Streetwise Professor

September 14, 2015

You May Not Be Interested In a Clash of Civilizations, But A Clash of Civilizations Is Interested In You

Filed under: China,History,Politics,Russia — The Professor @ 6:25 pm

Cast your eyes around the world, and they are likely to land on a scene of conflict and chaos. In the Middle East, obviously, from pillar (Libya) to post (the Persian Gulf). In the center of Eurasia (Ukraine). In the South China Sea and the DMZ. The world situation has not been this fraught since the 1930s.

If you are like me, you crave an explanation. You could do far worse than start with Samuel Huntington’s Clash of Civilizations. Huntington’s article and subsequent book of the same title unleashed a storm of furious criticism when it came out in 1993. But standing 22 years later, Huntington looks prescient, and many of his critics look like utter fools.

The best evidence of this is to look at the antagonists in the most important cockpits of conflicts.

Start with Ukraine. Putin has explicitly invoked the idea of “a Russian world” and has justified his actions in Ukraine and elsewhere as a legitimate defense of Russian people, language, and culture from the assaults of his enemies, especially in the West. Putin and other Russians tirelessly invoke contrasts between Russian civilization and European civilization in particular.

Putin and Russians generally think they are in a Clash of Civilizations.

Next consider China. China’s leadership too views China as a great civilization that was oppressed by others (Westerners, Japanese), and which is now assuming its proper place in the world. They express a clear cultural-civilizational-chauvinism. If anything, the Chinese people are even more aggressively chauvinistic than their leaders.

The Chinese leadership and people think they are in a Clash of Civilizations.

And of course, there is Islam. That Islam believes that it is in a civilizational war with just about everybody, but in particular the West, needs no explication. Yes, there is an intramural civil war within Islam, between Sunnis and Shia, but (a) this is complicated by a civilizational clash between Arab and Persian, and (b) this conflict is in no small part a battle over who will lead the clash of Islam with the infidels.

The jihadis and the mullahs and vast numbers of Muslims generally believe they are in a Clash of Civilizations.

Who doesn’t believe it? The skeptics and doubters reside mainly in one civilization: the Western.

Indeed, Huntington’s harshest critics resided (and reside) in the West. They are, in the main, progressives, which, like top quarks, come in left-handed (mainly those who self-identify as progressives) and right-handed (e.g., neocons as epitomized by Francis Fukuyama) varieties. Despite their differences in specific policies, they share a dialectical view that history progresses in one direction, and that it is relentlessly moving to a final state, and that in the end, humanity as a whole will converge to this state. The left progs’ final state is socialist/statist: the right progs’ final state is liberal and democratic.

Obama is clearly a progressive, so understood. His most consistent trope in responding to conflict, with Putin or the Islamists, is to say that history will leave them behind; that they are swimming against the tide of history. Obama said this to Putin about Ukraine: he just said it about Syria: he has said it about Isis. His policy towards Iran is predicated on the belief that once Iran is readmitted in into the community of nations, it will become a Normal Country, and discard its Islamist civilizational mission.

So part of the failure of many of those in the West to believe in the Clash of Civilizations is rooted in a worldview that such conflicts are an atavism that will disappear as the world converges to-progresses to-some homogenous end state in which all existing differences are dissolved.

But that’s not the only part. Another part is a paradox of Western civilization. The West’s distinguishing characteristics include skepticism, criticism and doubt. That very skepticism, criticism and doubt have led many (especially on the left, but also many on the right) to conclude that Western civilization is flawed, corrupt, defective, and certainly not superior to any other civilization, and hence not worth fighting for. Thus, the self-criticism that defines Western civilization prevents many in it from fighting for it. In this respect too, Obama is an exemplar.

A big part of the reason the past few years have seen a waxing of the Clash is precisely that the leader of the leader of Western civilization has declined to fight for it, due to a rather strange combination of fatalism (history will progress and nations will converge due to fundamental historical forces) and a belief that its civilization has no right to assert itself, because of its inherent flaws. This is in contrast to the American role post-1945, which self-confidently (on the whole, with exceptions like post-Vietnam) believed in the superiority of Western (and specifically American) civilization, and exerted its power (economic, social, cultural, and often military) to create and maintain a rough order even at the fault lines of civilizational conflict (notably the Middle East, but also between Europe and Russia, and between China and the rest of Asia).

