Russia and China building their gold reserves

Western economic commentary on China and Russia is usually coloured by monetarist assumptions not necessarily shared in Moscow and Beijing. For this reason, Russian and Chinese fiscal and monetary policies are misunderstood in financial markets, as well as the reasons their governments buy gold.

China has been notably relaxed about her own people acquiring gold, and the government itself appears to be absorbing all of China’s mine output. Russia is also building her official reserves from her own mine supply. The result over time has been the transfer of aboveground gold stocks towards these countries and their allies. The geo-political implications are highly important, but have been ignored by western governments.

China and Russia see themselves as having much in common: they are coordinating security, infrastructure projects and cross-border trade through the Shanghai Cooperation Organisation. Furthermore, those at the top have personal experience of the catastrophic failings of socialism, which have not yet been experienced in Western Europe and North America. Consequently neither government subscribes to the economic and monetary concepts prevalent in the West without serious reservations.

We saw evidence of this from Russia recently, with Putin’s appointment of his own personal economic adviser, Elvira Nabiullina, as the new head of Russia’s central bank. Ms Nabiullina is on record admiring, among others, the writings of Robert Higgs – a leading US economist of the Austrian School. She is therefore likely to take a strong line against the expansion of bank credit, which is confirmed by Russian commentators who believe she will prioritise reforms to strengthen bank balance sheets.

She is not alone. The People’s Bank of China recently let overnight money-market rates soar to over 20%. The message is clear for those prepared to look for it: they are not going to fuel an extended credit bubble. The two countries have learned how damaging a bank-credit-fuelled business cycle can be, and are determined to restrict bank lending. Western commentators find this hard to understand because it does not conform to the way western monetary policy works.

It seems that the leaders of both Russia and China are also painfully aware of the importance of currency stability in a way the West is not. The comparison with the West’s reckless monetary policies is stark. It follows that Russia and China are increasingly concerned about the major currencies, given both countries have substantial trade surpluses. Their exposure to this currency risk explains their keenness for gold. Furthermore, they know that if the renminbi and the rouble are to survive a western currency crisis, they must have the sound-money credibility provided by a combination of monetary restraint and gold backing. And the reason China is happy to let her citizens plough increasing amounts of their savings into gold is consistent with ensuring her people buy into sound money as well.

While the Chinese and Russian governments are authoritarian mercantilists, there are elements of the Austrian School’s economics in their approach. The tragedy for the West and Japan is they have embarked on the opposite weak-money course that can only end in the ultimate destruction of their currencies, leaving Russia and China as the dominant economic powers.

This article was previously published at


Shifting sands – part 3

Continued from part 2

Finally to China where the only thing to note is that the meme of credit exhaustion is starting to spread, given that every CNY100 of reported GDP in the first quarter required the addition of CNY52 in new credit – much of that flooding back in from abroad to play the property boom.

That this is likely to lead to an implosion in fairly short order seems to have been recognised by the new men in charge. Hence the unusual convening of an April session of the Politburo Standing Committee for a meeting dedicated to the economy. From this there emanated an official press release containing the following injunction:

China needs to cement its domestic economic growth momentum and guard against potential risks in financial sectors

It doesn’t sound as if another dash for growth is on the cards, now does it?

After the rout in the gold and silver market, all we can say is that though conspiracy theories inevitably abound, we have warned on numerous occasions that such a sell-off was always possible given the number of stale, trapped longs who have had no return for months while sitting at very elevated real and nominal valuations – and all in the face of ever-mounting equity rises, to boot. One may or may not care much for the idea of technicals as predictive tools, but, just once in a while, the break of an obvious trend line convinces those who do subscribe and gives rise to an avalanche of me-tooism and that was very much the case in gold and silver.

Since then everyone has come up with their own pet, Just So Story about what or who exactly triggered it. In all likelihood there was a multiplicity of overlapping causes, of which the two most important were probably:-

  • the absence of a Risk Off spike on Cyprus (with added piquancy of possible forced reserve sale at the ECB’s behest)
  • the absence of an immediate inflationary rally on the BOJ move

More fundamentally, we have to face up to the fact that the Sell Side has simply l-o-v-e-d the fact that commodities are weakening while equities and credit are storming ahead since this enables it to spin a new tale to customers about why they should now revert to type and stick with their traditional, fee-generating asset classes.

Much has been made of the recent raft of negative reports from those who were formerly the bull market’s greatest boosters, but in truth, as consummate salesmen, these worthies are only telling their disappointed customers what they already want to hear. No spiel sells as well as the one which allows an after-the-fact rationalization of an unlooked-for outcome. If you can’t be smart about where the market is going, it at least assuages wounded pride (and patches up a tarnished professional reputation) to sound knowledgeable about where it has been.

All this has contributed to a poisonous mix of factors – fundamental, technical, and sentimental – among which we can include the following shifts.

Firstly, in terms of the guiding mantras which the crowd is so wont to adopt, ‘Peak Oil’ has given way to ‘Shale Glut’ and ‘Super-Cycle’ Chinese gluttony has been transmuted to an expression of faith in the all-seeing Confucian Mandarins who will shrewdly rebalance economy and unleash consumer spending, needing no copper in excess of the present quota to do so. (Big Mining itself has been reinforcing this shift, leading to the unusual result that Big Mining share prices are showing even worse returns than are commodities, despite the overall vogue for equities).

Next, financial momentum itself is now a killer, since the more commodities lag, the more people fear being left behind in any less than full commitment to the incipient equity bubble whose warm glow of instant mark-to-market gains they again avidly crave.

Again, given the appalling price action of late, the same trend chasers who did so much to boost commodities on the way up have been liquidating/shorting stuff and buying financial assets for some time, even before the gold/silver purgative. Their potential overstretch is our present best hope.

Finally, a glance at break-evens shows that inflation fears have dissipated, possibly in a very premature fashion. For our part, we have always argued that the CB actions will be slow burners, as in the 1960s, until debt re-gearing and bank expansion again come to magnify solo CB pumping. It will be the inevitable reluctance to withdraw stimulus that will lead to catastrophe more than the initial decision to provide it and then, as monetary trust first falls and then is entirely lost, velocity will rise, CPI will accelerate, and real commodity prices will turn.

The widespread impatience with the inflationary argument arises partly because no one understands that for there to be ANY price rises, however CPI-modest, in a world awash in un(der)employment and surplus capacity, this can only be evidence of a deliberate monetary excess. Alas, for us, as investors, the fact that we understand the root of this error does not make its consequences any less significant for the pricing calculus with which we must contend or for the timescale over which we must deal with it.

Thus, QExtreme is now exclusively bidding up financial assets (the Herd comfort zone, as we have said) and real estate (the default for the Ordinary Joe). Yet all the while it is preventing a genuine re-invigoration by keeping zombie companies alive and bad governments in funds, thus depressing organic, vigorous ‘growth’ and so acting without immediately igniting an inflationary holocaust which may well require a much longer gestation process than most are prepared to countenance. Not a great near-term mix for tangibles, it must be said.


The two meetings

Besides the ongoing troubles in the eurozone, the other burning issue for investors is, of course, what will emerge from the just-concluded ‘Two Meetings’ in China where the new team of Li Keqiang and Xi Jinping have formally taken up the reins.

Before we make any comments on what has transpired, we must offer the essential caution that all we have so far are words carefully calculated to strike the right notes with an expectant mass audience. To what extent these reflect a genuine intent and what degree of consensus within the Party any such intent might command is entirely unknown and may well remain so at least until after the autumn Plenum of the Party Congress.

With those qualifications attached, what we can gather from the coverage so far presented is that, by their own admission, the incoming leaders know they face major problems of over-capacity in all manner of key industries—solar, aluminium, steel, etc.—and yet we also know that, despite this week’s ground-breaking bankruptcy of Suntech—old habits die hard when it comes to desisting from propping these industries up. Witness the announcement last week that the State Reserves Bureau would buy one-sixth of the nation’s aluminium and one-eighth of its zinc output this year— a bailout of an ailing sector, however you consider it. Nor does it bode well that steelmakers are pouring record amounts of the alloy a few brief months after many of them were facing ruin (aggregate profits fell a mere 98% last year) and despite a 20% YTD rise in the stocks of cold-rolled coil, a 40% rise in hot-rolled, and 90% rise in those of rebar.

By their own admission, too, the problem of chronic property speculation remains a bugbear and while the optimistic may be happy to wait for the accelerated urbanisation programme (about which no details have, of course, been vouchsafed) to absorb any vacant buildings, they have not yet quite managed to explain how it is that people whose average urban wage is some CNY 40,000 a year will afford all those CNY 20,000/sq m properties currently changing hands in the main urban centres. One means to achieve this financial marvel may well be through the notorious rehypothecated copper dodge (Asian stocks of the metal are up 90% so far in 2013 from the previous three year average) and via mis-invoiced export earnings (q.v., the $25 billion YTD discrepancy between China’s reported exports to HK and the latter’s reported , one-third lower imports therefrom). ‘Reform’ will have to find a way either to close this loophole or make it far less lucrative.

Urbanization may also have a few other hurdles to overcome if we heed the CASS-NDRC joint report on how Beijing’s 20 million inhabitants have already overstrained the land and water resources available to them. More to the point, the authorities have yet to admit that while they keep money and credit growth powering along in the 10s and 20s of percent a year and simultaneously set interest rates at or below the consequent rise in the cost of living, people will naturally look to the property market as a more secure outlet for their surplus cash, whether or not they also hope to get rich quick along the way.

By their own admission, too, fears of financial fragility are rising, as speculation mounts about a coming crackdown on both the notorious LGFVs and the regulation end-running WMPs into which many of these are subsequently bundled. The fact that the new CSRC chairman will be none other than former BOC boss Xiao Gang—the man who dubbed such products ‘Ponzi schemes’ in a recent tirade—might add substance to these rumours.

All this comes at a time when, as our friend Jim Walker at Asianomics pointed out, a report published under the twin auspices of the China Association of Trade in Services and the Chinese Academy of International Trade and Economic Cooperation estimated that the total of accounts receivable on company balance sheets amounts to a vertiginous CNY22 trillion—almost 40% of GDP and pretty much on a par with that extant the much larger United States. If correct, we should compare the 18% reported increase in this book credit (an increment of CNY3.4 trillion) with ’above-scale’ industry reported profits (not an exactly overlapping sample) of around CNY5.5 trillion. Staggering, indeed.

By their own more tacit admission, the authorities are all too aware that they have a problem on their hands with the growing public ire at the polluted state of the environment—a disquiet we could actually read as a sign of substantial material progress having been made, since such concerns are often too much of a luxury for a poor people, too busy scrambling to fill their children’s bellies to fret about the ambient air quality. 

For all the anecdotal horror at which we love to gawp, it does not do to be too superior about this. Just 60 years ago, the Great Smog which enveloped London for four cold, December days may have rendered 100,000 ill while contributing to the demise of up to 12,000 afflicted souls. Nor would any of us much care to stroll along the ordure-strewn thoroughfare of a Victorian city, much less eat the food or drink the water on offer there. Yet this, too, was a time of rapid material advance when wealth was being created across the social spectrum, at a hitherto unprecedented rate.

Nevertheless, China’s lack of accountable governance, its absence of private property rights, and its fetish for output regardless of many internal costs, much less external ones, makes this a difficult matter to address. Pampered metropolitan Lefties may bewail the role of capitalism in scarring the face of holy mother Gaia, but for a REAL disregard of one’s surroundings or one’s posterity, you have always had to look to the Collectivists to take the palm in the scorched earth stakes.

As well as extending the rule of law, the state needs to stop subsidizing heavy industry and making power and fuel artificially cheap while, conversely, it needs to insist upon proper waste disposal and to levy (or allow the market to levy, in an ideal world) a proper charge for rendering that detritus harmless.  If the Chinese people now want cleaner surroundings, this is what they must demand of their leaders and, by extension, of themselves, but it will not come without some sizeable short– to medium-term sacrifices in growth-for-growth’s sake and therefore in employment. The effect on costs and profitability may be a harder prospect to judge since the bill for some inputs (and for the treatment of many unwanted outputs) will no doubt rise, but the overall call on resources could likewise end up being reduced as efficiencies are incentivised and mindless capacity overlaps eradicated. Along with that fall in demand, the price paid for this lesser but better-utilised quota should move in tandem.

How much if any of this we get is a matter of no little doubt, as we said at the beginning of this article, but the local press is foursquare behind the idea that the new team represents at once a radical change and a reversion to the better management of the system which, so the accepted wisdom holds, was the norm under the aegis of Zhu Rongji—several of whose protégés are to be found in the refreshed line up of officials.

Caixin, for one, had this to say:-

Contrary to the expectations of many investors, policymakers have decided not to seek any big increases in government investment this year. Rather, they want to prevent any possible financial trouble tied to local government debt and the off-balance-sheet operations of commercial banks. That means regulations covering local government financing platforms are likely to be tightened… Also highlighted in the government policy book are plans to seek quality over quantity in economic growth, adjust real estate and business tax structures, control housing prices, and reign in fiscal spending.

Or, as more pithily expressed to Reuters by an anonymous visitor to the National People’s Congress:-

Delegates… were clearly agreed that their biggest risk was doing nothing.

