What’s next?

August 27th, 2015

Five decent reasons that the world is in big trouble. Our view is very different. The US has had 6-7 years of subpar growth and no meaningful inflation, and that’s with QE plus China’s spending spree. Without them it would have been much worse. If the Fed now wants to raise interest rates, as many continue to suggest, why doesn’t the Treasury 10x increase the sales of the 30 year bond, compared to the minuscule $16 billion in May? That’s the easy way and we won’t have to listen to the Fed Chair do her Hamlet routine every month; BTW China has now begun selling Treasuries, so Hamlet is off the hook for the moment.

There may be a new twist in this old story, one that explains how you can have massive QE without inflation. The amazing technology advances wrought in a decade since the 2007 iPhone and its competitors, the emergence of Google-world, and the maturing of computerized production of consumer and industrial equipment have not typically been factored into the calculations of the global financial situation. Normally, you’d see in a period of monetary easing on the order of QE4 some strong inflationary pressures but that has not happened. We think the world has gotten a bailout from technology in this crazy period.

In the current environment we’d also add to the good news story the absence of the toxic $60 trillion CDS’s that we’ve discussed at length, and we have a very different and much better situation than that which existed 7 years ago. Without a surprise, we expect the West to do pretty well, while the BRIC’s (and certain socialist theorists) have a tough time until they get their acts together. We’ll see.

$27 or $28 trillion in debt — pretty soon it adds up to real money

August 26th, 2015

Andrew Ross Sorkin:

Kenneth Rogoff has long warned of a potential financial crisis in China. Mr. Rogoff, a professor of economics at Harvard University, accurately predicted the eurozone debt crisis and for years has been telling anyone who would listen that China posed the next big threat to the global economy. He is starting to look right, again.

“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could,” Mr. Rogoff said on Monday from Cambridge, Mass., repeating a favorite line from Rudi Dornbusch, the German economist. (Mr. Rogoff sat in on Mr. Dornbusch’s class at M.I.T. in 1977.)

Mr. Rogoff, who is a chess grandmaster, has made a career of studying financial crises. After the 2008 financial crisis, Mr. Rogoff co-wrote “This Time Is Different,” a seminal book that examined eight centuries of financial crises. Every financial crisis, he and his co-author, Carmen M. Reinhart, concluded, stems from the same simple problem: too much debt.

To understand the wild machinations of the stock market in recent days in the United States and abroad, you need to look no further than China’s astounding debt load and sputtering economy — and its ability to infect the rest of the world.

“China is the classic ‘This time is different’ story,” Mr. Rogoff said, rattling off all the different rationalizations for why the country convinced itself — and many others — that it could load up on debt but was somehow immune to the laws of economic gravity. He cited the government’s control over the markets, the hundreds of millions of workers migrating to cities and the country’s saving rate of about 30 percent of disposable income as just some of the reasons China was said to be impervious to a severe downturn.

“It’s very vulnerable,” Mr. Rogoff added. “There is a lot of debt.” How much debt remains an open question, given the opacity of China’s market. The country’s debt load rose from $7 trillion in 2007 to $28 trillion by mid-2014, according to a report published earlier this year by the consulting firm McKinsey & Company, China.

“At 282 percent of G.D.P., China’s debt as a share of G.D.P., while manageable, is larger than that of the United States or Germany,” said the McKinsey study. “Several factors are worrisome: Half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.”

Excerpts from Ambrose Evans-Pritchard:

The world financial system is at a dangerous juncture. Markets no longer believe that China’s Communist leaders are in full control of the country’s $27 trillion debt bubble, or know how to manage fast-moving events beyond their ken. This could be the early stage of a very serious situation,” said Larry Summers, the former US Treasury Secretary. He compared it to the two spasms of the Asian crisis in the summer of 1997 and again in August 1998. Ominously, he also compared it to the “heart attack” of August 2007.