So one way to understand the mess that the world is in now is to take Huntington’s idea of enduring antagonisms and frictions between competing and incompatible civilizations, and add the retreat of the one power that largely kept those antagonisms and frictions under control.

We are arguably in the midst of a new world war, though one that is fortunately, for now anyways, not as cataclysmic as the two that preceded it. But it is a different type of world war not only because of its lower intensity, but because it is not a war between two dominant blocs. Instead, it is a multipolar war with at least four major civilizations jostling at various points around the globe. This multipolarity makes the struggle less predictable, and far more confusing. It will only become more so unless the West, and in particular the US, realizes the nature of the ongoing conflict, and reengages accordingly.

A phrase often attributed to Trotsky (probably wrongly) seems apt here: “You may not be interested in war, but war is interested in you.” Rephrased: you may not be interested in a Clash of Civilizations, but a Clash of Civilizations is interested in you. If we don’t awaken to that reality, we are destined to be the losers in that clash.

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September 9, 2015

The Future of Chinese Futures

Filed under: China,Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 8:19 pm

China has created some amazingly successful futures markets in recent years. By contract volume, the top 5 ag futures are traded in Zhengzhou, Dalian, or Shanghai, as are 4 out of the top 5 metals contracts. Once upon a time, China also had the most heavily traded equity futures contracts. Once upon a time, like two months ago.

Then the crash happened, and China thrashed around looking for scapegoats, and rounded up the usual suspects: Speculators! And it suspected that the CSI 300 Index and CSI 500 Index futures contracts were the speculators’ weapons of mass destruction of choice. So it labeled trades of bigger than 10 (!) contracts “abnormal”–and we know what happens to people in China who engage in unnatural financial practices! It also increased fees four-fold, and bumped up margin requirements.

The end result? Success! Trading volumes declined 99 percent. You read that right. 99 percent. Speculation problem solved! I’m guessing that the fear of prosecution for financial crimes was by far the biggest contributor to that drop.

The stock market (led, as is usually the case, by index futures) was bearing bad news, so the Chinese decided to shoot the messenger. Then back over it a few times with a tank and bury it in cement. Just to make sure.

There is a wider lesson here. Namely, China may talk the reform talk, but doesn’t walk the reform walk. It likes one way bets:  markets when they are rising, not when they are falling. And not just the futures markets have been told to get their minds right. Chinese authorities-and by authorities, I mean security services-have told fund managers not to sell, only buy. A market with Chinese characteristics, apparently: all buyers and no sellers. Kind of zen actually, in the spirit of “what is the sound of one hand clapping?”

This urge to exercise ham-fisted control is exactly the kind of thing that will impede China’s development going forward. It will undermine the ability of capital markets to do their jobs of incentivizing the accumulation of capital and directing it to the highest value uses.

China’s predilection for control has manifested itself in futures markets in other ways. You might recall some months ago that I wrote about China’s threats against Singapore and ICE if the American exchange offered lookalike contracts on ZCE cotton and sugar at its new Singapore affiliate. Yesterday ICE announced the contracts it will launch in Singapore, and cotton and sugar lookalikes were conspicuous by their absence.

No competition for us, thank you. We’re Chinese.

This protectionism may help ensure the success of China’s new futures market initiative: an oil futures contract. Protectionism and pricing in yuan and constraints on the ability of mainland firms to trade overseas make it likely that the contract will succeed. The Chinese are overoptimistic, however, if they believe this contract will supplant WTI and/or Brent. LME and COMEX copper, and ICE cotton and sugar, to give some examples, have thrived even as Chinese markets in these commodities grew. Moreover, myriad restrictions on the ability of foreigners to trade in China and the currency issue will make the Shanghai contract impractical as a hedging and speculative vehicle for non-Chinese firms and funds: the main non-Chinese trading will likely be arbitrage plays between Shanghai, CME/NYMEX and ICE, which will ironically serve to boost to the US exchanges’ volumes.

