is absorbed and fades with time.

Sunday, December 13, 2015

How High Is High? How Low Is Low?

Extreme Conditions Do Occur
How high is high? When asking this question it would also be wise to ponder the following, How low is low? Markets are capable of making extreme moves and we should remember trees don't grow to the sky and markets don't go up forever. As someone who has traded commodities for decades I would strongly recommend anyone considering jumping into the super high risk snake pit of commodity trading to steer clear of it. While I have had victories I have also gone through a slew of painful losses and been bludgeoned by markets and price swings that have defied all logic. Adding to a traders pain and woes is that when you are caught on the bad side of an ugly trade the speed that a vicious market can dish out its brutal assault is usually extremely underestimated.  After over 30 years of trading commodities I will flat out state without any reservations that lies and manipulation run rampant. If you think anyone is looking out for the small independent trader in the stock market or commodity market you are wrong.

Who Predicted Oil Would Do This?
A recent article caught my interest, it said; It is always darkest before the dawn. In other words, the energy market could see crude-oil prices tumble further in the coming days after closing near seven-year lows. January West Texas Intermediate crude tumbled $2.32, or 5.8%, to settle at $37.65 a barrel. At least one chart pattern followed by technical analysts is pointing to more pain for the WTI contract as oil tilted below $37 a barrel in early Tuesday's trade. Talk has surfaced of 20 dollar oil at the same time some analyst said it is time for investors to jump in and "pick a bottom" pointing out energy stocks are now a bargain. History has shown that markets defy logic and our opinions are often wrong. Five years ago few market gurus predicted oil would be trade at such low prices today. It is difficult to say where the price of oil will be next month.  

After asking the question of how high is high I must also ask, how low is low? Markets can make extreme or wild moves that charts often are unable to predict. This means it is both dangerous and difficult to pick a market top or bottom. Various technical trading systems while indicating an overbought or oversold market fail when asked to answer these two questions that would make us infallible and legendary investors. Today markets have added a couple new dimensions that will play an interesting role in just how violent and savage price swings are going forward. One of those is that computers now do a great deal of the trading and they are programmed to prey on the weaknesses of human trader using computing programs that exploit where stops are placed, this improves their ability to wash the weak out of their positions. Another factor is many people have grown far to complacent.

The "buy the dip" mentality and the idea that the central banks coupled with the too big to fail financial institutions will keep these distorted markets elevated has become entrenched in the minds of many investors. This has lessened the importance of economic fundamentals and the question of how sustainable this market is. It has also put on the back-burner the question and issue of, how high is high.  I have seen and heard far too many comments by those bullish on higher equity prices and ever higher markets basing their strategy on a policy of  "don't fight the Fed" and "buy the dips." While this has worked since 2009 it is no guarantee that it will continue to produce positive results in the future. The "buy the dip mantra" will prove very costly when a real drop in the market does occur. A saying often used cautions traders they should never try to catch a falling knife.

One problem we face in the current stock market is a lack of traders holding short positions. Several of the stocks that were recently on strong uptrends appear at heart to be fundamentally unstable and may have been driven higher by bears capitulating and buying back their positions rather than market fundamentals. We have witnessed massive moves in several speculative stocks like Amazon, Tesla, and Netflix that are hard to defend by any other reasoning than shorts being squeezed out of the market. It is logical to think the higher a market goes the more vulnerable it becomes to a major violent decline or sudden savage downward price moves. A lack of short positions will bode poorly for the market if it falls rapidly because in such a situation as shorts take profit and buy back their positions they act as a floor under the market giving it support. The floor under this market is questionable and with contagion a growing concern it is understandable that junk bonds have begun to take a beating.

The point of this post is to remind all of us the world of investing is a dangerous place and that much of how people react to events depends on how things are set up or how the cards are stacked when things happen, develop, and unfold. We often see that market reaction has more to do with timing and perception rather than being driven by reality. The economy tends to develop loops that feed back upon themselves, to this market driver we must add cross border money flows, central bank intervention, currency manipulation, and derivatives. This is only part of the list of pitfalls we face when we develop expectations that drive prices . To top things off we should recognize that at any time an unexpected black swan crisis is always lurking in the wings. This reinforces the idea that we should remain humble in trying to answer the questions of, how high is high, and how low is low. I have learned some valuable lessons over the years, one markets don't go in just one direction, values constantly shift, and after you lose your money it is to late.

