Red Ponzi Ticking—-China And The Dark Side Of The Global Bubble, Part 1

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China is not a $10 trillion growth miracle with transition challenges; it is a quasi-totalitarian nation gone mad digging, building, borrowing, spending and speculating in a magnitude that has no historical parallel. So doing, It has fashioned itself into an incendiary volcano of unpayable debt and wasteful, crazy-ass overinvestment in everything.  It cannot be slowed, stabilized or transitioned by edicts and new plans from the comrades in Beijing. It is the greatest economic train wreck in human history barreling toward a bridgeless chasm.

Donald Trump is absolutely correct that China is a great economic menace. But that’s not owing to incompetence at the State and Commerce Departments or USTR in cutting bad trade deals.

Nor is it even primarily due to the fact that China egregiously manipulates it currency, massively subsidizes its exports, wantonly steals technology, chronically infringes patents and hacks propriety business information like there is no tomorrow.

If that were the extent of China’s sins, a new sheriff in the White House wielding a big stick and possessing a steely backbone—-attributes loudly claimed by The Donald—-might be able to reset the game. After hard-nosed negotiations, he might even obtain a more level and transparent playing field, thereby eventually reducing our current debilitating $500 billion import trade with China and retrieving at least some of the millions of jobs which have been off-shored to the far side of the planet.

The world fundamentally changed in the early 1990s when Mr. Deng and Chairman Greenspan jointly initiated the present era of Bubble Finance. The latter elected to inflate rather than deflate the domestic US economy and to thereby export dollar liabilities in their trillions to the rest of the world.

At the same time, having depreciated the yuan by 60%, Mr. Deng discovered that to keep China’s nascent export machine booming he needed to run the printing presses in the basement of the People Bank of China (PBOC) red hot, thereby sopping up the massive inflow of Greenspan’s dollars and keeping China’s exchange rate pegged to the US dollar.

So doing, Beijing kept domestic wages and prices cheap and turned China into an export powerhouse by draining its vast rice paddies of history’s greatest warehouse of untapped industrial labor. In fact, in less than two decades it mobilized more new industrial workers than had existed in the US, Europe and Japan combined at the time in the early 1990s when Mr. Deng proclaimed that it was glorious to be rich.

Unfortunately, that wasn’t the half of it. Greenspan’s dollar profligacy was inherently contagious. By the 1990s, the governments of most of the developed world were run by statists and socialists who were loath to see their exchange rates soar in the face of Greenspan’s epic flood of surplus dollars.

So rather than harvesting social gains from the cheap American exports Greenspan had on offer, the new ECB and the BOJ reciprocated with monetary expansion designed to keep their exchange rates down and protect domestic industries and labor .

Old fashioned economists were wont to call this a race to the currency bottom, and surely it was that. But what it really did was unleash a global tsunami of credit expansion and an economic race of another sort. Namely, to today’s nearly universal malady of Peak Debt.

As we documented earlier, the combined central banks of the world have expanded their balance sheets from $2 trillion to $21 trillion or by 10X during the past two decades. So doing they drove the price of credit and capital to the subterranean zones of economic history and rationality, but they did not abolish the laws of economics entirely.

To wit, the more you subsidize an economic resource, the more of it you get. That’s what happened with credit and capital when China and its global supply chain ran their printing presses fast enough to keep up with the Fed and its DM world counterparts.

In less than two decades, public and private debt outstanding in the world rose six foldfrom $40 trillion to $225 trillion. On paper that represented a gain that was nearly 4X greater than the global GDP expansion during that period, but in fact it was far worse.

That’s because as the global credit spree reached its apogee in recent years malinvestment and wasteful, inefficient fixed asset investment became rampant. In effect, the central banks of the world were enabling the “printing” of GDP which wasn’t wealth, wasn’t sustainable and wasn’t the fruit of genuine capitalist enterprise; it was only transient GDP ledger entries destined to become future year write-offs, losses and white elephants.

Global Debt and GDP- 1994 and 2014

The world’s central bank driven credit binge had a dual impact. In the developed world and especially the US it resulted in a vast inflation of household debt and leverage—-or the equivalent of an internal LBO as we saw in Chapter 6. Accordingly, the aging households of the DM world were able to live beyond their means or level of current production and income for nearly two decades, boosting mightily the call on exports from China and its emergent supply chain from South Korea and Taiwan to the Persian Gulf and Brazil.