And the crushing of the CSI300 and CSI500 contracts will impede development of a robust oil futures market. The brutal killing of these contracts will make market participants think twice about entering positions in a new oil futures contract, especially long dated ones (which are an important part of the CME/NYMEX and ICE markets). Who wants to get into a position in a market that may be all but shut down when the market sends the wrong message? This could be the ultimate roach motel: traders can check in, but they can’t check out. Or the Chinese equivalent of Hotel California: traders can check in, but they can never leave. So traders will be reluctant to check in in the first place. Ironically, moreover, this will encourage the in-and-out day trading that the Chinese authorities say that they condemn: you can’t get stuck in a position if you don’t hold a position.

In other words, China has a choice. I can choose to allow markets to operate in fair economic weather or foul, and thereby encourage the growth of robust contracts in oil or equities. Or it can choose to squash markets during economic storms, and impede their development even in good times.

I do not see how, given the absence of the rule of law and the just-demonstrated willingness to intervene ruthlessly, that China can credibly commit to a policy of non-intervention going forward. And because of this, it will stunt the development of its financial markets, and its economic growth. Unfettered power and control have a price.


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August 25, 2015

Donald Trump: Leader of the Mercantilist Zombie Apocalypse

Filed under: China,Economics,Politics — The Professor @ 6:53 pm

Running the risk of serious brain damage, I watched Trump on O’Reilly last night. It was a cage match to determine the world champion of economic ignorance. I declare it a tie.

The “discussion” started out with China. O’Reilly asked Trump about China’s alleged devaluation policy. Except O’Reilly couldn’t pronounce “devalue”: he kept saying “devaluate.” But Trump took the bait and ranted (but I repeat myself) about how China has relentlessly devalued its currency over the years.

Except, of course, it hasn’t. It devalued years ago, but since the financial crisis it has pegged the yuan to the dollar, and only recently made two small devaluations.

Indeed, the yuan has been appreciating in recent years. Since 2011 the yuan has risen from about 6.8 to the dollar to 6.2 to the dollar, before dropping to 6.4 to the dollar as a result of the devaluations. It is arguable whether the yuan is undervalued or overvalued as a result of the peg, but that’s something completely different than devaluation. And it is just wrong to say, as Trump does, that China has been relentlessly devaluing its currency for years. If anything, indicators are that the currency has become overvalue of late: in particular, capital outflows signal overvaluation. Look at real estate markets in the Bay Area, Vancouver, Sydney, etc., or step into any luxury car showroom in the US, and you will see a lot of Chinese buyers. That’s a telling anecdote, but there is hard data to back that up.

What’s more, it’s not as if the US has been passive post-crisis. QE anyone? To ignore this is to ignore one elephant in the room, and criticizing the currency peg without mentioning QE has more than a little of the feel of “Mommy! No fair! Johnnie hit me back!”

Further, even if the Chinese have engaged in policies that keep their currency artificially low, the effect on the US is not unambiguously bad. Yes, some US industries and workers are harmed, but consumers overall would get a great boon, as we exchange overvalued paper for artificially cheap goods. It is not uniformly bad for US manufacturing either, as many of the “consumers” are manufacturers who can purchase cheaper inputs. This raises the derived demand for other inputs, including some labor.

The best part was where Trump repeated one of his common themes that American leadership is dumb (I don’t disagree) but that Chinese leadership is really smart. But then he went on to screech that the Chinese have created a huge bubble that is imploding, and threatens to bring down the US economy with it. But, if the Chinese leadership is so damn smart, why would they create a huge bubble, and then be incapable of preventing its bursting? And if we live in a zero sum world where China’s gain is America’s loss, wouldn’t a Chinese economic collapse be good for the US?

Another lowlight was the discussion of trade with Mexico, which is apparently also governed by those overqualified for Mensa. (Who knew?) He is furious at Nabisco for moving a plant from Chicago to Mexico. Presumably if elected president he will force the company to forego use of the “Ritz” brand (because that’s the name on a fancy-schmancy American hotel!) and preclude them from selling Oreos with a cream center in the US. Nope, just two dry chocolate biscuits, unsweetened, held together with a nail. Ford also came in for a bashing for moving assembly to Mexico.

