Michael Bond: The discussion of bubbles applies to both the US and China today, the two largest economies. Yet it is China that is taking steps to reign theirs in with follow-on consequences for our own. What most will miss is that if China pulls back from its own Gilded age and redistributes its wealth, they can transition to a consumer economy faster and sustainable economic growth will increase over time.
We need to do the same. In the meantime the global financial markets are at risk. It is important to understand that in times of global financial stress money flows to safety first and that includes US Treasuries and US Mega Cap stocks as a precursor to deep market corrections.
Weary of Their Capitalism Experiment
by Doug Noland
Bubbles are self-reinforcing, yet inevitably unsustainable inflation. There are different types of Bubbles – Credit and speculative asset Bubbles being the most common. Inflationary processes are fed by some extraordinary monetary phenomena, with protracted Bubbles invariably enjoying systematic governmental support (i.e. loose central bank policies, government incentives and backstops, stimulus measures, etc.). As I’m fond of saying, “Bubbles go to unimaginable extremes – then double.” “Quadruple” seems more applicable these days.
Fundamentally, Bubbles at their core are mechanisms of wealth redistribution and destruction, though for some time pernicious effects tend to be masked by the Bubble Illusion of fantastic development, innovation and expanding prosperity. Bubble-related inequality intensifies over the life of the cycle, turning highly destabilizing late in the Bubble period. Wealth and (financial and market) power become increasingly concentrated. Governments face mounting pressure – from an increasingly disaffected populace, as well as from the inordinately powerful financial and corporate sectors. Panicky governmental measures to hold collapse at bay invariably become instrumental in climactic “Terminal Phase” blow-off excess.
I’ll add that Bubble consequences are anathema to communist governments. That said, the overpowering seduction of “fantastic development, innovation and broad-based prosperity” can prove irresistible. This has especially been the case for a nation tenaciously determined to attain what it views as its rightful standing as a global superpower.
It’s a challenge to place the historic Chinese Bubble into proper context. Chinese Bank Assets have inflated more than 10-fold from 2004’s $4.5 TN to June 2021’s $52 TN. China ended Q1 with a debt-to-GDP ratio of 329% (IIF data), having doubled since the 2008 crisis. And while the latest iteration of Aggregate Financing (China’s measure of broad Credit growth) dates back only to 2017, it captures the parabolic nature of late-cycle excess. Aggregate Financing has inflated $7.9 TN, or 18%, over the past 17 months to $46.7 TN, with growth since 2017 at $18.3 TN, or 64%.
China has never experienced such spectacular wealth. Their over 1,000 billionaires exceed even the U.S. A booming equities market has lavishly rewarded entrepreneurs and corporate executives, along with the mass of speculators – including the thousands of Chinese hedge funds that have sprung up, along with millions of online retail speculators. But when it comes to bountiful growth in perceived wealth, a large segment of the population has enjoyed previously unimaginable gains from apartment price inflation.
Beijing has accumulated a $3.34 TN international reserves war chest, bolstered by years of U.S. trade deficits and global “hot money” flows. These reserves have been instrumental in China’s capacity to continue years of profligacy without typical emerging market boom and bust dynamics. Links from Fed QE to China’s boom are rather direct.
China’s ascendancy on the world stage mirrors the trajectory of its Credit expansion. The “Nine Dash Line” and militarization of the South China Sea. The Belt and Road initiative. Their uncompromising approach to U.S. trade negotiations. The Hong Kong crackdown. Playing hardball with Australia and others. Military drills off the coast of Taiwan. Negotiations with the Taliban. Partnered with Russia, China is building a global faction to rival the U.S.-led western alliance.
Beijing adopted markets and capitalistic development as necessary expedients to meet its developmental and geopolitical objectives. Bubbles inflated – and ran unchecked. Beijing repeatedly moved to rein in excess – and repeatedly lost its nerve and backed off. To be sure, Bubbles feed off timid policymaking. The communist party recognized in 2017 that Bubbles and associated inequality had become serious risks. A more determined effort to get the Bubble under control was scuttled, however, first because of acrimonious Trump trade negotiations, and then in response to Covid. The pandemic response saw parabolic Credit excess like never before.
President Xi and Chinese leadership have grown Weary of Their Experiment in Capitalism. It served its purpose, but has turned increasingly problematic. They clearly appreciate the risks associated with Bubbles and inequality – perhaps even recognizing the existential threat.