At the same time, booming global trade and export demand in combination with red hot central bank printing presses in China and the EM engendered the greatest CapEx boom in world history. Much of it occurred in China, but also in its satellite resource and mining colonies such as Australia and Brazil and in the global shipping and materials processing industries, most especially energy.

Needless to say, there is no possible scenario in which global CapEx could have grown from an already elevated $1 trillion annual rate in the year 2000 to $3 trillion barely a decade later in a world of honest money and market priced capital. Instead, the world’s central banks enabled what old fashioned liberal economics a century ago called a crack-up boom.

As is evident from the chart, rampant gains in global CapEx are now over and done, and a long era of falling investment and payback has begun. In the interim, however, there is relentless deflation—–the natural consequence of massive excess capacity and the lapse into variable cost pricing by firms desperately seeking cash flow to service their gargantuan debts.

Citi-global-capex-by-sector1

Needless to say, China was the epicenter of this global crack-up boom. Unrestrained by any traditions of sound money or even vestigial mechanisms of market discipline and financial controls, the communist party apparatchiks who inherited Mr. Mao’s epic mess let loose a credit-driven construction and investment mania like the world have never before seen.

But as we document below, it amounted to a veritable Red Ponzi. That’s the real menace.

If a prospective President Trump wants to shut it down, he need not appoint Carl Icahn as the nation’s chief trade negotiator or even bother with the dispatching the TPP or reforming the WTO (World Trade Organization). He only needs to tell the Fed to get its foot off the neck of US savers and retirees and allow US dollar interest rates to rise to market clearing levels.

That would also clear-out the Red Ponzi in a New York minute, and start the world on the long path back to capitalist prosperity.

Something Rotten In The State Of Denmark

But as of now, there is something really rotten in the state of Denmark. And we are not talking just about the hapless socialist utopia on the Jutland Peninsula——even if it does strip assets from homeless refugees, charge savers 75 basis points for the deposit privilege and allocate nearly 60% of its GDP to the Welfare State and its untoward ministrations.

In fact, the rot is planetary owing to the crack-up boom described above. At this late stage of the great credit deformation there is unaccountable, implausible, whacko-world stuff going on everywhere, but the frightful part is that most of it goes unremarked or is viewed as par for the course by the mainstream narrative.

The topic at hand, therefore, is the looming implosion of China’s Red Ponzi; and, more specifically, the preposterous Wall Street/Washington presumption that it’s just another really big economy that overdid the “growth” thing and is now looking to Beijing’s firm hand to effect a smooth transition.

That is, an orderly migration from a manufacturing, export and fixed investment boom-land to a pleasant new regime of shopping, motoring, and mass consumption.

Would that it could. But China is not a $10 trillion growth miracle with transition challenges; it is a quasi-totalitarian nation gone mad digging, building, borrowing, spending and speculating in a magnitude that has no historical parallel.

So doing, It has fashioned itself into an incendiary volcano of unpayable debt and wasteful, crazy-ass overinvestment in everything.  It cannot be slowed, stabilized or transitioned by edicts and new plans from the comrades in Beijing. It is the greatest economic train wreck in human history barreling toward a bridgeless chasm.

And that proposition makes all the difference in the world. If China goes down hard the global economy cannot avoid a thundering financial and macroeconomic dislocation. And not just because China accounts for 17% of the world’s $80 trillion of GDP or that it has been the planet’s growth engine most of this century.

In fact, China is the rotten epicenter of the world’s two decade long plunge into an immense central bank fostered monetary fraud and credit explosion that has deformed and destabilized the very warp and woof of the global economy.

But in China the financial madness has gone to a unfathomable extreme because in the early 1990s a desperate oligarchy of despots who ruled with machine guns discovered a better means to stay in power. That is, the printing press in the basement of the PBOC—-and just in the nick of time (for them).

Print they did. As indicated above, the bought in dollars, euros and other currencies hand-over-fist in order to peg their own money and lubricate Mr. Deng’s export factories.