Perhaps to give him more intellectual credit than he deserves, Trump is a died-in-the-wool mercantilist who believes trade is a zero sum game, and who favors protectionism and beggar-thy-neighbor currency policies. He talks like it is the late-80s, and Japan is still an economic juggernaut that will overwhelm the US, completely overlooking the fact that Japan’s crypto-mercantilist policies gifted it a 25 year long lost decade, and that neo-mercantilist China is on the brink of the same fate. If it is lucky.

Adam Smith is spinning in his grave.

But alas, mercantilism is a like a zombie. It has no brain, and has proven impossible to kill. Which means, I guess, that in Donald Trump, it has found its perfect advocate.

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August 23, 2015

China’s Michael Jackson Moment Has Arrived

Filed under: China,Economics,Politics — The Professor @ 7:05 pm

About 6 years ago, reflecting on China’s massive stimulus effort in the aftermath of the crisis, I referred to the country as the “Michael Jackson economy,” sustained by artificial stimulants, and extending the analogy, predicted it would not end well. In the years since, Chinese economic statistics have performed according to plan with metronomic regularity, but all of the distortions inherent in an investment-driven, credit-financed boom only accumulated. Throughout this period, China interfered in markets, by the manipulation of crucial prices, notably interest rates and the exchange rate, and the implementation of measures to direct capital to favored sectors and firms.

Signs of resource misallocation have abounded most notably in the form of massive overcapacity in myriad industries (e.g., steel), the construction of vacant cities, and a relentless rise in debt-to-GDP that is approaching the stratospheric levels attained by Japan before its crash in the early 1990s.

It was inevitable that this was not sustainable. But although Chinese authorities indicated at some level they understood this, and talked about transitioning away from the credit, export and investment-driven growth model towards a consumption-driven one, political economy considerations that tend to favor established interests, and no doubt a deep fear about their inability to maintain control and social peace during a transition, kept them from kicking the old habits. And now it appears that the Michael Jackson-esque denouement is nigh.

All signs are of an impending economic crisis in China. The recent stock market decline is one symptom (but mainly a symptom), as are other economic data. But the surest sign is the panic evidenced by truly gargantuan stimulus measures (totaling around $2 trillion, or four plus TARPs, according to Christopher Balding’s figuring) and the recent decision to devalue the yuan.

The real slowdown is an especial concern because of the Rube Goldberg nature of the Chinese financial system, and the massive amounts of debt that has accumulated since 2009. The government is using a variety of measures to take the associated risk on its balance sheet (although it is using indirect means to conceal this fact), but even the government balance sheet is not bottomless. In such a debt-dominated and opaque financial system, a full-blown financial crisis that would greatly exacerbate the real slowdown is quite possible.

There are a couple of lessons here that need to be emphasized. The first is the dubious value of GDP as a measure of economic performance, especially in an investment-driven, highly managed economy. Investment is a cost incurred in the expectation of realizing a greater benefit in the future: it is not a benefit  in itself. In an economy where price signals and incentives are deeply distorted by financial repression, capital controls, and crucially a high-powered incentive system that ties remuneration and promotion of government officials to GDP targets, there will be massive malinvestment. With this malinvestment, future returns will be small and negative, and often insufficient to service the debt used to finance it.

When the investment is made it looks great in the GDP figures. But in an economy where investment accounts for upwards of 50 percent of GDP, the destruction of value caused by the malinvestment is staggeringly large.

The GDP-linked high powered incentive system is likely especially pernicious. Investment decisions should be forward looking, but the incentive system drives officials to make “investments” based on their current cost, not the expectation of their future returns.  Big investment (cost!) today means big GDP today means life is good for the cadres. This is beyond perverse.*

Another lesson is that no one should be surprised. Logic and experience lead to the same conclusion. Economic logic teaches that distortions of prices and top-down resource allocation mechanisms destroy wealth rather than create it. Experience, from extreme cases like the USSR to less extreme ones like Japan, illustrate vividly the hard reckoning that a managed system must eventually face.

I am only surprised that people are surprised. Even though logic and experience should have led people to question the Chinese “miracle,” and to doubt rather than tout its GDP figures, for years Smart People** have marveled at Chinese economic performance and sang paeans to its wise government steersmen. They were mesmerized by GDP figures, and confused costs with benefits. But just as it was inevitable that Michael Jackson’s dependence on artificial means would eventually result in a health crisis, it was inevitable that China’s dependence on artificial stimulants and distortionary interventions driven by political agendas and warped incentives wold result in an economic crisis.