“Xi Jinping Takes Aim at the Gross Inequalities of China’s ‘Gilded Age’,” was the title of Friday’s (August 20th) insightful Financial Times opinion piece authored by James Kynge:
“Having spent four decades creating one of the most unequal societies on Earth, Beijing is now seized by a mantra of ‘common prosperity’ — or redistributing spoils to hundreds of millions of have-nots… ‘There is a sea-change in the way the Chinese Communist party sees its legitimacy,’ said Yu Jie, a researcher at Chatham House, a London-based think-tank. ‘Xi is addressing ordinary peoples’ agonies over unequal distribution of income and the lack of equal access to basic social welfare and some services.’ A commission led by Xi issued a call to arms this week. It said China would ‘regulate excessively high incomes and encourage high-income groups and enterprises to return more to society’. While the party had long allowed some people and regions to ‘get rich first’, it was now prioritising ‘common prosperity for all’. At stake is the CCP’s social contract with China’s people, Yu said. ‘If the party defends the current status quo that is manifestly unfair in its distribution of wealth and opportunity, trust from ordinary people will collapse.’”
Of course, Beijing today seeks to redistribute wealth. Mr. Kynge’s article notes that “some 600m Chinese live off a monthly income of about Rmb1,000 ($154).” Beijing finds the momentous power achieved by China’s big Internet companies as unacceptable. They are determined to crack down on various industries they see as promoting inequality or offering socially undesirable goods and services. They will now insist on the communist party having a hand in everything of significant importance. And in no way are they willing to now tolerate market forces dictating the nature of the cycle’s downside. Beijing is seizing the reins.
This week offered important confirmation of the faltering China Bubble thesis. It has become increasingly clear Beijing is determined to impose a radical shift in the flow of finance, investment, and the allocation of resources and wealth throughout the entire Chinese economy. And while government measures can certainly dictate lending and real investment, I don’t see how a destabilizing interruption in the flow of finance and speculative deleveraging can be avoided at this point.
The risk versus reward calculus for speculative endeavors has been momentously altered, albeit for stocks, corporate Credit and real estate. China’s Bubbles are in serious jeopardy – and I would now expect de-risking/deleveraging to gain momentum. Unfolding dynamics are putting China’s historic apartment Bubble at grave risk, especially for the highly inflated upper end. The week was notable for faltering Chinese Bubble contagion destabilizing global markets.
The Shanghai Composite dropped 2.5% this week, with the growth-oriented ChiNext Index sinking 4.6%. Hong Kong’s Hang Seng Index was slammed 5.8%. South Korea’s KOSPI fell 3.5%, and Taiwan’s TAIEX Index dropped 3.8%. Japan’s Nikkei lost 3.4%. Stocks were hit 2.6% in Brazil.
The Bloomberg Commodities Index slumped 4.2% this week. WTI Crude sank $6.30, or 10.6%. Industrial metals were under heavy liquidation. Copper fell 5.9%, Lead 3.6%, Nickel 6.1%, Tin 8.7%, and Zinc 3.5%. Palladium was crushed 14.3%. Iron Ore fell 6.3% (down 38% from May high to a 2021 low) and Steel Rebar 4.5%. Curiously, the soft commodities were also under pressure. Wheat dropped 5.9%, Corn 6.3%, Soybeans 9.2%, Rubber 4.7%, Coffee 2.5% and Sugar 1.9%.
Contagion erupted also in global currency markets, with the commodity currencies under notable pressure. Leading on the downside, the South African rand declined 3.7%, the Australian dollar 3.2%, the New Zealand dollar 2.9%, the Norwegian krone 2.5%, the Brazilian real 2.5%, the Canadian dollar 2.4%, and the Mexican peso 2.4%. China’s renminbi declined 0.37% versus the dollar.
It evolved over years into a distinctive global Bubble Dynamic, with highly synchronized risk markets across the globe. China emerged as the marginal source of global Credit, speculative leverage, demand for commodities, and much more. U.S. market immunity to China’s faltering Bubble began to fade this week. So far, “risk off” has been relegated to the “fringe” – with small cap weakness and hints of risk aversion in junk debt. But I would expect de-risking/deleveraging to begin gravitating from the “Periphery” toward the “Core.”
Ten-year Treasury yields dipped two bps this week to 1.26%, a rather uninspiring gain considering China and global market developments. This raises the question of how much support the Treasury market has left to offer in the event of an intensifying “risk off” dynamic. I believe a major global de-risking/deleveraging dynamic has commenced in China and Asia. U.S. “investors” seem oblivious to the risk posed to our highly speculative markets in equities, corporate Credit and derivatives.
Original Post 21 August 2021
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Categories: Doug Noland