Professor Christopher Balding from Peking University wrote on FT Alphaville that China is lurching from one incoherent policy to another, shedding credibility and its aura of omnipotence at every stage. “There is a very real risk that Beijing is losing control of the story,” he said. The speed with which this episode has now engulfed US markets – trading at 50pc above their historic average on the long-term Shiller price/earnings ratio, and primed for trouble – suggests that events could all too easily metastasize into a self-perpetuating crisis of confidence.

Martin Feldstein sees the market troubles coming from QE by the Fed. Our view is pretty idiosyncratic. The US has had 6-7 years of subpar growth and no meaningful inflation, and that’s with QE plus China’s spending spree. Without them it would have been much worse. If the Fed now wants to raise interest rates, as many continue to suggest, why doesn’t the Treasury 10x increase the sales of the 30 year bond, compared to the minuscule $16 billion in May?

Final point: with the $27-28 trillion China debt versus their $8-10 trillion GDP (who knows what the real number is?), China really needs to put in place a comprehensive Action Plan ASAP, but it will be shocking if it does. We suspect that the problem is that the people with the knowledge to do so and the people who can make such decisions are two distinct groups that do not overlap.

More stupidization

August 25th, 2015

More idiocy from the nation’s leading universities and elsewhere. Bonus fun: guess who caused the stock market’s problems. Yup, it’s him. And did you know this: “The last time America slammed the immigration door shut, in 1929, with the implementation of President Coolidge’s great mistake, the Johnson-Reed Act of 1924, a stock market crash and the Great Depression followed.” The Johnson-Reed Act? Never heard of it. Here’s the real story.

Katy bar the door……..but wait!

August 25th, 2015

At the end of a piece the other day, we said Katy bar the door if Shanghai and Shenzhen were down big again Monday. And that happened of course, but it’s no big deal, at least in the US. It’s pretty much a buying opportunity here. (For hedge funds that bet big on solar or commodities it’s another matter entirely, and we expect a few corpses; the real contagion threat is if, in unwinding loser positions they somehow impact the financial system itself.) As for China, they’re not very far down the learning curve on market economics and business management. They responded to the 2008 global meltdown by building things, anywhere, anytime, useful or not, and added $5 trillion, $7 trillion or whatever in debt in the process. What they need to do now is obvious (action plan suggested here), but we rather doubt they will be able to pull such a comprehensive plan together quickly. Instead, the WSJ reports the PBOC is planning to lower reserve requirements, which is kind of pathetic and sad. (BTW, in the US we have our own version of the Chinese leadership’s level of understanding of private sector market economics.) So this is going to take a while for China, given the kinds of systemic problems that IBD and others identified a decade ago.

Stupidization continues apace

August 24th, 2015

We discussed this first in How Your iPod is ruining America; ah, sweet nostalgia for 2005. Then a couple of years later in a piece noting that it wasn’t that long ago that many people knew farmers and soldiers, and very few do now. It’s a different world, and in many ways not a better one. For today we’ll follow up with the current Beloit list, and a sampling of some of the fine courses available at college today. Finally, on a lighter note, we direct your attention to the 4th cartoon from the bottom of this entertaining list. Cheers!

Is it 2008 again or is it something else?

August 23rd, 2015

It all began around now in 2007 with the Bear Stearns conference call about the lousy fixed income market and sub-prime mortgage problems, government-caused but the banks were willing players while the getting was good. Shortly thereafter in 2008 Bear was gone, then Merrill, and oil went to $147 a barrel, which itself was nuts and unsustainable. (We recall Goldman and others said $200 oil was just around the corner, probably talking their book.) Then AIG cratered and got a bailout, then the government’s idiotic decision to let Lehman fail, then world credit markets seized up. In the background was a murky risk that turned a bad situation into a catastrophe, the roughly $60 trillion in Credit Default Swaps that ceased to hedge anything when counterparty institutions vanished from the face of the earth.

Today it’s China that’s the problem. Its slow growth and industrial overcapacity have oil at $40 (and maybe heading for $20). The big China banks have a lot of bad loans that they haven’t written off, as we’ve discussed at length (eg, here and here). Certainly the numbers are a multiple of official estimates. But so what? China’s loan issues seem to us first-generation bad banking (inflated collateral values, crony deals, bad audits, simple stuff).