But let’s not rest there. Look at the following extracts from new Premier Li Keqiang’s headline, after-party press conference and judge for yourself which way the wind is blowing:-

Reforming is about curbing government power, it is a self-imposed revolution, it will require real sacrifice, and this will be painful, but this is what is wanted by the Government and demanded by the people.”

“We need to build a clean government and make our government more credible … The important thing is action—talking the talk is not as good as walking the walk.”

“The highest priority will be to maintain sustainable economic growth.” [emphasis ours]

“We said that in pursing reform we now have to navigate uncharted waters. We may also have to confront some protracted problems. This is because we will have to shake up vested interests… Sometimes stirring vested interests may be more difficult than stirring the soul, but however deep the water may be, we will wade into the water. This is because we have no alternative. Reform concerns the destiny of our country and the future of our nation.”

As he proclaimed at the end of last year:-

Reform is like rowing upstream. Failing to advance means falling back. Those who refuse to reform may not make mistakes, but they will be blamed for not assuming their historical responsibility.

The old saying has it that ‘fine words butter no parsnips’ and there are few less root vegetable-greasing words than those which emanate from a politician’s mouth, but, in light of all the foregoing, it does very much seem as if the CCP regards the present juncture as an existential moment in its 90-odd year history.

Having raised expectations so high and having the luxury of a honeymoon period in their relationship with their long-suffering subjects in which to enact any radical changes, we must assume that the leadership would be very unwise to slip back into business-as-usual anytime soon and so disappoint the hopes of so many.

To what extent reform will be attempted—and how much resolve will be shown when, as is highly likely, the effects of those reforms expose the many interdependent flaws and critical fractures in the system—only time will tell but, one way or another, it is hard to resist the impression that those in China—and, by extension, those of us who make our living trying to account for that nation’s effects on the wider world—are truly about to ’live in interesting times’


Going all in

For several long months now, the market has been treated to an unadulterated diet of such gross monetary irresponsibility, both concrete and conceptual, from what seems like the four corners of the globe and it has reacted accordingly by putting Other People’s Money where the relevant central banker’s mouth is. Sadly, it seems we are not only past the point where what was formerly viewed as a slightly risqué ‘unorthodoxy’ has become almost trite in its application, but that like the nerdy kid who happens to have done something cool for once in his life, your average central banker has begun to revel in what he supposes to be his new-found daring – a behaviour in whose prosecution he is largely free from any vestige outside control or accountability.

Indeed, this attitude has become so widespread that he and his speck-eyed peers now appear to be engaged in some kind of juvenile, mine’s-bigger-than-yours contest to push the boundaries of what both historical record and theoretical understanding tell us to be advisable. After all, it was sixty years ago now that Mises was telling people, in an article decrying the malign influence of Keynes, that:-

The economists did not contest the fact that a credit expansion in its initial stage makes business boom. But they pointed out how such a contrived boom must inevitably collapse after a while and produce a general depression. This demonstration could appeal to statesmen intent on promoting the enduring well-being of their nation. It could not influence demagogues who care for nothing but success in the impending election campaign and are not in the least troubled about what will happen the day after tomorrow. But it is precisely such people who have become supreme in the political life of this age of wars and revolutions. In defiance of all the teachings of the economists, inflation and credit expansion have been elevated to the dignity of the first principle of economic policy. Nearly all governments are now committed to reckless spending, and finance their deficits by issuing additional quantities of unredeemable paper money and by boundless credit expansion.

In this vein and though we should by now have become numbed to displays of such insistent folly, we cannot but find it a touch ludicrous that the Fed’s Jeremy Stein could give a speech warning about the utterly undeniable dangers of ‘overheating in credit markets’ – presumably with a straight face – only to be pooh-poohed a week or so later by his boss when similar concerns were raised at that latter’s regular meeting with the pampered, corporate welfare insiders at the Treasury Advisor Borrowing Committee.

The wise will take cold comfort from this, being all too cognisant of the fact that our esteemed Fed Chairman – much like his once-revered predecessor in office – has clearly demonstrated, both in the record of his public pronouncements and the belatedly-published transcripts of what he said in camera as the late crisis unfolded, that he is dispositionally unable to recognise the signs of a bubble in a beer glass, much less in a bond price or a balance sheet, since such a phenomenon plays no role in either his dogmatic and mechanistic model of the real world while the possibility that he may be personally in error finds no place in his monumental intellectual conceit.

Adding to the sense that nothing will dissuade these quacks from bleeding and cupping their poor patient until he expires under their assault, in a speech (delivered before a union audience, no less!) that Madame Defarge of the rentier class, Janet Yellen, also vouchsafed the hint that the Fed’s newly-adopted ‘Evans Rule’ – of continued, massive intervention until such time as unemployment subsides below 6 1/2%, assuming that CPI ‘projections’ (Oh, I d-o-o-o love a hard, independently-verifiable, objective target) likewise remain below 2 ½% – was not to be seen so much a ‘threshold’ for restriction as a gentle reminder that a rethink might soon be in order.

Not that the Fed Vice Chair was alone in her infamy. The week’s earlier publication of the Bank of England minutes revealed that there are other central bankers itching to help Wall St. and the City make their bogey for the year. Indeed, it seems that the outgoing Governor had wanted to pre-empt his hubristic successor-elect by easing now and not waiting for said Canadian newcomer to make good his less than modestly declared mission to ‘refound’ the three hundred year-old institution over which he will be suzerain, as part of his personal goal to show the whole of Europe how to ‘get those economies going and fix those financial systems’.

Not content with this, up stepped King’s fellow dove, David Miles, to set out a ‘model’ (roll of the eye-balls) which, by dint of equating the propensity to ‘inflation’ (i.e., to ongoing price rises) not to the supply of money in the system (thereby denying three centuries of theorising) nor with any consideration for the demand for said money (so ignoring the whole 140-odd year history of subjective marginal economics), but solely to the estimated degree of physical and human ‘slack’ in the economy, gave us a QED in favour of more QE.

Having set up the metrics of his toy universe, Mr. Miles told us proudly that he then gave it over to the silicon gods to perform 20,000 iterations with it and arrived – Hey Presto! – at the precise conclusion that the Bank needed to be 16% (sic) more accommodative, in other words, to buy another £60 billion gilts, even though, as our Great Engineer himself admitted:-

The model does not say that asset purchases are the only way this should be achieved.  If there are monetary policy tools that are more reliably effective in boosting demand, they should be used.  But it is not clear what these are, which is why I have calibrated the model to reflect my own assessment of the evidence of the impact of asset purchases. 

As every right thinking person should know (and hence climateers excepted), the principle problem of mathematical computation is encapsulated in the phrase GIGO – Garbage in, Garbage Out. One of the parameters Miles adopts in his latter-day difference engine is that UK GDP ‘should’ run at a steady 3% rate of increase. Since this was roughly the experience of the laughingly-dubbed ‘Great Moderation’ which stretched from the economic travails of the early 90s to the eve of the Crash, this superficially seems to be a reasonable assumption.

What he has overlooked, however, is that while real GDP currently lies some 20% below where an extrapolation of that trend would otherwise suggest, the reckoning of total hours worked in the economy has fully recouped its intervening losses, while, for the past five years of slump and sub-par growth, the RPIX measure of price changes has risen by an average 3.9% p.a. which is the worst performance in 17 years (a ‘remit’-busting failure of policy which, if the yields on gilts maturing in 2055 are any guide, is expected to persist for the entirety of the next four decades!)

Putting these gross aggregates charily together, we can see that, whereas GDP per hour worked rose, with only minor variations, at a trend of 2.5% per annum for the first 37-years of the floating rate era, in the succeeding five years of the crisis, it has declined by 0.8% a year – a fall of a duration and severity unprecedented in the modern record despite the Bank’s fivefold, £325 billion intervention (equivalent to 25% of average GDP over the period and to more than half the state’s cumulative deficit).

So, here’s a question: is it just possible that the long misrule of NeuenArbeiterPartei under the leadership of RobespiBlaire and Culpability Brown (as we always used to refer to them) led to a progressive stultification of the system to the point that the country effectively now lies broken? Sapping entrepreneurial endeavour, burdening the economy with costs and with a mare’s nest of legal and regulatory hindrances, swelling the tax-sucking ranks of patronage amid both the Apparat and the welfare proletariat, this was a reign during which people desperately tried to maintain the illusion of a progressive rise in living standards by incurring crushing levels of debt and relying for nourishment on the bitter fruits of property speculation.

Couple this with the uncomprehending inability of the successor ConDem(n)s to tackle the problems they inherited – as well as with the political elite’s right-on, Davos-man fetish for needlessly driving up energy prices in the service of that jealous pagan deity, Mother Gaia – and you have a nation about whose prospects it is all too easy to despair.

Never mind though, Mr Miles: just run the printing presses a little more – nay! 16% more – prolifically and we have no doubt that all will soon be well again!

How far we are from the pellucid wisdom of Ludwig von Mises can be gathered from what he told a lay audience, just as the groundwork was being laid for the Great Inflation which would ravage the 1970s and early 80s, viz.:-

The nineteenth century the slogan of those excellent British economists who were titans at criticizing socialistic enthusiasts was: ‘There is but one method of relieving the conditions of the future generations of the masses, and that is to accelerate the formation of capital as against the increase of population.’ Since then, there has taken place a tremendous increase in population, for which the silly term ‘population explosion’ was invented. However, we are not having a ‘capital explosion’, only an ‘explosion’ of wishes and an ‘explosion’ of futile attempts to substitute something else—fiat money or credit money—for money.

Meanwhile, Perfidious Albion is left with the sorry combination of activist central bankers, weak growth, a soaring visible trade gap, a record current account deficit, and a scramble to exit positions from those who had previously seen the country as something of a safe haven. With technical indicators already flashing red (if also a touch oversold, at present), is there any floor beneath a currency which its own supposed guardians would dearly love to depreciate further?

Such problems are not confined to the oceanic side of the Channel, of course, as has been highlighted in the deliciously barbed correspondence between the CEO of  US tyre company Titan, Morry Taylor, and French industry minister Arnaud Montebourg over that country’s industrial outlook and business climate. Without getting too deeply into the spat, it should be noted that Eurostat data suggest that the French government typically spends (not including ‘investment’) two-thirds more on its almost 63 million citoyens than does the Italian on its 61 million, yet it is the latter who bear the brunt of the criticism. 

(In the interests of fair disclosure, the same source shows that we virtuous 62 million Brits enjoy the dubious benefits of 45% more state largesse than do our Italian cousins, if 15% less than our French neighbours and even the ostensibly hard-core Dutch splurge as much on their 17 million as do the afflicted Spanish on their 47 million).

In Spain itself, we have had another failed property lender and the rather cheerless message from embattled Premier Rajoy that ‘there are no green shoots, there is no spring’. On the Western littoral of the peninsula, Portugal has also had to downgrade its forecasts to encompass a deeper shrinkage than was first pencilled in – as a result, by some unforeseeable mischance, of the deeper than anticipated slump which has ravaged the rest of the continent, to which it dispatches 70% of its exports and from which it receives the bulk of its tourists.

In Italy, the chorus of disquiet at the prospect that Il Cavaliere might just attract more votes than anyone else in the weekend elections is swelling to a Verdi-like crescendo (remember that democratic choice is all well and good as long as you vote for the candidate preferred by the global hegemons). More broadly, the signs are not good here either. Retail sales last year were at their lowest level in a decade, while industrial orders fell to their fewest (and at their fastest pace) since the slump, taking them down almost a quarter from their 2007 peak and landing them back where they stood at the very launch of the single currency. Hardly a ringing endorsement of the project!

Thankfully, Germany is potentially providing an offset. We use the qualifier because even if the IfO survey is beginning to show its typical lagged response to a surge in local liquidity, this has yet to translate into business revenues and hence, one has to fear, into earnings. Nonetheless, let’s take cheer where we can: Eurozone biflation is bringing a much-needed cheer to the bosses of the Mittelstand.

Abroad in Asia more attention is suddenly being paid to the fact that Shinzo Abe – after being mugged in the corridors of the recent G20 summit (and possibly warned there that he might need to cultivate some wider good will if he wishes to enlist third-party support in his ongoing dispute with China) – is having to back-pedal a touch in Japan as rumours circulate that he might not even get to appoint the most unredeemed, the wildest-eyed inflationist to the top spot at the BoJ next month.

J is for Japan, but J is also for J-curve – that unfortunate constellation whereby the effects of a lowered currency exert more of an upward influence on the import bill than on contemporaneous export revenues. Hence why the country suffered a record trade deficit last month. The fact that LNG prices in the Pacific basin surged to more than $19/mmbtu this month, even as the yen was shedding 10% of its value vis-à-vis the dollar is but one adverse side-effect of Abe’s quackery.

In the near-term, it may be that the accounts of a number of Japanese corporates are unduly flattered by the translation effect, but we doubt they themselves will be fooled by such transitory gains into a radical alteration of their business plans. What should be made clear here is that in volume terms Japanese exports are 10% lower than they were at the post-Fukushima rebound, one sixth lower than the last, pre-Crash spike, and no greater than they were in early 2006 (on a price-adjusted basis, the trajectory of imports is not wholly dissimilar).