Sunday, December 6, 2015

How Americans Feel About The Economy / Taking America's Pulse

Buying Is Easy-Paying Is Hard!
A great deal of how we feel about the economy is usually based on what we hear and see. For much of America it simply comes down to has your child just lost or found a job and then issues such as what is the pay and their prospects going forward. Compounding the employment problem is trends in the type of jobs being created have not been favorable, many of them pay little and are only part-time positions. The issue of healthcare is also front and center, meaning how much will you have to pay and how will you and those in your family be affected as policy prices soar far faster than wages or inflation. To complicate matters our feeling can be temporarily skewed by the purchase of a new car or home that we may or may not be able to afford.

An Inconvenient Truth
The Fed's inability to get the economy off the bottom has been twisted into a "they are doing their best" story in the wake of difficult problems with a "we are better off than we were" spin. Many people have ignored how poisonous low-interest rates have hurt savers and how easy money has spurred poor allocation of capital. Adding to this confusion is that we should embrace a short-term economic prop that results from the Republican's almost jubilant capitulation on the recent budget deal. The general consensus is that the Republicans were in the unenviable position of being politically dammed for any pullback in the economy and would pay a huge price in the upcoming presidential election if they held fast and hard to cut spending. Sadly, while propping up spending this will only add to the exploding national debt.

Decades of overspending, undersaving, offshoring our jobs and a slew of bad habits coupled with bad policies have brought us to where we are today. It is easy to make promises, and we have made many, but the tough part is keeping them. It is hard to ignore that other than a very short-term stimulus or a temporary prop artificially low-interest rates have some rather bad and damaging side effects, if that were not true they would be the norm. In November of 2014, the national debt was poised to pass the 18 trillion mark. As of now, the National Debt Clock shows 777 billion dollars has been added to the total and the amount owed continues to grow. Ironically a big part of the discussion in both Democrat and the Republican presidential debates centers around growing inequality and jobs supporting the very important middle-class lifestyle that propels this county forward. As candidates elbowed each other aside to take credit for our few victories they made even greater efforts to distance themselves from the many failures.

Adding to the confusion is that some of the numbers put out there for us to absorb are somewhat questionable and based on facts or assumptions that carry rather negative implications.I counsel a lot of people who are out of their careers and have a family and can not find work. Many are taking out their pensions to live off of because they can not find work. That is going to be the next big crisis is all the people laid off or unemployed taking out their pensions."  It appears to me this is a big reason the labor participation rate should be front and center as well as the quality of the jobs being created. It is clear this does not paint a picture of a bountiful future.

Consider this a vivid reminder that success has many fathers and failure is an orphan, but at the end of the day we are left with reality, and as of late it is not a beautiful thing. To those who think all is well I would like to remind them of the old saying, "you can't tell a book by its cover". This means those with an agenda will go to extremes to spin news such as the recent job numbers, but what we are told could be wrong. When we delve a little deeper into the story of our economy sadly, we find it is not a tale of redemption and growth but a horror story based on deceit. The average American is not reading these words because they really don't care or prefer not to know about the problems we face. Timing is another issue, and it seems never a good time to bring up the bad news. This is why the masses often react with surprise and shock when reality raises its ugly head.

Saturday, December 5, 2015

Bond Market Bubble Ending Has Massive Ramifications

Is The Bond Market A Bubble?
Never before do I remember seeing so many predictions of interest rates remaining low forever and a day. Currently, it appears the whole world is trapped in an easy money low-interest rate environment with no way out. This is a sign that in the future a massive problem is developing and it holds huge economic ramifications and a great deal of risk. Many of us think the bond market is a bubble and when it pops it will leave a massive path of destruction in its wake, yet it is clear the general public is totally unaware of the ramifications it will have, these even extend down to reduced payouts on pensions.  A lot of money has rushed into government bonds in a flight to safety, and this has sent yields lower and lower. This may be part of a conundrum created by the reality of too much freshly printed money floating around and people needing someplace to stash it. In the world today investors look for large markets to park their money because it implies a degree of liquidity that insures a quick exit if necessary.

Many people have been caught off guard by the collapse of oil prices and the havoc they are causing in many markets. Even more of a concern should be a focused on what happens if a popping of the bond market bubble occurs. The idea of money quickly leaving the bond market should be a big concern to all governments. Bonds are not just issued by America but by countries all around the world. While some forecasters predict America is now set to grow at the fastest pace in a decade debt investors are signaling their skepticism as commodities plunge and slowdowns in Europe and Asia threaten the U.S. recovery. Recently the bond market's outlook for inflation over the next three decades fell below 1.9 percent annually. Investors’ expectations for consumer-price increases have diminished as the Federal Reserve debated how soon to raise its benchmark interest rate which has been held close to zero in an effort to support demand in the economy. It is hard to know if this is an indicator the marketplace feels comfortable that inflation is going to remain tepid or if concern for safety is driving this market, but I contend it is the later coupled with an influx of foreign capital and a strong dollar.