And there are mounting signs that that moment has arrived. Perhaps it will result in a serious crisis. Perhaps it will result in multiple lost decades (a la Japan). But one way or another, forecasts of future Chinese economic dominance are going to look quite embarrassing.

* This is a different issue than whether Chinese officials routinely falsify economic data. Given the high powered incentives at the lower and middle levels of the governing hierarchy, and the need for the government to demonstrate its alleged economic competence at the upper levels, the incentives to falsify data are acute.

** H/T @soncharm, of Rhymes With Cars and Girls.

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August 12, 2015

Hey, It’s August: The Russian Economy Imitates the Kursk

Filed under: China,Economics,Energy,Politics,Russia — The Professor @ 1:37 pm

Despite happy talk from the government in recent months, Russia continues its downward economic spiral. The economy contracted by 4.6 percent in the second quarter. This is pretty appalling, given that oil prices had rebounded some. The Economics Ministry says this is “the lowest point” for Russia, but given the recent rout in oil prices, and the troubling signs coming out of Russia, this seems unduly optimistic. If anything Q3 and Q4 are likely to be worse. These therefore seem to be more realistic predictions:

“While second-quarter growth surprised on the downside, perhaps far more importantly is the fact that the outlook for the Russian economy has deteriorated so far in the third quarter,” Piotr Matys, a London-based foreign-exchange strategist at Rabobank, said by e-mail.

. . . .

“The economic prospects for the coming quarters look pretty grim,” Liza Ermolenko, an analyst at London-based Capital Economics Ltd., said by e-mail. “Industry appears to have been a major cause behind the deterioration in the second quarter, having gone from being a relative bright spot in the first quarter.”

The consensus is now that the current economic situation is more dire than 2008-2009, and that it is likely to persist far longer.

On top of this, China’s sudden devaulation of the Yuan has caused a further decline in commodity prices, with Brent now below $50/bbl. This has contributed to a further decline in the Ruble, which fell about 2 percent in the aftermath of China’s move.  The Russian currency is now around 65 to the dollar.  Russia is particularly vulnerable to an extended Chinese malaise, not to mention a hard Chinese landing.

The Russian Central Bank now faces the same conundrum that it confronted last summer and fall. It can choose between loosening monetary policy to spur the economy but would thereby spur inflation (already running at over 15 percent) and pressure the ruble even further. Or it can choose to defend the Ruble, which would hamstring the real economy, and potentially spur capital flight if the credibility of the RCB’s action is doubted. Which leg does it chew off?

Wherever Putin and his economic advisers look, the scene is bleak indeed. The situation in China is particularly ominous, because Putin had grabbed onto China like a drowning man, hoping it would rescue him from the blows raining down from sanctions and the commodity price implosion. But the Chinese devaluation, combined with a litany of other grim statistics coming out of China, suggests that if China is not drowning itself, it is struggling mightily to keep its head above water.  Russia is particularly vulnerable to an extended Chinese malaise, not to mention a hard Chinese landing. Putin counted on China’s economic support to allow him to continue his Ukrainian adventure and weather the resulting sanctions.  It’s not happening (Chinese direct investment into Russia has fallen by 25 percent), and the prospects of it happening anytime soon are diminishing daily.

Nor are the long run prospects particularly encouraging, not with Bloomberg running articles titled “Russian Workers Vie With Greece in Race for Productivity Abyss,” the upshot of which is that Russia has the lowest productivity in Europe, running at 50 percent of the European average and 30 percent below Greece. (Which makes this boast by the Russian Minister of Industry and Trade that Russia has overtaken the US in labor productivity even more hilarious.)

In brief, the Russian economy is doing an imitation of the Kursk, 15 years ago. The only difference is that Putin has yet to admit the economy has sunk.


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July 22, 2015

Vlad’s Pivot to Oblivion

Filed under: China,Commodities,Economics,Energy,Politics,Russia — The Professor @ 7:09 pm

This story is a Sino-Russian twofer:

The contract between Russia and China for gas supplied via the western route known as Power of Siberia-2 is being delayed indefinitely, Vedomosti cited Russian officials. They say China is reviewing its energy needs due to the economic slowdown.

