Saturday, November 17, 2018

Strongly Linked China And Japan Are The Storm's Center

China And Japan As Part Of Global GDP (click to enlarge)
The IMF, the World Bank, and the United Nations all rank China and Japan as the second and third largest economies on the planet, together they are responsible for around 21% of global GDP. Cutting to the chase, much of what is happening in the markets is all about China and Japan which are strongly linked economically. Just over a year ago as China ending its 19th National Congress where the theme was all about a "new era" for China and how the country was about to take "center stage in the world" some of us noted all was not well. Those seeing flaws in the Chinese economy found it difficult to ignore that China's central bank had warned extreme credit creation and trouble in the shadow banking system could lead to a full-blown financial crisis. Even with this warning the People's Bank Of China continued pumping out liquidity knowing that if they stopped the whole system might seize up and cease to function, on the other hand, such actions only create more problems going forward.

So much for the assumption that many people hold that this particular kind of crisis cannot develop in a state-run financial system like China's where the banks are under Communist Party control. Wake up folks, you are delusional if you think any financial system or banking system is not under similar control. Whether it is the Fed or the BOJ politics do matter and those in charge of such institutions do not put the general public first. As for the title of this piece. "Strongly Linked China And Japan Are The Storm's Center" it should be noted that Japan was added because they currently lead the way in a new central bank experiment to ignore debt and print their way to glory by using the money they print to purchase equities. By doing so Japan is in effect nationalizing companies and transferring ownership from the private to the public sector.

A matter that has not garnered enough attention is how economic problems that develop in China will spill over and directly impact Japan. The Japanese economy is very vulnerable to a negative feedback loop that could have strong ramifications on its economy. While a strong distrust possibly even a dislike between the people and cultures exists, years ago the two countries joined together in an effort to maximize profiting from exporting to America. Over the years this relationship has morphed into an almost full-blown interdependence. This has intensified as China and Japan became major trading partners with Japanese direct investments surging and Japanese technology playing a critical role in the development and competitiveness of China’s global supply chains. In some ways, the two have become joined at the hip.

China Plays A Corrupt Game That Will Not End Well
Returning to the subject of China, today China faces a possible Minsky Moment, the tipping point when credit cycles break and euphoric booms collapse under their own weight. Asset speculation and property bubbles may have finally reached the point where they pose a “systemic financial risk” made worse by the plethora of wealth management products, trusts, and off-books lending taking place throughout the country. Corporate debt has reached disturbingly high levels and local governments are using tricks to evade credit curbs. This is why it may be appropriate to ask if China is about to follow in the footsteps of Japan and embark on a "lost decade" of its own.

With this being stated, we should not underestimate the strong bonds between China and Japan or the amount of corruption that runs through the Chinese economy. We should also remember it is not in the interest of Japan to see the yen strengthen because of the impact it has on their ability to export. In the same way that many people overestimated the strength of the Soviet Union prior to its fall in December of 1991 or the Japanese economy from 1986 to 1991, today people tend to exaggerate the strength of China. When Japan slipped from grace the real estate and stock market prices which were greatly inflated before its massive bubble burst in early 1992 crashed causing the "lost decades" and the problems that still haunt them today. I contend we do the same with China's economy, it seems Americans tend to supersize anything they can conjure up as a challenge to their supremacy.

While most Americans are familiar with the saying, "anything that happens in Vegas stays in Vegas" it has become very apparent that in our global economy things that happen in China do not stay in China and the same can be said of Japan.. This is obvious from the huge amount of wealth fleeing China over the last few years. While this has been downplayed by many economists that are busy with charts searching for what they call growth, the money flowing across porous borders has become very obvious to those of us that watched as house prices soared in Vancouver and most of Australia. Note both China and Japan have been busy supporting zombie companies and not allowing them to fail in an effort to convince the world all is well. These countries are strongly linked and both very big players in the global economy, also both have taken an unsustainable path forward, when either fails the other will be pressured so, look out below!

Footnote; Debt defaults can be quite ugly and have huge ramifications on the economy. Below is the link to first part of a three-part series that explores such an occurrence.
 https://A Minsky Moment Is When The Debt Pyramid Collapses .html

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