Many of us have a problem lending hard earned money out for a long period of time and we should be wary. Rates are based on predictions of future government deficits and events around the world that may or may not unfold as expected. It is not reassuring to know these forecasts are often formed and made on assumptions based on rosy scenarios or politically skewed to benefit those in power. Knowing of the effect that interest rates have on the value of bonds in the secondary markets, one might deduce that the 30-year bull run on bonds will have to come to an end the moment rates clearly signal they are about to rise. To give you a sense of what this may mean to U.S. Treasury Bond investors a 10-year treasury bond issued at a 2.82% interest rate could see a 42% loss in value from a mere 3% rise in interest rates. This means if you’d held $100,000 in these bonds prior to the rise in rates, you would only be able to sell those bonds for $58,000 in the secondary market after the 3% rise. Please note the $58,000 you get back would be before factoring in the loss of purchasing value lost from inflation.

A theory I have put forth in the past is that in light of rapidly growing global debt it might soon become apparent that storing your wealth in any kind of  "paper promise" is a bad idea. The term "liquidity trap" that has been used by Allen Greenspan and others can be difficult to understand. The result of such a trap can be that all the additional money poured into the system, even when coupled with lower rates, can no longer drive the economy forward. This would most likely happen when people realize the return on loaning money is simply not worth the risk!  Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? When this happens the only safe place to store wealth will be in "tangible assets" and other than those who print the money that nobody wants the only lenders will loan money for very short periods at super high rates. When this happens we are at the end game, the collapse of the economic efficiency of credit has powerful implications because credit is the lubricant that greases the wheels of commerce.

We should consider the possibility that inflation has been kept in check primarily because we as a society have invested a large percentage of our wealth into intangible products or goods such as stocks, bonds, and even currencies. If faith drops in intangible "promises" and money suddenly flows into tangible goods seeking a safe haven inflation would soar and this would drive interest rates upward. Like many of those who study the economy I worry about the massive number of promised being made and the debt being accumulated by governments, this all ties into the pace at which central banks have expanded the money supply. The timetable on which economic events unfold is often quite uneven and this supports the possibility of such an inflation scenario.  The current subsidizing of the auto, housing, and financial industry with an ad hoc disregard for basic economics produces a very flawed kind of growth. For years the ECB has manipulated bond rates lower for countries undeserving of such, as a result, Italy, and others have kept their debt service cost in check, but the fact is artificial rates from central banks mask and perpetuate a debt problem that will come back to haunt them.

The idea that markets are always efficient is a myth manufactured by so-called experts such as Paul Krugman in the ivory towers of academia. Disconnected from the real world those responsible for guiding our banking institutions often fail to see potential second and third order effects of debt monetization. In many ways, they pose one of the greatest threats to the stability of our economic system. A policy of blindly trusting anyone who claims to be an expert has disaster written all over it. If the bond market is indeed a bubble the implications of its collapse will be massive and such an event will not only affect bondholders but will test the economic foundations of both the country and the world. Not only will bondholders be stripped of wealth but soaring interest rates will magnify the nations debt service and rapidly impact our deficit in a negative way. It should never be forgotten that debts can go unpaid and promises are often left unfilled, the general impression that many people hold that it will be different this time will surely be tested.

Footnote; A bond bubble is a subject I wrote about a year ago and nothing has really changed since that time except debt has grown as growth remains tepid. If history has taught us anything it might be nothing stays the same forever. Below is a prior post concerning how in 1980 the Fed turned bonds on their ear by raising rates to 20% if you have the time it takes you down an interesting look at how we got to where we are today. As usual please feel free to explore the blog archives and as always you comments are encouraged.

Tuesday, December 1, 2015

China's Veiled Economy

To most of the world China's economy remains veiled behind a shroud and is far from transparent. Not only because China is far away from our shores, but because their economy is very controlled by a government that acts as its puppet master we often have a difficult time getting real information on what is happening. An all growth is good mentality that always included "building more and expanding more" has been China's mantra for years. The combination of these factors has lead to the massive credit trap that China now finds itself in. The lack of clean and precise numbers remains a problem because of political tinkering when it comes to economic data, this situation is magnified because the same government also extends its control over the media and even the internet. It often seems the only way the world would know the wheels had fallen off the economy would be if millions of Chinese hit the streets in protest and that is highly unlikely because China has heavily discouraged such actions for decades.