Nor has the return from the Lunar New Year break seen China add any further fuel to the flames, either. To the contrary, yet another ‘decisive’ edict has been issued in the (so far vain) attempt to crack down on the nation’s re-inflating property bubble. Adding to a growing presentiment that the central bank may act to head off what looks like an outpouring of new credit from the banks these past 8 weeks, it has this week withdrawn a record CNY910 billion from the market. The smart money now has it that current PBOC chief Zhou Xiaochuan will be promoted to a level of party seniority sufficient to obviate the need to retire now that he has celebrated his sixty-fifth birthday, implying that there will be no radical loosening of policy on that account, either.

He might need to act soon: the new vogue measure of ‘total social financing’ recorded a 160% yoy jump in January while the pace of boring old bank lending so far this year has been similarly robust and could come in as much as 40%-50% above the combined Jan-Feb total for 2011. At this rate, there will be no notable diminution to the already incredible CNY110 trillion in reported urban fixed-asset investment  undertaken these past four years – an amount equal to 145% of the US private economy and a number which has risen more than tenfold in a decade and which accounts for three-fifths of ‘national-scale’ industrial profits.

Whether this will be complicated by the problematical local government debt pile remains to be seen, but one sign that this is becoming a hot button issue is that the China Banking Regulatory Commission has just issued a directive insisting that any new loans extended to LGFVs must be covered by existing cash flows and that the projects for which the funds are intended must generate returns, while what it termed “irregular” lending to these vehicles was henceforth prohibited. That will be fun, given that the recently published provincial budget outlooks suggest the fact that more than half of their loans are due to mature this year.

In response to worries that the regime might act to rein in such developments, the Shanghai Comp underwent its biggest single-day plunge in 15 months, steel futures slipped to complete a 6% drop on the week, copper gapped lower to its weakest close of 2013, and rubber suffered further, making a 10% peak-trough decline from its pre-holiday highs. The FTSE A600 Bank index has, meanwhile, dropped 14%. With Komatsu telling us sales of diggers halved in the last nine-months of 2012 and rivals Caterpillar reporting its worst 3-month regional sales performance (-12%YOY) outside of either the GFC or the Asian Contagion of 1997-8, and with Foxconn announcing a hiring freeze, what little anecdotal evidence we can muster in this period of news blackout is not overwhelmingly positive. 

On a broader front, ahead of the all-important National People’s Congress next month, the local press is positively buzzing with assorted calls for ongoing reform – even to the point of positing the formation of a new super-bureaucracy to supersede the NDRC in this task. President Xi and his allies have presumably had something to do with this campaign and the man himself has naturally been very active in trying to secure his power base in the run up to his full inauguration, but much will remain up in the air until the proceedings have been completed and we get a first look at his first full exercise of power.

Never mind, ever alert to the people’s needs, the planners have just announced that they are taking forceful steps to counter the awful quality of the air in China’s choking megalopolises – they have issued a fatwah banning urban barbeques!


Cyclical déjà vu

Though it might seem a churlish observation to make amid so much barely-suppressed exuberance about the prospect for the markets in 2013, in many respects the past twelve months have shown much the same pattern as has marked each of the preceding four years. Characterized by the grinding hysteresis which we foresaw as far back as the end of 2008, this has broadly materialized in the form of rallies which stretch from one year end into the succeeding spring before a sell-off occurs which then extends into late summer-early autumn, whereupon the cycle reverts to rally and so on round again. 

Each time the Groundhog recovery in asset prices has been based upon the delivery of a stimulus from one or other of the major central banks which has temporarily brightened sentiment – and even improved the macro numbers for a while – before what a physiologist would call a ‘tolerance’ of the credit injection has set in, the economic data has deteriorated, and the unresolved and unliquidated problems which still linger from the preceding Boom have surfaced again to frustrate the optimists. 

Last year began amid ever more undeniable evidence that China was suffering a mini crisis of its own, with profits evaporating, unpaid bills mounting, and trade stagnating,  while the disparities between Europe’s sorely-afflicted south and its better-placed north blew up in to surging sovereign spreads and a €1 trillion-plus mountain of blocked credits piled up across the T2 system.  A further hiccup was then suffered as the two main American political parties acted out their tired old kabuki over the dire state of the nation’s budget.

However, on all three continents, the Keystone Kops aboard the imperilled paddy wagon just managed to wrench the wheel over in time to avoid the looming cliff edge.

For their part, the Chinese did exactly what they assured us they were not going to do and launched a vast new wave of stimulus in order to ease the new regime into office. Eastward, across an increasingly tense stretch of sea, the soon-to-be-Premier of Japan browbeat the BOJ into conducting an escalating series of interventions while, the other side of the wide Pacific, the defeat-disheartened Republicans bent the knee to their triumphantly re-elected opponent and quailed at the thought of being blamed for slashing government spending while the cynically–opportunist Bernanke Fed exploited a patch of economic softness to go all-in with a promise of unlimited bond buying.  

In Europe meanwhile, ECB Chief Mario Draghi declaimed with a truly operatic flourish that he would ‘do whatever it takes’ to keep the cash flowing to the olive basket and so magically relieved the tension in the Eurozone in true Wizard of Oz style.

After a last lurch down around the time of the US presidential vote, the markets have responded with increasing enthusiasm to the realisation that disaster has been postponed once more (if, sadly, not definitively averted). Hope has sprung eternal as stock markets have rallied, junk and emerging market debt spreads have collapsed, volatility has been crushed, and the erstwhile safe havens – such as US Treasuries and gold – have begun progressively to lose their allure.

Alas and alack, as a reflection of the growing disenchantment with what have frankly been the disappointing returns offered by the asset class over the past eighteen months, commodities have taken a deal longer than the other ‘Risk On’ assets to respond to this perceived good news, only beginning to hold their own (on a relative basis) as the new year began.

And so, at January’s close, we found ourselves flushed with the glow of higher prices and complacent in the face of further central bank largesse. Adding to the urge is the undeniable fact that we are all heartily tired of sitting on a stockpile of boring old, precautionary cash for quarter after fretful quarter.

Around such intangibles a new consensus has formed that equities are king, bonds are dead, and commodities—if we must pay them any heed at all—are the things to buy to protect against those few dark clouds, no bigger than a man’s hand, which serve to remind us that central banks cannot go on indefinitely adding money to the system at or below zero real interest rates while budget deficits yawn in undiminished magnitude without risking a conflagration of values too awful to fully contemplate. 

The irony is, of course, that the thing most likely to blow these few wisps of cumulus up into a terrifying inflationary gale is simply that people come to express more and more confidence that neither this eventuality, nor its gloomy deflationary opposite, will come to pass and so the money which is currently only burning a hole in their trouser pockets is brought out to set light to the world at large.

While we must be careful not to be trampled in such a bullish stampede by standing too incautiously in its path, there are both flaws to the premises on which such a Blue Sky mentality has been founded and more immediate concerns that the eagerness to believe has become so widespread and the voices of dissent so lacking that everyone is already leaning over the starboard side of what has therefore become an alarmingly heeling ship, one all to ready therefore to be tipped overboard with the first contrary gust of wind.

Let us (briefly) take China. Still in a policy hiatus due to the regime change and about to enter the macroeconomic purdah of the Lunar New Year, that has not precluded the Herd from wilfully taking as bullish a view as possible about likely developments there – even to the point that one senior analyst from a major bank could bring himself to tell his audience at a mining conference that to him the outlook for the commodity market was very much like it was in 2002 (from which secondary low, the reader might recall, it embarked on what some measures show was the best nine years in its history!) 

It seems that nothing will stop the idiot savants – as well as the consciously misleading – from plugging whatever numbers the state propaganda machine churns out straight into their ‘models’ in order to lend some spurious gloss of calculation to such pronouncements, no matter how unreliable, contradictory, or plain incredible these may be.

Take the Chinese GDP number for the broadest of these: Officially, last year’s nominal total came to CNY51.9 trillion, an increase of 9.8% or CNY4.6 trillion on 2011’s count. Yet, by adding up the individual data produced separately by the nation’s constituent 31 provinces and autonomous regions, we can calculate that the annual sum reached to CNY57.7 trillion (11% higher), and that growth accelerated to 11.1% yoy, representing an increment of CNY5.8 trillion which was a quarter larger than that given by the official tally. Spreadsheets, anyone?

By now it has become almost trite to compare the electricity stats with those for GDP or industrial production, yet we have a rather worrying disconnect in other areas of energy use, too. Industry up by a double-digit amount alongside a gain in refined oil product use of no more than half of that (5.2% yoy), of which diesel consumption barely ahead at 1.5%? Makes perfect sense to me!

Then we have the miraculous rebound in ‘profits’ posted in December (and we will risk a roll of the eyes by asking, once again, how can businesses even begin to compute earnings on a monthly basis?). Setting the seal on QIV’s auspicious rebound and so helping the Shanghai Composite to a further 8% gain, December’s winnings were supposedly a cool 68% greater than the average of the previous three months; revenues were no less than 13% higher and, hence, margins were reported to have jumped by half from 6.5% to 9.7%. Oh, for such levels of operational gearing in an expanding market! 

In the short run, what may come to haunt the China bulls is the fact that even this brief relaxation of policy has unleashed the same old dark forces of shopping basket inflation and property speculation. For example, the all-important pork price has risen by more than 10% in the past two month, prompting a release of supplies from the central reserve to try to quell the surge.

More worrying still – especially given the news that the much-bruited property tax will not now be rolled out across the country – land sales in China’s ten main cities were up by a factor of 3.6 last month from January 2012, according to the Shanghai E-house Real Estate Research Institute. Given that the area sold increased ‘only’ 77%, this also implies that the average price paid more than doubled. Stop-Go rules OK!

In light of this what would have been merely risible if it did not simultaneously display China’s increasingly belligerent response to foreign criticism alongside an utter lack of economic understanding, the mouthpiece People’s Daily this week carried an aggressive repudiation of assertions that the country’s monetary incontinence posed a threat to global stability.

Putting the cart firmly before the horse, the editorial argued that if a company had made a hypothetical land purchase ten years ago and if, on going public this year, that same land had been valued higher by a factor of 2,000 (sic!), if the central bank did not issue new money to the tune of around a quarter of that latest appraisal, the increase would be ‘just a bubble’!

No, really! We are not making this up as you can see here:-

On top of this, the writer contended, ‘price reforms can also lead to a substantial increase in the demand for money’ since, he went on, if prices rise, both companies and consumers have to pay more, ergo more money is patently needed – a problem which is moreover said to be ‘unique to China’! Truly, to invert Milton Friedman, monetary inflation is everywhere a real side problem!

Heaping a cloud-capped Pelion of further confusion upon this already lofty Ossa of muddle-headedness, a separate justification for the deluge is apparently that while America’s attempts of the last four years at disaster recovery have naturally focused on its predominant, highly-leveraged financial sector – meaning that every new, FRB-printed dollar could be multiplied up sixty times (sic) – poor, old, metal-bashing China, by contrast, has been doomed to rely on a mere 4:1 multiplier to assist its key industrial base (the limitation being imposed lest it blew its companies’ balance sheets up to imprudent levels of gearing) and hence it had to keep its central bank’s printing presses fifteen times as busy as those of the Fed!

Working up a full head of steam, the author closed this truly Swiftian self-parody with one last, glorious volley of logical howlers, by asserting that the crisis-averting increase in money supply has increased the risk (but only the risk, you will note) of debt expansion before the authorities became ‘scared’ enough to tighten policy and thus to usher in a ‘slump in domestic stock markets, a surge in loan demand, persistently high interest rates, and such financial risks as usurious loans, shadow banking, and trust loan expansion.’

Well, yes, but surely those were merely the unfortunate side effects of an attempt to address the dangerously building excess before the system exploded under its own pressure? No, this hero of socialism-with-Chinese-characteristics confidently concludes, ‘…the greater risk lies in an increasingly weak real economy.’ 

And this is the spokesman for a preternaturally-gifted ruling elite which is supposed to be reforming and rebalancing its economy in a ‘scientific’ manner and whose rarefied heights of dispassionate calculation we benighted Westerners cannot ever hope to match? Heaven help us all!

But if the ongoing suspension of disbelief regarding China is one of the great enormities of the current mini-bull market, the effort to disregard the sorry history of Japan’s last two decades by a semi-mystical appeal to the half-remembered exploits of eighty years ago is surely the other.

For now it seems, after twenty-plus years of evergreening loans while covering whatever real verdure there was in swathes of economically otiose concrete, the ‘one more heave’ generalship of the LDP will finally enact all of Paul Krugman’s wildest fantasies by further unbalancing its budget – this time with the untrammelled assistance of the central bank – and thereby repeat Finance Minister Korekiyo Takahashi’s feat of ‘rescuing’ his country from the clutches of the Great Depression.

That Takahashi’s real achievements are still somewhat moot is, of course, besides the point even though debate still rages about whether it was his 60% devaluation of the yen in late 1931; his reliance on proto-Keynesian pump priming and his insistence that the BoJ monetize at least some of the resulting deficits (not a small fraction of which were incurred by the country’s simultaneous annexation of Manchuria); his elimination of the capitalists’ ‘wasteful competition’ via his promotion of industrial cartelisation; or whether it was simply that the wider world was already coming out of the worst of its trough by the time his policies were being put into effect. Suffice it to say that a multitude of PhD dissertations and many a professorial citation count still depends on the construction of intricate counterfactuals about this episode, together with the conducting of exhaustive econometric testing of this ultimately untestable dispute.