Proposed Action Plan: use enormous central government borrowing capacity to refinance provincial debt, take the corporate write-offs, put in capital from the $3.6 trillion in forex reserves, restructure and merge companies in whatever the China equivalent of Chapter 11 is, and move on. We can’t understand why this is particularly bad for the US. The US is primarily a service economy. Industrial commodities 15% price slide in the last 8 months makes imports cheaper for the US and Europe. Industrial exporters like Caterpillar have already taken big hits. Technology continues to boom in unprecedented ways, making everything cheaper and faster. So what’s up with a 1000 point loss in the Dow in a week? Others are asking that question too.

Why then a panic that feels a lot like 2008 from time to time? (Single name CDS’s are apparently half what they were then.) Maybe China’s 260% of GDP debt is too hard to fix. Maybe the overcapacity in China has been underestimated by an order of magnitude. So what? It’s not our problem. Of course, as with CDS’s in 2008, perhaps the hedge fund industry of today has cooked up instruments that can cause just as much mischief. There’s either a big unknown out there that we just can’t see at present, or Fox Business and CNBC can return to showing commercials in the NYSE’s last trading hour. We’ll know more perhaps when Shanghai and Shenzhen open on Monday.

1-2 punch

August 23rd, 2015

Enjoy this and this. Or perhaps you’re more comfortable with this. We think the first two are on to something, and we have a hard time understanding why Krauthammer and Will are getting the vapors.

Up through the ground come a bubblin’ crude

August 22nd, 2015

A. Gary Shilling, who’s been around a long time:

I’m sticking with my forecast of $10 to $20 a barrel. The logic behind that February projection still seems valid. Cartels exist to keep prices above equilibrium. But that encourages cheating, as cartel members want more than their allotted share and outsiders sell more to take advantage of the artificially elevated price. So the job of the cartel leader — in OPEC’s case, Saudi Arabia — is to cut its production to accommodate the cheaters and prevent a price collapse. The Saudis had been doing that for decades, and as a result, OPEC production over the last 10 years has been flat, with all the growth instead enjoyed by non-OPEC producers, including U.S. frackers and Canadian oil-sands companies.

The Saudis got tired of seeing their market share shift to others, so they and the other financially strong Persian Gulf producers decided to play a high-level game of chicken. They figured, in that Nov. 27 OPEC meeting, that they could withstand low oil prices longer than the cheaters. So they effectively abandoned quotas. OPEC production last month was 31.5 million barrels a day, the highest since May 2012 and up 1.5 million barrels a day from the previous ceiling. The Saudis themselves are producing a record 10.35 million barrels a day.

In this war, the chicken-out price isn’t what’s needed to meet budget requirements, which ranges between $40 a barrel in Kuwait and $125 a barrel in Venezuela. It isn’t the cost of drilling, pipeline laying and other overhead expenses, either. No, it’s the marginal cost of getting the oil out of the ground once the wells are drilled, the pipelines laid and the overhead covered. It’s the price at which cash flow for an additional barrel drops to zero. In Texas’s Permian Basin and in the Persian Gulf, the marginal cost is $10 to $20 a barrel, and even lower for some Saudi oil fields.

As long as prices exceed marginal cost, more (not less) production is encouraged to make up for lost revenue. Some producers will raise output even at prices below marginal costs. Russia depends on energy exports to cover import costs and government spending. With the collapse in oil prices and Western sanctions, Russia is desperate for anything that will earn foreign exchange.

Even bankruptcies, such as KKR’s planned filing for Samson Resources Corp., won’t reduce output. In bankruptcy, highly leveraged companies shed their debt service, which lowers operating costs. KKR’s 2011 buyout of Samson left it with $3.6 billion in debt.