So doing, the PBOC expanded its balance sheet from $40 billion to $4 trillion during the course of a mere two decades. That’s a 100X gain. There is nothing like that in the history of central banking—–nor even in economists’ most febrile imaging’s about its possibilities.

The PBOC’s red hot printing press, in turn, emitted high-powered credit fuel. In the mid-1990s China had about $500 billion of public and private credit outstanding—hardly 1.0X its rickety GDP. Today that number is $30 trillion or even more, and 3X the size of its vastly inflated GDP accounts.

Yet nothing in this economic world, or the next, can grow at 60X in only 20 years and live to tell about it; and most especially not that treacherous economic commodity called debt. And even more especially, not in a system built on a tissue of top-down edicts, illusions, lies and impossibilities, and which sports not even a semblance of financial discipline, political accountability or free public speech.

The Red Ponzi—-A Witch’s Brew of Keynes and Lenin

In short, China is a witch’s brew of Keynes and Lenin. It’s the financial tempest which will slam the world’s great bloated edifice of central bank fostered faux prosperity.

So the right approach to the horrible danger at hand is not to dissect the pronouncements of Beijing in the manner of the old Kremlinologists. The occupants of the latter were destined to fail in the long run, but they at least knew what they were doing tactically in the here and now; it was worth the time to parse their word clouds and seating arrangements at state parades.

By contrast, and not to mix a metaphor, the Red Suzerains of Beijing have built a Potemkin village. But they actually believe it’s legitimate because they do not have even a passing acquaintanceship with the requisites and routines of a real capitalist economy.

Ever since the aging oligarch(s) who run China were delivered from Mao’s hideous dystopia by Mr. Deng’s chance discovery of printing press prosperity, they have lived in an ever expanding bubble that is so economically unreal that it would make the Truman Show envious. Any rulers with even a modicum of economic literacy would have recognized long ago that the Chinese economy is booby-trapped everywhere with waste, excess and unsustainability.

Here is but one example. Somewhere near Shanghai, credit-crazed developers built a replica of the Pentagon on 100 acres of land. This was not intended as a build-to-lease deal with the  PLA (People’s Liberation Army). It’s a shopping mall that apparently has no tenants and no customers!

One of the more accurate things we have ever said is that the USA’s Pentagon was built on a swampland of waste. That is, we do take our anti-statist viewpoint seriously and therefore firmly believe that the Warfare State is every bit as prone to mission creep and the prodigious waste of societal resources as is the Welfare State and the bailout breeding backrooms of Washington.

But America’s Pentagon at least has a public purpose and would return some benefit to society were its mission to be shrunk to honestly defend the homeland. By contrast, China’s “Pentagon” gives waste an altogether new definition.

Projects like the above—–and China is crawling with them—–are a screaming marker of an economic doomsday machine. They bespeak an inherently unsustainable and unstable simulacrum of capitalism where the purpose of credit is to fund state mandated GDP quota’s, not finance efficient investments with calculable risks and returns.

Accordingly, the outward forms of capitalism are belied by the substance of statist control and central planning. For example, there is no legitimate banking system in China—just giant state bureaus which are effectively run by party operatives.

Their modus operandi amounts to parceling out quotas for national GDP and credit growth from the top, and then water-falling them down a vast chain-of-command to the counties, townships and villages below.

There have never been any legitimate financial prices in China. All interest rates and FX rates have been pegged and regulated to the decimal point; nor has there ever been any honest financial accounting either—- bank loans have been perpetual options to extend and pretend.

And, needless to say, there is no system of financial discipline based on contract law. China’s GDP has grown by $10 trillion dollars during this century alone——-that is, there has been a boom across the land that makes the California gold rush appear pastoral by comparison.

Yet in all that frenzied prospecting there have allegedly been almost no mistakes, busted camps, empty pans or even personal bankruptcies. When something has occasionally gone wrong with an “investment” the prospectors have gathered in noisy crowds on the streets and pounded their pans for relief—-a courtesy that the regime has invariably granted.

Indeed, the Red Ponzi makes Wall Street look like an ethical improvement society. Developers there built an entire $50 billion replica of Manhattan Island near the port city of Tianjin—– complete with its own Rockefeller Center and Twin Towers. 

But the developers of this marvel neglected to tell their lenders and investors that no one lives there. Not even bankers!

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