We should perhaps first pause to take note that Takahashi is an unlikely hero, given that he once declared, in reminiscence of his mentor: ‘After two days of talking with Maeda, I realized that my concept of the state was shallow. The state was not something separate from the self. The state and the self were the same thing.’  Mussolini would have been proud of him. 

Moreover, this particular ‘genius’ seems to have subscribed to the same old canards of the underconsumptionist school, with all of its superficial appeals to the so-called circular flow mechanism. Hence, we have this pronouncement from the lips of the great man:-

If someone goes to a geisha house and calls a geisha, eats luxurious food, and spends 2,000 yen, we disapprove morally.  But if we analyze how that money is used, we find that the part that paid for food helps support the chef’s salary, and is used to pay for fish, meat, vegetables, and seasoning, or the costs of transporting it. The farmers, fishermen, and merchants who receive the money then buy clothes, food, and shelter. And the geisha uses the money she receives to buy food, clothes, cosmetics, and to pay taxes. If this hypothetical man does not go to a geisha house and saves his 2,000 yen, bank deposits will grow, but the efficacy of his money will be lessened. But he goes to a geisha house and his money is transferred to the hands of farmers, artisans, and fishermen. It goes in turn to various other producers and works twenty or thirty times over. From the individual’s point of view, it would be good to save his 2,000 yen, but when seen from the vantage point of the national economy, because the money works twenty or thirty times over, spending is better. 

No wonder his shade is being summoned as the tutelary deity of what is inevitably being termed ‘Abenomics’. Martin Wolf must be positively beaming with delight. 

Our own thoughts on this matter should need little exposition so let us content ourselves by citing the wise words of a man who is being sacrificed to this kami of inflationism, outgoing BOJ head Masaaki Shirakawa. In a speech given almost two years ago, he pointed up the dangers of overplaying the supposed similarities between 1930s Japan and the country of the 2010s before issuing a stark warning regarding the dangers of embarking upon a like  course to that followed on that earlier occasion:-

As many of you know, Mr. Takahashi was assassinated in 1936 by militarists when he was trying to stop ever-growing demand for military spending, and the course of events led to the eventual rampant inflation. I would argue that the introduction of the scheme of the Bank’s underwriting of government securities itself paved the way for eventual ballooning of fiscal spending, precisely because the scheme lacked the checking process through the market mechanism.

We often use the words of ‘entrance’ and ‘exit’ to discuss the conduct of monetary policy nowadays. In that terminology, we should interpret that the ‘entrance’ of the introduction of the Bank’s underwriting of government bonds in the early 1930s led to the ‘exit’ of the failure in containing growing demand for fiscal expenditure. In retrospect, we should note that the Bank’s underwriting of government bonds started as a ‘temporary measure’.

Though Mr. Takahashi stated that he issued government bonds by a means of the Bank’s underwriting just temporarily in his address at a Diet session, history tells us that it was not temporary. 

For reference, the toxic legacy of a government debt of 200% of GDP (sound familiar?), a vast monetary overhang, and shrunken markets eventually cast the defeated nation into a rapid inflationary whorl. After a one third reduction in 1946 as a result of that year’s currency conversion and capital levy, money supply shot back up by a factor of six between the end of that year and 1951/2, as official wholesale prices rose one hundredfold (even if the more representative black market ratio was closer to a more proportionate fivefold).

As a noted economist of the time, Martin Bronfenbrenner, remarked:

no serious attempt was made… to control either the volume of currency printed or the volume of bank deposits created to support not only the Government deficit but also the similar deficits of private firms

We can only hope that the contemporary Japanese will not suffer too much from what seems to be an active programme of decontrolling such an efflux.

And what of those hoping for a mercantile boost for Japan as the currency falls at its second fastest rate of the past generation? Well, perhaps it will turn out not to be the smartest thing to prosecute a policy guaranteed to increase input costs from abroad during a period when the country’ trade gap is the highest on record, when the terms of trade have already fallen by a fifth over the cycle, and when the ratio of imports to national income has only briefly been exceeded at any time in the modern era for the four quarters leading up to 2008’s global peak. 

Rather than waiting in vain for some instant miracle, it would be as well to  heed the caution of Toshiba Executive Vice President Makoto Kubo who told a press conference recently that:

The semiconductor-related business will benefit from a weak yen, but the rapid fall in the currency will increase costs because it uses a massive amount of electricity.

Or might we be led to doubt by noting, as was long ago remarked:

…‘because each farmer and the situation in each farm village differs, it would be wrong to impose a comprehensive relief program. Each region has its unique disease. We must begin by investigating these sicknesses and applying the correct cures. If we scatter money uniformly from the centre to the regions, we cannot eliminate the diseases.

Who said that, you ask? Why, a certain beatified inflationist by the name of Korekiyo Takahashi.

Back in that other Sick Man of the global economy, there has finally been a minor test of the complacency which has increasingly categorized the European scene.  Naturally, since Draghi’s deus ex machina nothing very concrete has been achieved, for all the endless summitry and fevered shuttle diplomacy, as joblessness has climbed, state indebtedness has worsened, and business confidence has further eroded.

Cyprus is only the latest to be – or not be, depending on the swing of the political weathercock – a potentially ‘systemic’ problem. Italy is on the verge of another Dantean descent into political chaos as the same-old, derivatives-enabled fudging of the account books to which the Japanese were so prone has come to haunt the Urprovinz of European banking. This, even though the cynic might enquire as to why a (quasi-)private European bank shouldn’t do what so many of its sovereign overlords once did with the help of exactly the same sorts of TBTF pirates to ensure that they met the Maastricht criteria for euro-entry? 

Though this may only comprise the latest of a long line of financial imbroglios, the political repercussions stretch further, not only by giving the irrepressible Silvio Berlusconi one last chance to strut his hour upon the stage, but in calling into question either or both of the competence and integrity of the current head of the ECB, a man who happened to be in office with the local central bank at the time. With an even more socially-incendiary corruption scandal having recently erupted in Spain – implicating many of the kingdom’s nomenklatura in a seedy little brown envelope scheme – it may be that another round of drama will ensue in the Eurozone after months of spread-tightening quietude.

Conversely, unease among the moral hazard jockeys has been sown by the steps taken by the Dutch government in taking over the failed mortgage company SNS Reaal (no, property crashes are not just an Anglo-Latin phenomenon). As part of this, at long last – almost five years too late, some might say – the subordinate bond holders have been made to share the pain of a bail-out. So, finally, someone has had the cojones to follow the lead of the doughty Danes and intrepid Icelanders and put a great, fat slug of risk back from whence it should never have been removed. 

Adding to the general angst, Germany and Finland have seized upon the action to join the Netherlanders in calling for the good and great to advance the implementation of a tougher rescue regime from the formerly proposed temporal wilderness of 2018 to a politically imminent (if still Augustinian ’Not yet, O Lord’) starting point of 2015 – though why this should happen any later than a week next Wednesday is beyond us!

Ironically, all this has blown up as the banks have brashly repaid some €130-odd billion of last year’s LTRO funding – a close and suggestive mirror of the €125 billion reduction in the big four TARGET2 creditors’ balances (and, hence, of the  EUR130 billion drop in Spain and Italy’s debits) which has taken place since the summer. Given that the euro has itself become the forex market’s new RORO bell-whether, a disruption in Spanish and Italian asset markets, Eurobanking stocks, or the currency itself could therefore see a widespread series of interlocking liquidations if confidence is not quickly restored.

It’s nice that such doubts resurface when US equity margin debt has hit its highest dollar amount since the 2007 top (indeed, it may well be a good deal higher than these December figures, given that the last three weeks have seen what look like record, pro rata inflows). Moreover equity mutual fund liquid assets have hit their own record low-equalling proportion of total assets and a multi-year low one of market cap: the bullish combo of high leverage and a reduced margin of safety has only previously been matched in the blow-off high of summer 2007. 

Notwithstanding the fact that S&P reported that the credit quality of leveraged loan and high-yield bond issuers is deteriorating, with downgrades outnumbering upgrades for the first time since 2009 and with the growth in debt outpacing that of cash flow for U.S. leveraged-loan issuers, junk bond yields have hit a record low while EM bond spreads stand at their narrowest since 2007. Volatility in stock and bonds, oil and gold, have also gone off the bottom of the chart thereby implying that no-one wants to buy protection in what is seen to be an unimpeded one-way path to the sunlit uplands where bogies are made by all and sundry, skilled or no.

Yes, we have clear signs of a breakout (at long last) from the channel drawn off the 2011 high which has been constraining industrial commodities (though neither these nor the broader CCI combo have yet quite breached the pennants drawn off their 2008/9 extremes) and, yes again, we can project up from this to new cyclical highs if we measure from the 2009 lows via the intervening consolidation; and, yes, ‘overbought’ can easily become more ‘overbought’ until a shock to sentiment occurs but, but, but….  the danger must surely be that everyone has already positioned so far for this best of all possible worlds, so well ahead of the expected CB largesse upon which much of this has been predicated, that disappointment looms even if its trigger remains to be determined. 

What we have to try to gauge is whether this is really the long-awaited easy money blow-off move, or whether we will once again be nursing our disappointments, come the Dog Days of summer. If the market can shake off the last few days’ attack of nerves then we might at least muster the confidence to play an extension of this tactical rally before we have to decide upon its candidacy for the much more significant role presaged by the likes of no lesser mortals than Ray Dalio and Bill Gross.

If, conversely, the few, hardy sellers win this particular round, we can resign ourselves to having nothing better to which to look forward than to suffer another tedious bout of up-and-down, cyclical déjà vu


The walking dead

“A formidable set of difficulties is encountered when we ask what there is left of the notion of monetary neutrality for a society which has once, for whatever reason, been thrown off the rails of steady advance, or for one which, like our own, has never really succeeded in adhering to them.

Does it… imply the maintenance of the situation existing at the moment, or the restoration of some previously existing situation, or the attainment of some situation never hitherto obtained?”

Sir Dennis Robertson,  A Survey of Modern Monetary Controversy, 1937

“Mr. Harrod… pins his faith chiefly to a policy of government borrowing, initiated at the very onset of the recession, to finance both a carefully prepared plan of capital works and also if necessary the maintenance of consumption… so soon as the transition is effected, the borrowing policy is to be reversed. It is not easy to square this programme with the pessimism of Mr. Harrod’s central analysis and indeed in the end he admits that he feels bound to contemplate the possibility that the government debt may on balance continually increase. 

After all, he consoles us, there are worse things than debt, alias the ownership of claims to income by poets and other worthy people; and fortunately it will be possible to combine the apotheosis of the rentier with his euthanasia”

Sir Dennis Robertson, Harrod: The Trade Cycle, 1937

Much to everyone’s relief – if to few people’s real surprise – the official Chinese numbers for the fourth quarter ‘improved’ from the previous trimesters’ mini-slough, with GDP accelerating from 7.4% yoy to 7.9% and industrial production ending the year at a 10.3% rate which was the fastest in nine months.

As usual, these data came with any number of attached caveats. Was it really possible, for example, that heavy industry grew at just under 10% in 2012 as a whole, while only using 3.8% more electrical power? Could this be done while rail freight actually dipped by 1.5% over the year or container traffic at the nation’s two biggest ports of Shanghai and Shenzhen only managed a combined 2.1% increase?

It does seem a touch problematical, doesn’t it?

Then again, what we do know – as we laid out in our last weekly edition [Material Evidence 13-01-25] – is that both fiscal outlays and credit provision grew markedly in the final quarter. Nevertheless, what we must look askance at is what supposedly resulted – the credibility-stretching 22% gain in profit and 15.6% jump in revenues (neither figure annualized) enjoyed by the SOE’s between the last three months of the year and the prior three. In yuan terms, we are asked to accept that QIV’s increment to revenues was the greatest on record; that to its profits, one not beaten since the first half of 2009 when the economy was roaring out of the post-Lehman slump.

What is also noticeable is that gross urban fixed asset investment for the year amounted to a massive Y34 trillion which, while computed on a different basis from the GFCF component of the number, represents a record high 70% of GDP. Moreover, the marginal extra UFAI undertaken in 2012 versus 2011 amounted to Y6.3 trillion (or +21%), which was a cool 136% of the Y4.9 trillion in declared extra nominal GDP (+9.8%), a surproportion only previously in evidence during the great reflation between June’09-June’10 – an episode to which much official hand-wringing has been devoted for having sown many of the troubles of misplaced investment and widespread peculation which so plagues the economy today.

Furthermore, the past twelve months’ cumulative CNY1.46 trillion positive trade balance was the largest since September 2009 and its YOY growth of CNY440 billion accounted for almost 10% of incremental GDP, the largest such contribution since 2007 despite the intent to focus henceforth on domestic, not foreign, sources of growth.

So, even if we take the Chinese numbers at face value (and all we have to say here is ‘Caterpillar’), the much vaunted ‘rebalancing’ would seem to have been postponed, once again, for reasons of short-term political expediency.

Any more confident analysis of China is being complicated by the fact that not only are the various institutions which comprise its leadership giving off conflicting signals – not least the obvious clash between the schedule of eye-wateringly expensive infrastructure schemes and the financial authorities’ moves to limit local governmental abuse of Off Balance Sheet platforms – but it is almost certain that we must wait until the formal handover of power in March for any major new policy initiatives to be given a more concrete form.

Reinforcing Failure

In the meanwhile, the market’s attention has been turned out past the Diaoyu/Senkaku islands towards a formerly slumbering Japan.