Meanwhile, all-in costs for U.S. fracking continue to plummet. OPEC believes that many projects in North Dakota are profitable at $24 to $41 a barrel. Lots of forecasters were deceived by the drop in working U.S. oil rigs, which fell from 1,931 in September 2014 to 1,917 last November to 884 in mid-August. Old vertical drilling rigs were taken out of service while the remaining horizontal drillers produced more wells per rig.

Hard to know where all this goes, but we’re suddenly optimistic reading this. Dramatically lower factor prices — lowest in 13 years for commodities — should be a good thing for growth, right? And technology is moving faster than ever, much faster than in the bad old days of 2008, right? And China has problems, but at least they don’t have to pretend they don’t anymore, since everyone knows now, and that should enable a whole set of growth initiatives that previously had to be done clandestinely, right? But still the Dow was off 531 points. BTW, we expect Shanghai and Shenzhen to be up pretty big on Monday. If they head south big time again, Katy bar the door.

Micro-aggressions beget Macro-mouth

August 21st, 2015

The top of the hour CBS news just said that July was the hottest month in history on the planet and that Jenner could have charges filed against “her” in some accident in Malibu. Stupidization continues apace. Bill Whittle understates the problem BTW.

More than a generation of Americans has been reared on the canons of stupidization and live in a country where thinking and speaking plain talk are often pretty much crimes. And one of the strangest things is that the media-politico elites on the conservative side have accepted this cultural rot as a given. So they shriek as loudly as their bretheren on the left when along comes Macro-mouth, saying things that were uncontroversial when we were young.

He’s had the good fortune to latch onto an issue that’s potentially a big winner, so much so that even some commenters over at the NYT seem to agree. (BTW, we’ve heard Donald Trump in discussions with thoughtful interviewers like Hugh Hewitt, and he’s quite good.) We have no idea where this is going, but one of the things Trump is doing is taking back plain language. This is called vulgarity by conservatives who sip their tea with pinky extended, but such vulgarity is desperately needed in a country where the young people have been taught that euphemism is the norm and plain talk is a crime.

Orange is the new black

August 20th, 2015

Take a look. Ugh. Let’s suppose you’re a cabinet secretary whose brief includes international relations and negotiations with foreign powers on military and similar matters. Further, you’re not sitting in your office; you’re always on the road visiting 112 countries. On how many of your 1470 days in office did you not receive an email containing confidential material?

Bonus fun: some guy we never heard of is a fool and worse.

Hey, must be the money

August 19th, 2015

No not Nelly, Ron Radosh, who notes that populism is back big time in both parties. Sanders and Trump are fun to watch and they sometimes even agree; politics hasn’t been this entertaining in a very long time. As for the tut-tutting from their betters in the media-politico establishment, what nasty scolds these worthies often seem. Why the genuine anger and nastiness from this claque, particularly towards Trump? There are several reasons but we want to note the Emperor’s New Clothes element in this often delightful farce. Both sides in the politico-media cartel have been living off the skim for a long time now, and living very well indeed. Very quietly with a wink and a nod to each other. One side skims off the $4 trillion federal spending, the other skims off corporate sponsors who pay to erect corporate barriers to entry and do the opposite when it comes to immigration. And both sides have High Moral Ground justifications for their smarmy behavior, possibly to conceal their creepiness from themselves and certainly to conceal it from the public. No wonder that so many in the politico-media comfort zone have gotten the vapors from hearing “vulgarities” and have gone off the deep end.

Who knew or dreamed that this could happen, and this fast?

August 18th, 2015

Who knew that we had descended so low that only an outlier says this:

1) A nation without borders is not a nation. There must be a wall across the southern border. 2) A nation without laws is not a nation. Laws passed in accordance with our Constitutional system of government must be enforced. 3) A nation that does not serve its own citizens is not a nation. Any immigration plan must improve jobs, wages and security for all Americans.

That these things are controversial crystalizes the stupidization of America.