Money Supply Grew From $10 To $24 Trillion Since 2008
Over the years corruption has flourished in China and growth of credit has gone unchecked. It is the nature of political systems to mask their flaws and is the case of China years of rapid growth have made this easy. It is important to remember that much of the growth in China after 2008 came from a massive 6.6 trillion dollar stimulus program that expanded credit and poured massive amounts of money into the system. This encouraged expansion and construction with little regard as to real demand or need. When critics and those who see the economy of China as containing major defects have made efforts to voice their concerns and point out weaknesses in the system they often have a hard time being heard over the noise of those touting the message of China being a case of potential unleashed.

Even today while many people concede that growth has slowed they still refuse to recognize just how much of past growth has been constructed on a foundation of sand. This is written not to diminish the accomplishments of China or to question their progress, but to point out much of what we have witnessed is the result of one time factors that have largely played out. Several factors have drastically changed politically, socially and from a military perspective since the days when America fueled China's growth. Recently what many Americans viewed as a beneficial relationship has morphed into something akin to fear or resentment. The new military swagger from Beijing coupled with a massive loss of American manufacturing jobs and the theft of intellectual knowledge has left many Americans unenthusiastic over the massive trade deficit with China. I contend China is in far dire straights than most people imagine and the reason it has gone unnoticed is because of the control their government has over the economy which makes it impossible to get accurate or specifically detailed numbers and information.

We must remember Beijing has been hit by the perfect financial storm as forces from a closed capital account, independent monetary policy, and a tightly managed exchange rate all have decided to plummet the economy at the same time. The lack of clean numbers combined with an intentional transparency issue has created a "guessathon" where we are forced to scan the latest pricing on what cargo ships are charging and how busy ports across the world appear to be in an effort to determine what is really happening. A big problem is that an "economy" by its nature can easily trick, hide, or mislead us as to what is occurring off stage or festering in the wings. Reality is often obscured without effort, but when a government is in full propaganda mode in an effort to reassure its people that all is well it can become impossible to see through the fog. China has become a huge player in the game of world finance and merits far more attention than a country like Greece, but this means going to a lot of work to get the truth.

China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. For years credit expanded rapidly in China, and now much of the country is mired in debt. As Beijing pursued a strong yuan policy pegged to the U.S. dollar. Since 2005 the yuan has appreciated about 30%, this profited those who put money in China, but now that the economy of China has become very shaky a lot of investors are questioning the risk of holding yuan assets. Now the country is experiencing massive capital outflows as several events and the the pain of attempting to hold its currency peg to the U.S. dollar finally became unbearable.  The  PBOC is under tremendous pressure as the responsibility of holding this mess together rest solidly on their shoulders. A massive scheme for the state to buy stock shares to halt a falling market while dealing with near bankrupt municipal authorities is only part of the woes they face.

Total Debt Is Soaring
Four big state-owned commercial banks and other mainly state-controlled banks account for nearly all official lending in China and their customers are largely state-owned firms. This has left little room for private banks and this means informal lending in China has grown rapidly over the past five years and even local governments borrow from the shadow banks. No one really knows how big the shadow banking sector has become, but shadow loans are estimated to make up 20% of all loans. This is only one of the problems that has developed and skewed China's development as the government controlled the economy from behind the curtain. For years the people of China have had the habit of saving much of what they earn but the low interest rates paid at banks has not rewarded savers, this is reflected by growth in the shadow banks and the fact much of their money has drifted into a bizarre housing market where prices are sky high. 

It is understood that China’s current-account surpluses have fueled its huge money-supply growth within a largely pegged currency over the years. As foreign exchange piled up, the People’s Bank of China continued to print more yuan. According to some estimates, China’s banking system has grown from $10 trillion to $24 trillion since 2008, but now the reverse may happen, if the yuan weakens, the central bank will effectively have to buy its own currency using foreign reserves to maintain its peg. This could mean the external trade position would now cause the central bank to shrink domestic money supply. Beijing will need to get used to the market forced deleveraging and slower growth. It is clear the economic efficiency of credit has started to collapse in China and the unwinding of its giant credit spree looks to be very painful.  All this plays into the view we all going to witness an overall deterioration that makes it logical for investors to get out of both the yuan and China. Expect to see a continuation of wealth leaving China and fleeing towards safety.

  Footnote; Please feel free to explore the blog archives and as always you comments are encouraged. For more on China see any of the post below,