Not that the simmering territorial dispute is to be too lightly dismissed – not now we have Chinese militarists issuing nuclear-tipped warnings to the Australians not to run with the US ‘tiger’ or the hated Japanese ‘wolf’, or while Japanese foreign officials criss-cross the sea lanes seemingly intent on marshalling all of China’s fractious neighbours behind them – but the immediate focus has been the Bank of Japan’s capitulation to the Abe government’s threats to pack its governing council with Yes men and to rewrite the law defining its powers if it did not throw its weight behind the latest attempt to deprive the archipelago’s many pensioners – as well as its other purchasers of imported stuffs – of a living income.

Not that this is how the matter is being presented, of course, as the dark forces of global Keynesianism exult at the prospect of yet another New Deal being launched somewhere in the world. After all, it must be about time that oneof them actually ‘did what it said on the tin’ and restored prosperity by means of a clod-hopping bout of fiscal-monetary intervention to a people from whom it was taken by an earlier series of similarly ill-judged interventions from on high.

Given the already heated political situation in the region, the timing could be better, particularly with regard to a yen whose 10-week decline has only been exceeded (benignly) in the reversal of safe haven flows once the Lehman crisis began to abate and (less happily) during the Sakakibara episode in 1995 which arguably set the stage for the global instability of 1997-98. Already, Japan’s neighbours and export competitors – the equally growth-scarce Korea and Taiwan – have begun to make noises about the policy implications, while the Bundesbank’s Jens Weidmann has also expressed hopes that this does not mean a return to the dark days of competitive devaluation.

But, more fundamental than this is the very question of what the Bank and the LDP think they can achieve. Does the country really need any further, grandiose, state-financed spending programmes even if it could apparently bear to spend Y200 trillion (sic) on disaster-‘toughening’ schemes, according to Abe advisor Satoshi Fujii? Can the country really be languishing so badly under the crushing burden of nominal interest rates which have barely inched above the giddy heights of 1% at the short end and 2.5% at the long these past fifteen years? Is the fall off in exports really either attributable to – or curable by – developments in the level of a real exchange rate which at its most unfavourable lay only 0.5 sigmas above its stationary, three-decade mean?

For now, the system has held together, with JGBs rallying under the same old QE rationale that has kept US yields from backing up in the face of yawning deficits. Given the presence of a non-price-sensitive buyer, wielding an inexhaustible cheque book, one would have to be truly foolhardy to short the bonds in one’s own currency though it is quite another matter if you come at them from abroad and later hope to spend the returns in your own, foreign domain.

It would not, however, be too wise for the authorities to flout the wishes of their long-suffering citizens, especially not when they have such a deep, vested interest in seeing neither their money, nor the banks and government debt which provide its backstop undermined. At a massive 115% of GDP, M1 money plays a bigger role in the economy than it does in most other developed nations (c.f., the ~50% in the Eurozone, or the ~20% which prevails in the US). As such, it makes up 55% of household financial assets and over 70% of financial net worth, with another 25% of the total exposed directly or otherwise to government debt.

For their part, banks hold over Y400 trillion in JGBs to back up their customers’ deposits, a total which is perhaps eight times larger than their equity capital  (meaning a 180bp back up in 10-year yields would effectively wipe them out, if properly marked to market), while other financial institutions hold as much again. This is clearly not a country where one should knowingly tinker with people’s faith in either of these instruments – cash or bonds – in the pursuit of a serially failed and oft-vitiated nostrum.

Perhaps that is why the BOJ seems to have both postponed the onset of its Fed-like QEternity programme to 2014 and to have hedged about the wider terms of its abasement with a number of caveats. Even though it has committed to covering not just the deficit twice over this year, but actually the entirety of government outlays, its outgoing governor did publicise the valid objections of board members Kiuchi and Sato, while reserving to the Bank the right to ‘ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances‘ and to attempt to hold the government to its pledge to ‘flexibly manage macroeconomic policy but also [to] formulate measures for strengthening competitiveness and [the] growth potential of Japan’s economy‘ while ensuring it will ‘steadily promote measures aimed at establishing a sustainable fiscal structure with a view  to ensuring the credibility of fiscal management’.

Good luck with that, we would be tempted to say, but the more fundamental point is not whether we gaijin think (along with the likes of Kyle Bass) that all this must soon break apart, but rather when Japanese banks, Japanese insurers and pension providers and, above all, Japanese individuals lose faith in their own money. Here, we might note that they have been quiet net sellers of JGBs for a few quarters now, their actions only being offset by the increased absorption of the BOJ itself. One thing is for sure; the ‘end to deflation’ will not be a gentle or controllable affair, if and when it comes, nor will its impact be limited to Japan alone.

An Inflationist’s Charter

Beyond the fact that most of the biens pensants have uncritically accepted that Japan is finally ‘doing the right thing’ in acting in this manner and aside from the rather incongruous paranoia they nonetheless seem to share about whether perfidious Nippon will steal a march on them as the yen falls under the programme’s influence, renewed mutterings have emerged regarding the advisability of moving towards some form of NGDP targeting everywhere else within their purlieu.

Though there are a few rags of respectability to this concept, to most of those who espouse it these serve only to clothe the stark nakedness of what is, at root, yet another inflationary nostrum. After all, what is the point of being a member of the clerisy if you do not have some blinding wheeze to advocate as a means of extracting the world from its present mess without first having to face the reality that indebtedness is too high, capital has been misallocated on a grand scale, and that – by and large – we have all been seduced by both easy credit and the promise of unearned welfare into living just a little too much for the pleasures of the moment given the paltry gains concurrently being made in our real incomes.

The scanty raiments of reason associated with this canard are those which seek to limit fluctuations emanating from the monetary side of the economy not just by controlling an ‘M’ (upon whose exact composition, naturally, very few agree!) but also the rate at which it courses through the system (its ‘velocity’, if you must). Given that even the later Hayek mused aloud about whether this might not, in fact, be advisable (though most of those citing him conveniently forget to mention that he immediately went on to express grave doubts as to how exactly such a programme would be implemented), the idea has had a certain fatal allure even for those who generally would not endorse any more intrusive forms of monetary engineering.

But, even if we concede this point – arguendo – to the fractional free bankers, if to no others, the ugly truth is that the kind of automatic, bottom-up, self-governing mechanism which the likes of George Selgin argue their system would comprise is not at all what is being envisaged at present. Instead, the likes of incoming BOE governor Mark Carney – a man conveniently escaping the worst consequences of the bout of Dutch disease allied to a housing bubble to which his policies have contributed in his own land – do not just want to stabilize NGDP, but to target its growth AND, moreover to move it back towards the trend it was following before the Crash.

For example, in the US, the 1984-2008 log trend ran at around 5.5% p.a.: currently, we find ourselves some 15% below that trajectory trend, while growing at approximately 4% pa.

Ergo, to get back on trend in, say, three years’ time would require a growth spurt amounting to 45% – or almost 10% p.a. What sort of money growth do you suppose  we are talking about to achieve THAT? And how much will arrive simply in the form of higher prices and not increased output, given that this is the sort of growth rate last seen in the Great Inflation of 1970-80?

For comparison, the UK faces a similar arithmetic, finding itself 16% below the pre-Crash trend and growing at less than half the prior pace, which means a 12% per year burst is needed, faster than was achieved during the booming 1980s when the RPI index ended up rising at a double digit rate. Then there is Europe. How are we to assure that the sorely-afflicted Latins reap the main benefit of any ECB largesse without blowing the still-affluent Teutons through the roof, especially given the fact that a three-year return to trend would have to double the pre-Lehman speed of increase?

Laying aside the question of what distortions and inducements to further capital wastage would occur were such at thing to be attempted on the necessary scale and quelling all doubts as to the advisability of even seeking to return to a trend which was artificially boosted by the nitro of the largest, arguably the most damaging, credit bubble in history, the very concept of NGDP suffers from problems of accuracy of measurement, representativeness, and timeliness.

NGDP under-represents the total flow of money in an economy by a good 50-60% by focusing only on the arbitrary Keynes-Kuznets final spending components and hence by ignoring activity in the more volatile, higher-order goods sectors whose smooth functioning are intrinsic to the very business of continued wealth creation and income generation.

Thus, even if we were to embark upon some semblance of this folly, the least we could do is to gauge our success with reference to the development of the more timely and accurate measurement of overall business revenues, not NGDP. Taking either sales themselves or, where not so readily available, an adjusted gross output measure as a proxy for these, it is also notable that the biggest present laggards in the US are to be found in residential construction, finance, non-food retail and – yes – government, while manufacturing has not only been growing faster than before the crash, but now lies only 4% or so below trend. Extractive industries are, of course, blazing the way forward as America’s energy revolution takes hold.

Thus, it could be argued that, however painful the process is for those who either work to a foreshortened, political timeframe or else who itch to earn some fleeting glory by ‘making the most of a good crisis’, the US is sluggish only in the areas which were responsible for the worst of the pre-crisis excess and conversely is doing pretty well, thank you, in the formerly neglected ones wherein tomorrow’s prosperity may be rebuilt. Pray tell how we are going to encourage this commendable re-orientation by lumping them all together and inflating the hell out of asset prices in order to make their aggregate rise more rapidly?

When Tomorrow Comes

In his recent allusion to this argument, there was a good deal of belated merit in what Raghuram Rajan had to say about why ‘stimulus has failed’. While it is always heartening to see one of the nomenklatura express such good sense in public, it never comes without a certain sense of frustration for, as readers of this publication will know only too well, we have been travelling  – largely unaccompanied – this same road to Damascus for many a long year now.

That said, indulge us while we rehearse the main line of reasoning, once more, in the interests of clarity.

When large scale borrowing takes place beyond people’s ex-ante willingness to save (i.e., to abstain from complete, much less beyond-income, gratification), the builders and the buyers, the fabricators and the food shoppers will eventually find they are working at cross purposes and basing their (often unconscious) estimates of future income and outgo on premises which run into conflict with one another and to schedules which cannot be synchronized as they should.

Such borrowing may arise of its own volition – especially under the promise of a technological or territorial ‘New Era’ – but, ultimately, it must rest on the willingness of the commercial banks to create sufficient means to underpin it and they, in their turn, are no less dependent on the central bank and its regulatory peers committing sins of omission, if not of outright commission, in allowing such a pervasive and prolonged departure from the desirable norm as will eventually end in a general ruin.

Borrowing in this manner means that more are ‘bringing spending forward’ than are postponing it. Thus, as a group we end up anticipating and alienating too much of what is, after all, an uncertain future income stream in order to indulge ourselves today. Worse yet, this communal Rake’s Progress means that we are all but ensuring that our future income will indeed fall short of what it is we – and our lenders – expect when we mortgage so much of it to them in the present.

Activity of this kind is bad enough when the borrowing is mainly directed at over-consumption of ephemeral goods and services – whether by governments or by private individuals – but at least such a ‘simple’ inflation (to use the Austrian parlance) can be easily recognised for the evil it is and can be hardly less easily dealt with. In principle, the same should apply when the objects of desire are more durable, even if the dangers here are compounded (a) by the monetary authority’s reluctance to countenance any action to prevent the rise in such politically-sensitive things as house prices and (b) by the high loan-income ratio and higher loan-to-value leverage often extended upon what always seem such sturdy forms of collateral.

In contrast, when the borrowing is devoted to building out industrial capacity – when it represents ‘cyclical’ inflation, as we would say – the scope for error becomes much larger even as it is insidiously less apparent. This is because the market for the planned new output lies not only further out into an unknowable future which is very unlikely to reflect the current pretensions of even the most confident of prognosticators, but because that market is only indirectly linked to the final consumer and is therefore all the more highly contingent upon the actions of others – whether suppliers, customers, competitors, providers of complementary goods, and users of similar resources, not to mention regulators, politicians, and warlords.

Again, while the problems increase the ‘higher’ such an enterprise lies ‘up’ the productive structure, away from the ultimate storefront, it is often here that the longest and largest financial commitments must be made, making the receipt of any false signals, in the form of overeasy credit conditions and overbouyant equity markets, not only more decisive as to its to its inception, but all the more perditious once ground has actually been broken.

When ‘tomorrow’ finally comes – as it progressively, day by day, must do – we are then all too apt to find that increasingly onerous degree of debt service to which we have blithely been contracting leaves us too little left over to spend on the consumables so called into being, meaning that the scale and composition of the capital stock laid down when we earlier availed ourselves of all that temptingly easy money can not hope to find a retrospective justification.

One way or other, a recognition must now be made of the magnitude of our error and if not blame, at least responsibility, must be apportioned where it is due; losses must be realised; and titles transferred as quickly as possible not only in order to make a fresh start at the earliest possible juncture – one which will ipso facto be based on a much more sober reckoning of our wants and means – but so that the effort to escape or to procrastinate does not itself forge a chain with which to weigh us further down. Write-offs and write-downs are much more salutary and far less invidious than the determined application of transfer politics by the horde of economically-illiterate careerists who populate the chambers of the legislature.