The demand growth for gas in China is slowing, at the same time access to liquefied natural gas (LNG) is becoming more available in the country, for example from Australia, due to the fall in oil prices, Sberbank CIB analyst Valery Nesterov told Vedomosti on Wednesday.

Repeat after me: Gazprom finalizes about one out of a hundred of the vapor deals it announces. This is especially true where China is involved.

There are three basic problems. First, the pipeline is expensive, primarily because the Russians insist on building it. After all, how else could they tunnel out money? And if they can’t tunnel out money, what the hell is Gazprom good for?

“Gazprom offers CNPC a high price, explaining this by the high cost of the Power of Siberia – 2 construction. China is ready to build the pipeline at a cheaper cost and at public tender, so its companies could participate and for the construction price to be transparent,” the president of the Russia-China analytical center Sergei Sanakoyev said.

Second, the pipeline would go to the western part of China, which is convenient for Gazprom, but it isn’t where China needs the gas.

Third, China doesn’t need as much gas period, because (a) new (LNG) supply is coming on line in Australia, and (b) despite the happy talk of official statistics, every indication is that the Chinese economy is slowing:

The demand growth for gas in China is slowing, at the same time access to liquefied natural gas (LNG) is becoming more available in the country, for example from Australia, due to the fall in oil prices, Sberbank CIB analyst Valery Nesterov told Vedomosti on Wednesday.

So how’s that pivot to Asia working out, Vladimir? Timing is everything in life, and Putin is counting on China precisely when China has its own issues to deal with. If China was continuing to power forward, Putin’s pivot would have turned him into China’s pilot fish. Now even being a pilot fish looks out of reach.

To all those who hyperventilated at the announcements of huge Sino-Russian gas deals: when will you people learn to discount virtually anything Gazprom says down to just above zero? That’s especially true when there was a huge political reason for Putin to hype such a deal. I guess suckers never learn.

The second part of the twofer here is the further evidence it provides of China’s economic troubles. Look at the commodity carnage going around: oil, copper, iron ore, gold, platinum, you name it are in the dumper. China put them there. This is just another pixel in the image.



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July 18, 2015

Nothing Says Panic Quite Like Three TARPs

Filed under: China,Economics,Energy,Politics,Regulation — The Professor @ 3:41 pm

The invaluable Christopher Balding has been tracking closely the massive financial support the Chinese government has been injecting into the banking system, the shadow banking system, local governments, and the stock market. In a blog post earlier this week, he estimated that this support totaled at least $692 billion, rising to $933 billion if the Reserve Ratio cut is counted as a subsidy to the banking system.

These funds went to the local government bond program I wrote about in June, an  investment in pension funds, PBOC 6 month loans to banks, and PBOC loans to the Chinese Securities Financing Corporation, which in turn will lend these funds to buy stock on margin.

But it’s hard to keep up! Christopher kindly shared with me his most recent calculation, which shows that the Chinese government keeps pumping in the money, most notably an additional $200 billion in loans to intermediaries who will use these funds for margin lending, and a rumored (but not yet confirmed) $160 billion in additional support for provincial municipal bonds. This brings the total to $1.3 trillion.

In RMB, that totals over 8 trillion (with a “t”, boys and girls). To Sinofy Evertt Dirksen: A trillion here and a trillion there, and pretty soon you are talking real money.

Another metric: $1.3 trillion is approximately three TARPs. Maybe we should start using that as a new unit of measurement, as in, “Chinese authorities intervened in the market and banking system today, providing an additional .5 TARPs in state funding.”

Yet another metric: $1.3 trillion is almost exactly $1000 per Chinese citizen. TARP was about $1500 per American. But China’s per capita GDP is (depending on whether you use exchange rates or PPP) about 1/5th or 1/7th of US GDP per capita. Thus, a low middle income country is spending roughly 3 to 5 times more per person as a percentage of per capita income than the high income US did. (Given that Chinese GDP is likely overstated-another issue that Christopher has analyzed in detail-the true multiples are even higher.)