More numbers

August 17th, 2015

Excerpted from Stockman:

the Chinese steel industry grew by 11X during the last 20 years, expanding from 125 million tons, which was already larger than the US and Japanese steel industries in the mid-1990s, to 1.1 billion tons today. But neither China nor the world can use that much steel, even as China’s aggressive “dumping” on the world market gathers force. China’s steel production is already swooning —– with output in the most recent month down nearly 5% Y/Y and prices off 26% since January and 55% since the three-year ago peak. During the first half of 2015, China’s large and medium steel mills spewed $3.5 billion of red ink, and that just a warm up for the carnage yet to come. China has upwards of 400- 500 million tons of steel capacity that will be idle once its construction boom stops and the rest of the world throws barriers up against its exports. The idling of China’s giant steel mills will cause a collapse of business, employment and incomes up and down the iron and steel food chain. China’s construction infrastructure is grotesquely overbuilt from cement kilns, to construction equipment manufacturers and distributors, to sand and gravel movers, to construction site vendors. In three recent years China used more cement than did the United States during the entire 20th century

He doesn’t think the signals are conflicting. WRM has similar thoughts and the prose is less purple.

Humor from an unusual source

August 16th, 2015

A campaign ad from Maureen Dowd?

Into the valley of death rode the 600

August 15th, 2015

Not our favorite guy, but he got this one right about the retreat, but that’s not really the point, since we chose to get involved in a multi-century disaster. So many things we collectively just didn’t know in 2003. To what extent the senior advisors to President Bush were unaware of this ideology and the 1400 year war going on in the Middle East is certainly unforgivable among people who are paid to know these things and have lived in that world for decades.

Austrian School analysis

August 14th, 2015

Kevin Williianson. As Ed McMahon used to say: you are correct sir!

Conflicting signals, again

August 13th, 2015

AEP:

Chinese companies have borrowed huge sums in US dollars on off-shore markets to circumvent lending curbs at home, and these are typically the weakest firms shut off from China’s banking system.

Hans Redeker from Morgan Stanley says short-term dollar liabilities reached $1.3 trillion earlier this year. “This is 9.5pc of Chinese GDP. When short-term foreign debt reaches this level in emerging markets it is a perfect indicator of coming stress. It is exactly what we saw in the Asian crisis in the 1990s,” he said.

Devaluation would risk setting off serious capital flight, far beyond the sort of outflows seen so far – with estimates varying from $400bn to $800bn over the last five quarters. This could spin out of control easily if markets suspect that Beijing is itself fanning the flames. While the PBOC could counter outflows by running down reserves – as it is already doing to a degree, at a pace of $15bn a month – such a policy entails automatic monetary tightening and might make matters worse.

The slowdown in China is not yet serious enough to justify such a risk. True, the trade-weighted exchange rate has soared 22pc since mid-2012, the result of being strapped to a rocketing dollar at the wrong moment. The yuan is up 60pc against the Japanese yen.

This loss of competitiveness has been painful – and is getting worse as the shrinking supply of migrant labour from the countryside pushes up wages – but it was not the chief cause of the crunch in the first half of the year.

The economy hit a brick wall because monetary and fiscal policy were too tight. The authorities failed to act as falling inflation pushed one-year borrowing costs in real terms from zero in 2011 to 5pc by the end of 2014.

They also failed to anticipate a “fiscal cliff” earlier this year as official revenue from land sales collapsed, and local governments were prohibited from bank borrowing — understandably perhaps given debts of $5 trillion.

Nomura says monetary policy is now as loose as in the depths of the post-Lehman crisis. Its ‘growth surprise index’ for China touched bottom in May and is now signalling a “strong rebound”.

Capital Economics said bank loans jumped to 15.5pc in June, the fastest pace since 2012. “There are already signs that policy easing is gaining traction,” it said.

It is worth remembering that the authorities are no longer targeting headline growth. Their lode star these days is employment, a far more relevant gauge for the survival of the Communist regime. On this score, there is no great drama. The economy generated 7.2m extra jobs in the first half half of 2015, well ahead of the 10m annual target.

Few dispute that China is in trouble. Credit has been stretched to the limit and beyond. The jump in debt from 120pc to 260pc of GDP in seven years is unprecedented in any major economy in modern times.