At this point, we are poorer than we assumed we would be and we may even be absolutely poorer than we were before we strayed off the path of intertemporal co-ordination which is illuminated by the beacons of self-regulating, time preference-determined ‘natural’ interest rates. Though it may seem callous to call now for a ‘liquidation’ of our mistakes, it is the attempt to camouflage this wherein the most pressing dangers lie. The so-called ‘secondary depression’ which are told to avoid at all costs is one thing (and it is still not proven that, only assuming a core quantity of money supply is assured, Pigou – or ‘real balance’ – effects will not cause this to blow itself out so long as prices are sufficiently flexible downwards in the slump to increase that unshrunken kernel’s overall purchasing power), but the progressive petrification of the whole spirit of free enterprise which is its alleged preventative is quite another.

Pricing out Recovery

Alongside the clamour for more monetary monkey business, much lip service is also being paid to the need for ‘structural reform’ and, in the Austrian sense of increasing responsiveness and removing barriers to initiative – what Fritz Machlup called an ‘Auflockerung’ – this is indeed a necessity. But this is not something which will be enacted by governments eager to extend corporate welfare to failed Wall St. Banks, uncompetitive French car companies, needlessly duplicated Chinese steel manufacturers and the like. Nor are they and their central banking friends likely to aid the requisite process of ‘recalculation’ – of working out what one should pay for something today and what one is likely to get for it or the things fashioned from it, tomorrow if interest rates are being falsified, taxation is volatile (upwards, at least), and exchange rates are subject to sudden wrenching shifts.

At bottom, to be coherent, interest rates should correspond to the price ratio between present and future goods and the eagle-eyed entrepreneur is the man who can recognise an arbitrageable disparity between the two in specific instances and hence can put something which is currently being undervalued to a better, alternative use. But, if he judges the spread between current inputs and his expected, risk-adjusted output is too narrow to be worth his effort, he will not be willing to provide an income to those selling the first, or employment to those who might otherwise make a living by transforming them under his guidance into the second.

Yet much of the thrust of today’s rabid Rooseveltianism is conspiring to keep this critical spread overly compressed and entrepreneurs understandably coy to embark upon major new undertakings.

  • Raw inputs cost too much because of easy money, ZIRP storage arbitrage, green rent-seeking, and welfare-subsidized consumption
  • Labour remains expensive due to dole-encouraged withholding and the high ancillary costs imposed by an overweening and unaffordable state apparatus
  • Expected returns on capital – outside of those to be gained by gaming the capital markets, that is – are depressed by the anti-capitalist thrust of taxation and the regulatory and legal flux to  which entrepreneurs are being subjected to an unnecessarily elevated degree
  • The prospective flow of sales receipts is also being diluted by the presence of so much state- and bank-supported, sub-marginal deadwood in the market.

One of the features of a slump in which can be found the seeds of a subsequent regeneration is that the inputs to a more sustainable and inherently profitable production process can be had cheaply. To this end the irrational fear of the bogeyman of ‘deflation’ is itself the root cause of the process by which the aptitude for change and the appetite for risk can become quasi-permanently suppressed.

Bankruptcy breaks up unviable capital combinations and frees up willing workers for the business of founding new industries and of identifying and satisfying new tastes, a point that Ludwig Lachmann was every ready to extol. ‘Capital’ is a concept; it is a dynamic, it is not an inert, physical lump of easily-stilled mechanisms. In the right hands, yesterday’s failed crop can become the fertilizer of tomorrow’s harvest as long as its owners are encouraged to realize their losses and to sell it on to those with a better vision of how to utilize it at a price commensurate with the new endeavour’s chances of success.

Sadly beguiled by their own theoretical cleverness, those setting policy today are so fixated on the idea of forcing people to buy things just to be rid of the excess money which is being forced upon them and so dead set against anything actually costing less than it used to, no matter how ludicrous the previous valuation or how commercially wrong-headed the purpose to which it was being dedicated, that their own efforts at ‘stimulus’ are forestalling this act of revaluation and release – this recapitalization of the decapitalized – and so are turning them instead into the greatest mass sedative ever prescribed to the mercantile classes.

The Big Freeze

In our Austrian narrative of a ‘cyclical’ inflation, fiduciary (unsaved) credit is preferentially funnelled towards investment in new capacity and expanded business. This soon leads to an unlooked-for degree of competition for resources with the earners of increased wages who are mostly still unsated in their demand for the existing array of consumables, items which the expansionists are either not planning to provide just yet, if at all. Such a conflict of desire can only end up in widespread over-extension; in the appearance of large quantities of ‘frozen’ capital; and hence in disappointed creditors and investors amid a general disco-ordination of plans.

In contrast to such an overheated condition, much of today’s unsaved credit is being directed at ensuring that zombie companies can display the barest signs of animation so as to enable their bankers to justify the ‘evergreening’ of their loans. Working on a cash basis, possibly too unprofitable to pay tax, certainly not amortizing their debt and probably bleeding capital by eating into their depreciation allowances, such ICU-institutions do little more than clutter up their lenders’ balance sheets, cling on to experienced and diligent staff, occupy prime property, burn electricity, and buy in stock – and so deny their more vibrant, self-reliant counterparts, whose innate abilities are greater but who have to operate on a fully commercial basis, the room and the means to grow.

Every great efflorescence of life, every great evolutionary advance in the long and violent history of dear old Mother Earth has come in the wake of a mass extinction. Without the Alvarez meteorite, after all, we hairless apes would probably not be here to debate the finer points of how our policies are only serving to maintain the economic dinosaurs in command of their niche, far beyond their natural span.

Making matters worse, the remainder of the credit inflation is being monopolised by incontinent states and their skulk of rent-seeking jackals, elites whose intrinsic capital efficiencies are vanishingly small (if not actually negative) and whose activities are therefore particularly likely to contribute to capital consumption.

Here we are faced with the awful irony that, in their manful attempt to lighten the load of indebtedness, central banks are helping generate ever more debt. Whereas the money they are creating is supposed to be a final means of settlement which extinguishes debt at the completion of a contracted period of service, it is instead giving rise to more of that which must, one day, be settled. Hence the source of that widely-shared and intensely pernicious confusion of what are static accounting identities in the macro reports with the dynamic process of economic life. We do not need someone else to borrow in our place if we choose to pay down our debts: if we sell without buying in order to discharge our obligations, our satisfied creditor now has both the wherewithal and the available wares to buy in our stead. Even if we find, alas, that we cannot fulfil our contract, to substitute another claim for it by transferring it to some larger, less constrained entity such as the state is to fall for a sunk cost fallacy. We took and used the present goods over which command was given us by our lender and we turned out not to be able to replace them: thus they are irrevocably lost, no matter what anyone cares to scribble in the pages of their accounting ledger.

Unable as we are to see this, we will continue to invest in negative productivity and purposely to select against the fittest. Instead of a classic Austrian overheating, we now have an Ice Age: instead of a credit bubble, we have a debt black hole.

Just as in Japan, we have transferred private actor difficulties into public sector ones where no legal framework exists to resolve the resulting problems. Worse than this, we now face a classic ‘public choice’ trap, to introduce the concept elucidated by the late, great James Buchanan.

Once we decide to move private liabilities onto the public balance sheet instead of swiftly excising them in the crisis, not only are the protocols for later resolution sorely lacking, but the incentives are almost entirely absent, too.  Being ‘public’ debts which no individual entity can be said to have incurred, there is too diffuse a sense of responsibility for them – if not an outright tragedy of the commons. Since there are no identifiable culprits for the evils they entrain, outside the hated ‘capitalist’ caricatures of popular invective, it is all too easy for the economic illiterates in parliament to pretend that they were in no way responsible for the debt the incoming regime has inherited (even if often in great part from its own former time in office).

Wedded to the state’s arbitrary ability to impose financing charges on third parties (and the fact that pressure-group politics will see the regime’s court favourites and swing voters militate not to bear any concentration of this cost) is the fact it runs completely counter to political ambition to say “we will do less – less intervention, less spending, less feather-bedding – than the losers you just ejected”.

Given a further boost by the almost universal faith in half-fdigested Keynesian nostrums (exemplified perhaps by the recent apoptheosis of the dreadful old Leftie patriarch, Robert Skidelsky), we are about to discover that by saving the banks, we are destroying the pension and insurance companies upon whom the average man is no less reliant. As a result, many of our present day states are fast approaching the limits of budget credibility and so have no choice but to resort more and more to seigniorage in order to survive. Some would, indeed, already have exhausted that reservoir, too, were it not that such infernal devices as TARGET2 allow them to draw heavily upon the reputation and good-standing of their neighbours.

That this policy has not yet led to a resurgence of  old-fashioned, shopping-basket price rises (even if, in contrast, its malign, if seductive, effect on asset prices is not to be denied) is largely down to luck.

An increase in the supply of money leads to higher prices only to the extent its recipients’ desire to hold it does not increase in due proportion. What we have seen in the past four years is that, largely, it has. Firstly, higher degrees of credit have lost much of their superficial sheen of ‘moneyness’ since the collapse, meaning that the parties to an exchange are now far less willing to rely upon the ready negotiability and unquestioned fungibility of lesser IOUs as a means of settlement than they were during the boom. Secondly, the banks themselves have not been able to throw off so many of their more dubious accommodations into the ask-no-questions-tell-no-lies underworld of a now-moribund ABS market. Adding to the squeeze, as we have already set out, they have encumbered their balance sheets with a host of low-grade borrowers at the same time that both regulatory capital requirements and wholesale market funding possibilities have become a good deal less conducive to blind expansion than they were in the Blue Sky days of yore. Thus, a greater proportion of a money supply which is having to ‘do more work’ than has been the norm is being generated ‘outside’ the commercial banks rather than ‘inside’ them – i.e., by the central banks through their vastly expanded range of operations.

This, too, is a case of lowest common denominator lending, since what these central banks prefer to monetize above all is government (and quasi-government) debt. In this way they are temporarily satisfying people’s heightened need for money by removing the worst constraints from those closet Jacobins who, we have argued above, are the very people obstructing the process of recuperation and regeneration.

With a nod to the ideas of Axel Leijonhufvud, what this also may imply is that the income-constrained recipients of welfare (personal or corporate) are the agents least likely to cling on to any of their dole, while the still-healthy who receive it at one remove are fast becoming Ricardian equivalence hoarders – knowing, as they do, that, as the only obviously identifiable sources of wealth and with very little patronage to shield them, Leviathan will soon come ravening after them. So, with the associated opportunity costs eradicated by the central banks’ flawed attempts at stimulus, they are clutching tight to their caches of sterile silver ahead of the day when they fear they must render it up wholesale to an aggressively insistent Caesar.

Beyond the Impasse

Thus we have the paradox that, on the one hand, we must be grateful that the central banks are finding too few takers for the snake oil of inflation to do its corrosive work because the supposed solution it offers is not only arbitrary and dishonest, but because it also confounds accounting and so destroys capital and wastes further resources – progressively the moreso, the more rapid and variable its rate of propagation. That it also tends to favour the least savoury elements of society (i.e., the plutocrats and the politically-protected), means that any stay of execution is further to be welcomed on moral, as well as on material, grounds.

On the other hand, the maintenance of ZIRP – and its extension across the maturity spectrum is doing little to help and much to harm. Some say it counter-intuitively promotes saving as those who still can set more current income aside to make up for the lowered returns they receive on their nest eggs. If only this were so, for even though this is something the mainstream perversely insists on decrying, it is actually the wellspring of our well-being. Your author, however, doubts it does much to promote saving in any productive sense: instead it serves to keep capital locked up in dead undertakings and so slowly bleeds the rest of us dry, therefore destroying real savings, not adding to them and continuing the recession, not curtailing it.

At some point, this dangerous impasse will have to be resolved, either in an admission that macroeconomic means have failed and that renaissance must at last be sought – as we have long argued – in providing a more conducive microeconomic milieu (an epiphany which will be a long time coming since it implies the headlong retreat of the Provider State militant) or, alas, in a ‘flight to real values’ and a conflagration of financial claims to wealth amid the rubble of a monetary collapse.

But perhaps we must not be too hasty in calling for the turning point to arrive. Japanese experience teaches us that the stand-off can be maintained for nigh-on a generation if the benefits of slow price declines (not ‘deflation’, please) become widely recognised and if people further accept that if the state is to subsume their unserviceable private debt contracts while not taxing the skin from their backs in order to do so, they must volunteer to surrender up a good part of their income to it by continually adding to their holdings of its obligations (both dated – JGBs – and perpetual – currency). Of course, it helps if the people in question are both productive and thrifty enough to have no need for external finance and possess a high home-bias in their investments and so are not overly susceptible to sudden reversals of sentiment on the part of the hot-money crowd.

As for the rest of us – who are not necessarily endowed with such commendable attributes of forbearance – whether we further resist it or no, everything points to the conclusion that the Mighty Ozzes at the central banks have not yet lost their will for the struggle and that the creeping ‘euthanasia of the rentier’ and ‘monetary policy à outrance’ will be further prosecuted, no matter how high the cost or how exiguous the results.

Such is the curse of the Platonic arrogance of our masters and their willing enablers.


Niall Ferguson on the rise of China

Episode 69: Harvard Professor Niall Ferguson talks to GoldMoney’s Alasdair Macleod about global politics, with special emphasis on China’s prospects and challenges in the years ahead.

They discuss the political and economic situation in China, and the need for the Chinese government to start privatising state enterprises, reshape the country’s rule of law and globalise the renminbi. For Ferguson, the key question is whether or not Beijing will introduce reliable private property rights so that the rising middle class can feel secure.