Such massive spending-arguably the most gargantuan stimulus package ever-is not the sign of a confident leadership. It is a clear sign of panic.

Remember the extreme panic in DC and Wall Street in the post-Lehman period that culminated with TARP? Even in that hysterical environment, people questioned the need for and advisability of TARP. But in the end panic won out. That is the only reason TARP passed: people were scared stiff at what would happen if it didn’t.

Now think of how panicked the Chinese must be to implement measures that dwarf TARP. That’s what economists call revealed preference. Or, in this instance, revealed panic.

This gives the lie to official statistics, which showed a (patently unbelievable even absent this massive stimulus) .1 percentage point decline in the growth rate. Also giving the lie to the official statistics is the collapse in China-driven commodity prices, notably iron ore and coal, and oil as well. The slowdown in commodity economies further discredits the official Chinese data.

The Chinese stock market is getting most of the attention. This is the drunk-looking-under-the-streetlamp-for-his-keys phenomenon. The stock market is visible, and people can relate to it: this is why the government is using massive carrots (notably the support for margin lending) and even bigger sticks to try to arrest the decline. This would suppress the most visible manifestation of crisis. But the real dangers are lurking out of sight, in the leveraged sector (most notably the rats’ nest of non-bank lenders, but the banks are concealing a lot too), SOEs, and a real economy whose performance is masked by dodgy official statistics.

I’ve long referred to China as the Michael Jackson Economy, kept going by intense dosages of economic/financial drugs, cosmetic surgeries, and stimulants. The Chinese authorities are now administering the biggest dosages ever. This is an indication that the patient is doing quite badly. Further, although such actions may delay the inevitable, they make the end all the more horrific.

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July 12, 2015

The Chinese SEC, as in, Securities Execution Commission

Filed under: China,Economics,Politics,Regulation — The Professor @ 7:45 pm

Trying to staunch the bleeding in the stock market, China is unleashing the full power of a police state. A Securities Execution Commission, if you will:

China’s police ministry is teaming up with the securities regulator to probe short selling, as the government works to stem a stock plunge that has erased $3.9 trillion in market value.

The Ministry of Public Security said it will help the China Securities Regulatory Commission investigate evidence of “malicious” short selling of stocks and indexes, according to a statement on its website Thursday. Vice Public Security Minister Meng Qingfeng visited the regulator’s offices in Beijing on Thursday, the official Xinhua News Agency said earlier on its microblog.

The move comes after the securities regulator pledged to “strictly” punish market manipulation and China’s state-run media blamed short selling, rumor-mongering and foreign meddling for fueling the stock slide. The ruling Communist Party has announced an unprecedented series of measures to boost shares, including banningmajor shareholders, executives and directors from selling stakes.

Whenever a police ministry “teams up” with securities regulators, watch out. You can bet-and it wouldn’t be speculation!-that some poor schmoes are going to do hard time for manipulative short selling. And China being China, it is not beyond the realm of possibility that some really unlucky bastards will wind up in front of a firing squad or inside a mobile execution van.

And isn’t it always the way? Stock price declines are always blamed on short sellers. Always. And with stocks, manipulation accusations are thrown about on the way down, but never on the way up.

If the Chinese authorities want to find a market manipulator, they need to look no further than the nearest mirror.  Which is precisely why they are so intent on finding someone else to blame.

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July 8, 2015

Monkeys Fly in China

Filed under: China,Economics,Exchanges,Regulation — The Professor @ 5:56 pm

In the very early days of this blog, I told the story about what Chief Economic Advisor Beryl Sprinkel said on Black Monday, 1987, when a panicked Treasury Secretary James Baker wanted to close the stock market: “We’ll close these markets when monkeys fly out of my ass.” No monkeys flew, and the markets stayed open, eventually stabilized, and then recovered.

But many monkeys are flying out of many asses in China. Although the authorities have not closed the stock markets, individual companies have halted trading in their stocks: trading in more than one-half of the listings in China is currently suspended.

Halting trading more than for a short interval in order to resolve information asymmetries and permit the flow of liquidity to stocks that have just experienced an information event (as during a temporary stock halt in the US) is in general a bad idea. (Post-87, Greenwald and Stein wrote a paper published in the JOB laying out this argument.) An uncoordinated and extended halt of many stocks is a really horrible idea, because of the negative externalities. That is, uncoordinated flying monkeys wreak even more havoc than coordinated ones.