For sheer intensity of credit excess, it is twice the level of Japan’s Nikkei bubble in the late 1980s, and I doubt that it will end any better. At least Japan was already rich when it let rip. China faces much the same demographic crisis before it crosses the development threshold.

It is in any case wrestling with an impossible contradiction: aspiring to hi-tech growth on the economic cutting edge, yet under top-down Communist party control and spreading repression. That way lies the middle income trap, the curse of all authoritarian regimes that fail to reform in time.

Yet this is a story for the next fifteen years. The Communist Party has not yet run out of stimulus and is clearly deploying the state banking system to engineer yet another mini-cycle right now. One day China will pull the lever and nothing will happen. We are not there yet.

This reminds us of another AEP piece from December 2007, when there also were conflicting signals. A few months later Bear was gone and things did not go so well after that.

A different take

August 12th, 2015

Bloomberg, 7 August:

China’s foreign-exchange reserves fell for a third month as the central bank kept the yuan steady against the dollar amid capital outflows and plunging stocks. The reserves declined by $43 billion in July to $3.65 trillion, the least since August 2013, the People’s Bank of China said Friday. The holdings, which are more than triple the size of any other country’s, shrank in each of the last four quarters as the central bank bought yuan to stabilize the exchange rate. The currency’s closing levels in Shanghai this week have matched the tightest range recorded since a greenback peg ended a decade ago.

“The drop reflects the central bank’s intervention in the market to keep the yuan stable, as well as the continued capital outflows,” said Li Miaoxian, a Beijing-based economist at Bocom International Holdings Co.

China has been limiting yuan moves to encourage greater global use as it seeks to have it added to the International Monetary Fund’s reserve-currency basket at a review in November. A 28 percent slump in the Shanghai Composite Index of shares from a mid-June peak has boosted outflows and demand for the dollar. This is the first time the PBOC has announced the foreign-reserves data on a monthly basis. The Chinese central bank, which used to release the figures each quarter, has adopted stricter IMF norms to improve data transparency as part of its reserve-currency bid.

A decade ago we noted studies of bad loans at Chinese banks. China uses its foreign-exchange reserves for periodic bank bailouts. Think back to the situation in 2012, and imagine how much worse it is today. We wouldn’t be surprised if part of the rationale for devaluation is keeping as much powder dry as possible to deal with the significant issues at banks and other financial institutions.

Bonus fun: Spielberg shoots dinosaurs and the crowd goes wild.

Super bonus fun: you-know-who acts really presidential at the 1 minute mark.

Breaking news

August 11th, 2015

WSJ:

China’s central bank devalued its tightly controlled currency Tuesday as the world’s second-largest economy continues to sputter. In an apparent effort to blunt criticism over China’s exchange-rate policy, the People’s Bank of China took the step with an eye toward making the yuan’s value more market-based. China sets a midpoint for the value of the yuan. In daily trading, the yuan is allowed to move 2% above or below that midpoint, which is called the daily fixing. But Chinese officials sometimes ignore the daily moves, at times setting the fixing so that the yuan is stronger against the dollar a day after the market has indicated it should be weaker. With Tuesday’s move the fixing will now be based on how the yuan closes in the previous trading session. As a result, the yuan’s fixing was lowered 1.9%

Yuh, that’l work to stem the 8% export decline! In other breaking news, the most widely recognized company and product in world history, Coca-Cola, has decided to change its name to Refrigerator, in order to better coordinate its internal corporate processes. Spokesman: “this will enhance brand value for the marketplace. We would have gone with Alphabet, but it was taken.” Finally, we note that PCP has been acquired by some company, the greatest victory of FASB 142 on the planet. (If you want to know why, just ask.)

Question of the day

August 10th, 2015

Marty Peretz leads us to the question of the day: what kind of negotiator are you if you can’t get four hostages released in exchange for $150 billion? Also, Mark Steyn points out Carly Fiorina’s sense of humor.