China fears that its large dollar claims will be worth much less in the future. Besides complaining about this, they are looking for ways to diversify their wealth and revenue stream. Ferguson points out though that there are limits to their ability to secure hard assets. They also discuss China’s relationship with Russia and its role in the Shanghai Cooperation Organisation.

Ferguson states that the gold flow from “the West to the Rest” is reflective of declining Western power. The world’s centre of gravity is shifting east – a shift that is going to continue, and that is taking place at an extremely fast pace when looked at in a historical context. Though China’s economic expansion could slow, Ferguson expects another 20 years of solid growth before demographic problems force the country’s economy to stall.

Finally they talk about Japan’s debt problems and the faulty design of the European currency union. Though Ferguson expects the eurozone to stay together, he expects a Japanese-style “lost decade” – and one sadly lacking in Japanese-style social harmony.

This podcast was recorded on 14 November 2012 and previously published at


Plus ça change

Conveniently coming just in time for the crucial Party conference, the official China PMI index inched above the 50-level watershed and so was enough to gladden the heart of loyal cadres and sell-side analysts everywhere. Truly now the bottom is in place and we can return to unbroken months of expanding economic activity under the wise guidance of the new leaders, all the while looking forward to inexorably higher asset prices across the globe!

Well, perhaps. But, is it really sensible to suppose that the weight of evidence offered by this one, single datum is enough to tip the scale of judgement, or would it be better to seek for confirmation elsewhere – not least in the next instalment of said series, given that it is not seasonally adjusted and so is subject to the vagaries of the Chinese lunar holiday calendar?

Certainly, we might be allowed to nurse our scepticism a little longer, if only because one of the main economic sectors contributing to this uptick was the otherwise badly bruised steel industry. Having increased production by a bare 1.7% in the first nine months over the like period in 2011, October’s more favourable constellation of input prices has combined with a long-overdue reduction of inventories to spur the country’s mills to encompass a PMI-boosting, 8% jump in the daily rate of output when compared to late September.

All well and good, but recall this is an industry in which profits of the so-called ‘above-scale’ firms fell 68% YOY, while the listed steel companies actually made an aggregate net loss. Even the mighty Baosteel has been suffering; printing a ‘profit’ partly by dint of asset dispositions – and, even then, returning less on capital than would one of China’s notoriously unremunerative bank deposits. Incidentally, we put the quotation marks around the ‘profit’ to highlight the fact that the explosion in the firm’s accounts receivable has amounted to almost four-fifths of reported operating income over the last six months.

Rationalization, in a business with fast approaching 900mt of capacity servicing no more than 680mt of domestic demand, has proved elusive, largely because of the usual curse of local government politics. Not only are steel companies major local employers, but they pay taxes based on output, not profit, greatly increasing the perverse incentives to which their management is subject.

Adding a certain frisson to the situation is a Bernstein Research report into steel trader fraud. Here, with echoes of the Great Salad Oil Swindle perpetrated by Tino de Angelis exactly fifty years ago, it appears that a number of firms have not only been pledging the same steel as collateral several times over, but that some of the alloy so committed consisted of nothing more than a surface layer of steel laid on top of a pile of near-valueless sand. As a result of this discovery, it is said that Guangzhou traders are now only making good on half their orders, rather than on the already recession-shrunken 70% characteristic of the previous three months, raising the question of just who will buy the new product pouring out of the mills.

Though there are the inevitable murmurings of better things to come as the government launches yet more, white elephant, infrastructure projects, those pinning their hopes on a sustainable upswing manifesting itself in the near future would do well to listen to what Ma Guoqiang, Baosteel’s general manager recently said in an online briefing.

Judging from current global and domestic economic growth, it is realistic to expect the ‘cold winter season’ to last for three to five years, and the steel sector will not be an exception.

Some heed of this ill wind seems to have been taken by the big miners, notably BHP Billiton, which has radically restyled its corporate message in recent months to the point that the most prominent slogan in its latest presentational material was that its focus has shifted from the marginal tonne to the capital efficient tonne.”

A far cry, indeed, from last year’s defiant emphasis on the super-cycle; on ever mounting, Chinese per capita usage; and on the heady plans for the $80 billion in new capex need to surf this envisaged wave.

Highlighting the contrast, Chief Executive Marius Kloppers – fresh from cancelling no less than $68 billion of those projected expenditures – struck a much more sombre note last month, telling his audience that:-

Miners have responded to unsustainably high prices for some commodities such as iron ore and metallurgical coal over the past decade by building new production capacity. Over that period, robust demand growth from China and other developing nations outstripped production growth as the industry grappled with escalating mining costs and strengthening currencies in commodity producing countries…

But the industry has improved its ability to meet incremental demand with low cost supply and commodities demand growth from emerging economies, particularly in China, is forecast to moderate as developing economies transition to consumption-led growth from infrastructure-led growth…

…what we are now witnessing is the rebalancing of supply and demand and a progressive recalibration of prices back to long term sustainable pricing levels. In effect, what this means is that the record prices we experienced over the past decade, driven by the ‘demand shock’, will not be there to support returns over the next 10 years. What we can instead expect is demand growth at more predictable and sustainable levels and more moderated pricing. This ‘mean reversion’ in prices and returns is something we at BHP Billiton have anticipated for some time…

…The physical iron ore demand of China will go down. That high end of the cost curve will disappear. Still a very good business but not the massive EBIT margins we have today… a very significantly less amount of revenue…

It may well be, of course, that Mr. Kloppers will prove no more prescient regarding the genesis of this tough, new reality than he was in foretelling the demise of the old, Klondike era but it would seem foolhardy not to assume that the head of one of the largest and most successful integrated mining companies might be able to give us some pointers as to conditions on (or may be, under) the ground.

Elsewhere in Asia, PMI’s were mixed in terms of month-on-month changes, but were almost universally mired on the contractionary side of the ledger – though you would never have guessed this to be the case, given the positive glow elicited by the one or two less gloomy releases seen in the region of late. We would only reiterate that the place still suffers from a widespread reliance on exports to a faltering Europe as well as to a still-tepid America. Together with the complex entanglement which much of the Orient has woven with a China still wrestling with the superposition of a Gosplan-like growth directive and layers of rampant nest-feathering on top of a very Austrian credit bust, this strongly implies that it will take more than a brief – and possibly random – interruption of the downwave to instil any confidence that the worst truly is behind us. Just ask Panasonic, HTC, Dongyang, or Sharp.

Adding to the suspicion that things are not exactly steaming full ahead, the first intimations of October’s banking figures from China suggest that an almost complete reversal of the prior month’s large deposit increase was suffered by the Big 4, while, on the other side of the balance sheet, lending was very weak right up to the last three days of the month when an extraordinary CNY100 billion late burst saved the day. Word is that much of this took the form of corporate credit – but how much of that represents distressed borrowing, only time will tell.

Amid press comments to the effect that SME loan demand was weak (not surprising perhaps, given the lacklustre showing at the autumn instalment of the Canton Fair), that lending was about complete for the year, and that even local infrastructure finance was largely being limited to roll-overs and to ensuring completion of existing projects, matters seem a deal less settled than the permabulls would have us believe.

And let us be in no doubt just how pivotal Chinese banks are to the whole, top-heavy, output-driven, malinvested superstructure. In the year through end-September, just sixteen of them were responsible for no less than 54% of the entire sum of aggregate profits posted by the country’s 2,493 listed companies – even if they could only manage this unhealthy predominance by the determined misrepresentation of their bad loan levels. After they had extracted their bounteous harvest of rents, the nation’s commercial and industrial rump of 2,477 firms saw their revenues inch up by less than 5%, their pre-receivable ‘profits’ fall 18%, and their already exiguous operating margins slump 22% to a mere 4.3 cents on the dollar.

Nor was there much cheer to be had from Li Zibin, president of the China Association of Small and Medium Enterprises, who announced that his members were facing more difficulties this year than they did in 2008. Citing the slowdown both home and abroad, Li said that rising labour costs, pricier raw materials, fund-raising difficulties, and the appreciation of the RMB were among the private sector’s litany of woes.

Then again, a certain degree of caution is only to be expected when we take into account the ongoing rumours that the imminent leadership handover is still the subject of internecine strife between the factions. Not only has former leader, éminence grise – and ‘conservative’ hard-liner – Jiang Zemin been unusually prominent of late but reformists Zhu Rongji and Li Ruihuan have also resurfaced from self-imposed obscurity to root for the opposing team, if to little obvious effect if we believe the spin the SCMP has put on events.

Tellingly, the PLA Daily issued a forthright declaration of its loyalty to the Party and Chairman Hu, warning of the need to guard against the existence of hostile forces in and outside China… ready to make trouble. Note the ominous use of the first of those two positional prepositions.

Faced with what could be the appearance of the most tenebrous of cygneous waterfowl in Economy No.2, the results of the upcoming vote in Economy No.1 might seem to offer far less chance of triggering a decisive shift. After all, the cynic would see the difference between the candidates as one more of degree than of kind, especially if he were to limit his concern to the policies the two candidates will actually get around to enacting, rather than those whose superficial distinctions have been grossly exaggerated at the hustings.

As the inimitable H. L. Mencken long ago phrased it: 

Each party steals so many articles of faith from the other, and the candidates spend so much time making each other’s speeches, that by the time election day is past there is nothing much to do save turn the sitting rascals out and let a new gang in.

Yes, there is a chance that, freed from the personal need to secure further re-election, Obama might become more radical in his final term – and thus enact a greater programme of tax-and-spend, as well as giving rein to a more undiluted brand of eco-alarmism and green energy boondoggling. Little of that strikes your author as at all helpful to the chances of a meaningful American renaissance.

Against this, Romney promises to be more business-friendly – though one has to doubt whether his proposed menu of tax cuts will really be offset as it should by a like, much less by a desirably greater, reduction in outlays. One unalloyed plus is that he purports to offer far less in the way of impediments to further entrepreneurial success in securing the development of America’s rich mineral legacy. In contrast, his rather crude, eschatological take on foreign policy could prove horribly disruptive to us all if he surrenders control over his country’s might to the implicit furtherance of another, far less heedful country’s warlike agenda.

Whoever wins, we are sure to wake up on Wednesday morning with the Bernanke Fed continuing to wreak havoc by destroying the pricing ability of capital markets; with Federal debt growing at the rate of $40,000 a second – not all that far shy of what a typical family earns in a year – with a debilitating dependency on the state all too elevated, and with any number of restraints to peace and progress not only unresolved, but utterly unresolvable under present conditions and under the leadership of two such solidly mainstream candidates.

It’s not as if we’re going to give Ron Paul a chance to fix things, now is it?

Already, real net private product per capita has been stagnant for more than a decade, mirroring its poor showing during the inflationary disaster of forty years ago. Even if Romney and Ryan were to win and Bernanke were then to tender his resignation to two men who have openly disparaged him during the campaign, the latter’s replacement would be both outnumbered by a dovish FOMC and a prisoner of the initial conditions from which he must start. To expect a radical turnaround under such conditions would be to display as much naivety about the prospects for ‘change’ as did the incumbent’s worldwide fan club of bien pensants four short years ago.

In Europe, the Greeks and Spaniards continue to play fast and loose in the face of looming catastrophe – each seemingly about to founder between the Scylla of economic inevitability and the Charybdis of an ECB intransigence which is fully buttressed by the craven mendacity of those northern politicians who have tried to pretend that the dispelling of that illusion of EMU ‘convergence’ on whose maintenance they have long staked their careers will bear no direct consequences for their own electorates.

Beyond this we must repeat our recent – and ever more widely echoed – musings about the vulnerability of a French nation almost completely bereft of any fiscal sea-room while it wallows, rudderless on the lee shore of its intrinsic lack of industrial competitiveness and as its leaders either squabble on the bridge or fly hither and yon as diplomatic busybodies, full of empty pretensions to winning La Gloire abroad.

In recognition of this, no less a figure of the European left than Gerhard Schröder – the former German Chancellor and the present, heavyweight sponsor of prime SPD candidate (and after-dinner entertainer par excellence) Peter Steinbruck – has publicly called upon President Hollande to admit that his election promises cannot possibly be kept; that the lowering of the retirement age cannot be financed; that his taxation policy will lead both to capital flight and to lower job creation;  and that problems will arise as soon as France starts to struggle to rollover its debts.

In France itself, the employers’ lobby Medef has talked of an economic ‘hurricane’ afflicting its members and of business leaders being in a state of ‘quasi panic’ at the prospect of a further turn of the screw. Bearing this out, the INSEE reading of employer expectations for their own future production has slumped to a two standard-deviation low, putting it well down among the depths recorded during the GFC, the Maastricht crisis, and the turmoil of 1983 when a former socialist President – François Mitterand – nearly wrecked the ship of state in his turn.

All this is taking place in a land which was the locus of much of the dreadful banking policy which financed the boom and, ergo, is the place for whose defence the current, ill-conceived interventions have largely been concerted. It is a country clearly in decline. The current account has slid, slowly but surely, from the typical surplus of around €40 billion-a-year when the euro was launched to the point where the French are now piling up an equal-and-opposite deficit of €40 billion a year. Debt/GDP has doubled in twenty years to reach a ratio of close to 90%. Overall unemployment has hit a 13-year high, with 25% of those under-25 officially currently out of work. Total employment has barely grown in a decade, while almost half the country’s manufacturing jobs have disappeared over the past generation.