Halting trading in a large number of stocks increases selling pressure on stocks that are still trading. This happens for at least a couple of reasons. First, individuals who need to raise cash (e.g., to meet margin calls) are forced to concentrate their sales in the stocks that keep trading. This tends to concentrate selling pressure, rather than diffuse it. Second, individuals who want to rebalance their portfolios away from equity into cash or bonds have to concentrate their sales in the stocks that continue to trade. Again, this concentrates selling pressure.

This creates a vicious feedback loop. A number of companies halt trading, which forces selling pressure to spill over with greater force on other stocks, which leads some of these companies to halt trading, which intensifies selling pressure on other companies, and so on. The ultimate likely outcome is a protracted lockdown of the entire market. Protracted because who is going to be the firm to restart trading first, and risk having everyone sell the hell out of them?

The vaunted Chinese economic managers (ha!) have well and truly bungled this one. They should have prevented open-ended trading halts, or had a coordinated stoppage and restarting of trading. The coordination failure at work now is manifest.

Again, I believe that the sharp selloff is more of a symptom of a deeper economic problem than a potential direct cause of such a problem. The main adverse spillover that the stock selloff could cause is through the margin debt channel. Margin calls could lead to fire sales of illiquid assets. Again, the more stocks that are not trading, the more severe these fire sales in non-equity assets will be: this is another adverse consequence of uncoordinated monkey launches. Moreover, failures to meet margin calls will saddle the lenders (themselves often highly leveraged) with losses. Both of these channels could have adverse consequences in the brokerage, banking and shadow banking sectors. Their balance sheets are not that hale and hearty to begin with, and this kind of shock could spark broader financial distress throughout the sector.*

In other words, the stock market decline is less of a crisis in itself, than a potential catalyst to a crisis via informational and fire sale channels. And perversely, uncoordinated trading halts in the stock market are more likely to intensify than mitigate any such catalytic effect.

But the Mandarins know everything, so I’m sure it will turn out swell.

In the meantime, the Mandarins have a message for all investors in China. Good luck with that!

* Perhaps one could argue, as Michael Brennan did when trying to explain price limits in futures markets in the JFE in 1986, that halting trading could ease pressure on margin credit. I am skeptical though. Even if stocks stop trading, margin lenders are likely to demand additional security in current conditions. Indeed, trading halts that reduce the informational content of stock prices create a source of uncertainty to margin lenders which they are likely to compensate for by demanding additional margin based on their estimate of the stock price once trading recommences, plus a premium to compensate for the uncertainty.

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July 6, 2015

China: Catching a Falling Knife

Filed under: China,Economics — The Professor @ 6:13 pm

The People’s Bank of China is effectively funding an effort by a group of brokers to buy equity (to the tune of about $20 billion) in an attempt to stem the massive selloff in Chinese stocks. The news barely checked the relentless decline, which I will expect will resume with a vengeance.

In other words, China is panicking, and attempting to catch a falling knife, as the phrase goes. And that almost never works out well.

Actually, I don’t think that the equity market decline is China’s big problem, except to the extent that it is a harbinger of a dramatic slowing of the growth in the economy, or perhaps an absolute decline in the economy. Countries survive equity market meltdowns. It is the leveraged sector that is the concern. In China, that includes not just banks, but the plethora of shadow banks, trusts, and local government funding vehicles, all with murky interconnections with the banks.

There are pronounced signs of economic stagnation besides the shuddering equity market. The lack of growth in electricity generation is one. The sharp declines in China-sensitive commodities, notably oil, iron ore, and copper are another: oil was down 8 plus percent today. (Cheers, Vlad!) If it was oil alone, one could write it off to the market deciding that a generous Iran deal was imminent. The broad fall suggests that it is China, China, China.

The equity market, and the government’s response to it, is therefore a symptom of this broader economic problem. What the Chinese (and those long energy and metals production) need to be especially concerned about is if a decline in growth sets off a banking or shadow banking crisis. Then the Chinese central bank and government will be in the unenviable position of catching a barrage of plummeting arrows.

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