Taxes are already at their highest proportion of private income in more than a decade helping the state spend an eye-watering 55% of GDP (where, naturally, its outlays greatly outstrip private, net income) and yet all M. Hollande can think of to do is to expand its enervating sway even further.  Hardly the best way to promote a national revival, one feels.

Whether the ECB can afford to make good on the Draghi boast in the case of Spain is one thing (whether it can do so by adhering to its own rules on collateral eligibility appears to be a second!). Whether it could go beyond that and shore up an increasingly restive Italy is another. But the idea that it could then keep France afloat in its hour of need seems altogether a stretch too far. Even such consummate operators as Merkel and Schäuble would struggle to tell their weary voters that the only way to avoid another, Versailles-scale transfer of resources to Paris would be to undergo another socially-destructive bout of unbridled monetary inflation.

If the Hollande administration does as expected, it will this week reaffirm its purblindness by quietly burying the forthcoming report on national competitiveness being compiled by former EADS boss Louis Gallois. Worryingly wedded to the failed prescription of the Keynesian mainstream – and hence terrified that consumption will suffer, however unaffordable it may be when production is so unprofitable – ministers have already spoken out against Gallois’ eminently sensible suggestion to cut welfare payments, to lower employment charges, and to hike VAT as a budgetary offset – which combination would make work pay better for both contracting parties while introducing many of the rebalancing forces to be expected of an internal devaluation without entraining many of its unnecessary side effects.

Here, in the response to Gallois’ report, we may look for our first indications of whether France’s political elite are even aware of the monumental nature of the task which confronts them. If not, we may begin to end our doubts about whether their policies will end up posing the greatest threat to the Grand Project by which they and their predecessors in office have long set such great store.


Hope springs eternal

The minor uptick in China’s ‘flash’ PMI estimate for October – from 47.9 to 49.1 – has sparked the usual explosion of uncritical hopefulness (on the part of those who, by and large, thought there never could be a slowdown under the aegis of the all-powerful CCP to begin with,) that this finally marks a bottom in that country’s economic cycle.

In giving vent to such optimism, the Sinomaniacs conveniently overlooked the fact that much of the improvement was down to the fact that it was the price indices, rather than those relating to output or employment, which struggled back above the expansion/contraction threshold of 50 – a circumstance which might just temper their extend-and-pretend expectations of an ever-imminent monetary relaxation, were they to reflect on it for a moment between jubilations.

Worse still, the Pollyannas appear to have forgotten that the PMI simply gauges whether things are generally better or worse than they were last month – and that in a non-quantitative manner, to boot. The unequivocal answer is worse (if marginally so, this time) for the twelfth consecutive month and for the fifteenth out of the last sixteen occasions. Thus, it may be true that the rate of decline seems to have slowed – how enduringly, only time will tell – but the fact of that ongoing decline itself remains, even after so many uninterrupted months of economic deterioration.

China bulls and the other assorted, ‘next quarter’ blue-skyers may have either venal or psychological reasons to puff this one reading up as a sign of a coming (and oft-postponed) dawn, but the test of an analyst who knows his stuff – and who is not afraid to be honest with you – is whether he makes this simple, but crucial, distinction in his commentary.

Of course, such an outpouring of positive sentiment will be very much to the taste of those in Beijing who have managed the seemingly miraculous feat of going into the Party Congress to the glowing accompaniment of an official GDP series which has been accelerating all year, quickening from a 6.1% annualized pace in the first quarter to 8.2% in the second and a resounding 9.1% in the third.

The fact that those same quarters have seen rail freight traffic slow from 3.7% YOY to 0.8% and on to a contraction of 5.8%; or have witnessed Shanghai port container throughput reverse from an expansion of 3.5% YOY to a shrinkage of 1.2% is, apparently, not to be invested with any significance.

Nor is the fact that while industrial production is officially up 10% YTD, those same industries have managed to consume smaller and smaller marginal increments of electrical power along the way; sliding, month by month, from a 4.1% YOY gain in March to a 3.2% one in June and on to a paltry 0.9% increase in September (which slender, overall uptick was comprised of an actual fall in heavy industrial usage).

In much the same manner, apparent consumption of refined oil products was up only 3.4% YTD, with diesel barely ahead at +1.1%. Again, not much evidence of a robust economy, there.

As the slowdown progresses, everywhere but in the reports of the authorities and the minds of their cheerleaders, profits have collapsed in their turn. So far this year, the chemical industry has seen earnings decline 18.1%; cement makers returned 53% less than in 2011; flat glass makers swung to a loss equivalent to around one-third of last year’s reported profits. Miners – whether ferrous or non-ferrous – saw income slip by around 5%, while that accruing to smelters/processors in the first group slumped by no less than 81%, flattering the performance of companies in the second category, even though they themselves booked 30% less.

The other side to this has been a surge in the debts companies owe to one another. As Caixin reported, the China Iron & Steel Association said that, at the end of July, the amount of net receivables and net payables of the 81 steel companies it monitored were up 17.8% and 10.6% respectively from the same month the previous year.

In even worse straits, the 90 enterprises monitored by the China National Coal Association reported an increase of 48.7% in  net receivables from 2011, while the China Machinery Industry Federation said those for its members were up 16.9% YOY to a monster CNY 2.5 trillion. No wonder Caterpillar announced it was ‘ramping down’ production in the country.

To see these trends in a little more detail, let us examine those cosseted children of the latest economic cycle, the SOEs. These reported 9-month revenues of CNY 31 trillion which represented a relatively anaemic 9.5% gain from the like period in 2011 when sales had stormed ahead by almost a quarter from 2010. Costs were up 11.1% and hence profits fell a sharp 11.4% to CNY1.6 tln.

That represented a nominal ROE of 5.1% overall, split as to 5.5% for the centrally-controlled firms and a bare 2.9% for their local peers – which latter therefore made a big fat zero in real terms after accounting for the concurrent rise in consumer prices.

Even that does not tell the full horror of the troubles afflicting them, for the simultaneous rise in the tally of accounts receivable amounted to 1/3 of those ostensible ‘profits’ (the overall stock of receivables now stretches to 1.7 times annualised earnings), while inventories swelled by an amount equivalent to the whole of reported income. Days’ sales of inventory rose from 83 to 94.4, while days of receivables climbed to 31.8 from 28.8, putting their combined drain on working capital up to a whopping 126 days-equivalent!

So, here we have a bleak vista of mounting credit, declining margins, unpaid bills, underemployed capacity – even the rare earth market has swung so far from dearth to glut that plant is now being mothballed! – and there also remains precious little hope for making non-operating gains by diverting preferentially-granted credit into a bubbling property market. A clear indicator of this stress is that credit (deferred payment) is rising much faster than money (immediate payment).

This is an ugly constellation indeed, especially since it is giving rise to official concerns about the state of local government finances. Faced with slowing – even falling – tax revenues, these latter are squeezing already pincered companies by demanding advance payment of taxes, as well as by organizing sweeps whose aim is the mass-levying of ‘fines’ for alleged regulatory violations (presumably something of a shock after all these years of turning a blind eye in the pursuit of growth at all costs). These are also, of course, the very same local authorities who are nursing the sickliest of the SOEs and they are the same institutions who will supposedly be riding to the rescue by showering  trillions of yuan on even more infrastructure and real estate developments of dubious commercial worth.

According to a report issued by the Development Research Centre of the State Council, the final months of this year will be critical to the pretence of providing ‘stimulus’ via this medium as something of the order of two-fifths of all local government debts fall due by the end of this year, with another 10% or so scheduled to mature by the close of 2013.

Having all but tripled in the last six years, something in excess of CNY11 trillion is now owed by such entities – largely through the conduits offered by the infamous ‘financing vehicles’ – leaving Wei Jianing, deputy director of the Macroeconomy Department at the DRCSC, to fret that: “There are worries over whether local governments could pay off the principal and interests when the repayment hike comes.”

Presumably Mr Wei will be taking little comfort from the happenstance of a nugatory uptick in the Purchasing Managers’ Index!

Far across the Senkaku Islands, Japanese money supply has been decelerating from its recent impressive lick, while small business confidence has plummeted below even the post-Fukushima trough. Meanwhile, the nation’s exports languish at levels first seen in 2004, thanks to the toxic mix of the fallout from the territorial spat with the Chinese and the general Asian weakness – also evident this week in Singapore (IP -2.5% YOY), Thailand (manufacturing output off 13.7% YOY to rest where it was in 2007), and the Philippines (exports off 9% YOY to stand no higher than in 2005).

All this sufficed to bring about a record trade deficit of close to Y1 trillion in Japan itself last month, at which point it was threatening to swallow the large monthly investment income component whole and, hence, to restrict the growth of the capital pool on which the country so heavily relies.

Nothing daunted, after two decades of bluebottle-against-a-windowpane policy-making, the country is again to be dosed with the same old, ineffective, patent medicine as the BoJ prepares to increase its version of QE by a cool Y10 trillion ($125 billion), some of which will help fund the already over-indebted government’s imminent Y700 billion fiscal injection.

You would think they would long since have have learned the futility of what they are about; the fact that this has eluded them for all these years should worry us greatly about our own masters’ willingness to draw the correct lessons on that grim tomorrow when their own programmes are undeniably seen to have failed. Can we not admit it is folly always to resort to the crude economics of a Krugman – the macroeconomic equivalent of the château generalship of the Somme – and to whine that we have only failed because we have not thrown enough money or lives into the fray.

In Europe meanwhile, the gaudy circus of summitry has again rolled through town to little effect. Greece seems to be back to playing brinkmanship with the Troika. ‘Two more Years of Foot-dragging’ was the headline in one German newspaper as it was rumoured that our inveterate Hellenic hand-out seekers were about to pouch another €20 billion, together with extended payment terms and a reduced coupon on their Pelion upon Ossa of existing loans. Talk about creating financial zombies!!!

Draghi bearded the lions in their den when he dissembled before the Bundestag, giving them his earnest that he would never exceed his mandate; that it was simply inconceivable that his unlimited bond purchases could be construed as monetizing state debt, or that it could in any way turn out to be inflationary.

No-one asked the obvious question that if all this was true, and if the OMTs were to exert such a subtle influence on the economy, why he felt compelled to ride roughshod over the (adopted) traditions of the institution he heads in order to implement them.

Among the few dissenting voices was that of the president of the German Savings Bank Association, Georg Fahrenschon, who declared that: “Private savings should not be further penalised. The ECB should not direct itself to minimizing the outlays of the debtor countries, but to ensuring monetary stability, today, tomorrow, and the day after that” 

At the same press conference, however, he revealed the schizophrenia which Draghi’s actions have induced. German savers prefer to hold their wealth in the form of savings accounts – out of distrust and uncertainty – yet half of them see a house as the best guarantee for their old age and a third of them intend to buy one now.

If the former impulse gives way only a little in favour of the latter, that double-digit rate of increase in the local money supply will soon deliver the thrifty German burgers, almost the last of their breed, into that vortex of balance sheet ruination which is widely seen (if less openly articulated) as the real key to solving Europe’s otherwise intractable debt crisis.

Before then, however, it would seem that the country might be in for more testing times than has been the case to date. Certainly the decline in the IfO index this past six months – registered despite a rising stock market and a diminution of the sense of crisis in the Zone – is of a magnitude which has typically accompanied significant downturns in activity. With monetary creation running so hot in Germany, it would be unusual, to say the least, for revenues and profits to fall sufficiently far to trigger a serious setback – which is essentially what the IfO index is telling us is expected to occur – but nevertheless this does bear close attention.

Finally, there are one or two hints that the US is starting to sputter. Certainly, the rapid decline in core (ex-defence and aircraft) capital goods numbers tells us so. At -10% YOY, orders are now falling at the sorts of rates experienced in both the Tech bust and the GFC itself. In the past three months, nominal levels have come to rest where they were in the late 1990s while, in real terms, the series has not been this depressed since it was first compiled in the current form, two decades ago.

Those, like us, who have tended to regard the States as the best of a bad bunch, will have to hope this is nothing more than a little pre-election caution and that it will be accordingly reversed in a month or two’s time.


The SCO, China, Iran, and gold

I make no apology for returning to the subject of China, its role in the Shanghai Cooperation Organisation, and gold. Gold is now a strategic metal for present and future SCO governments, which between them have over 40% of the world’s population; and now that the price of gold is re-establishing its rising trend, understanding its future role as a replacement for the US dollar is increasingly urgent, because gold is wealth and this wealth is being transferred from west to east.

The SCO is an economic bloc consisting of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. Between them they produce about 26% of the world’s gold, none of which leaves the SCO. Other nations accepted as future members are India, Iran, Pakistan, Mongolia and as soon as NATO leaves, Afghanistan. Belarus and Sri Lanka are on the waiting list. It is no less than the economic unification of most of Asia, with a combined population of three billion. All their central banks are buying gold, and the gold imported by the citizens of just two of them (India and China) accounts for all but 400-500 tonnes of the rest of the world’s mine production – and some of that (particularly in Africa) is now also controlled by China.

One of the SCO’s economic objectives is to do away with the dollar for cross-border trade between members. Any doubts we may have on the matter have now been dispelled as a result of the US Government’s monetary sanctions on Iran.

Iran is important, because it supplies crude oil to China and India, and the Americans have banned all countries from buying Iranian oil on pain of sanctions. The consequence has been to force Iran to settle some of her trade in gold, giving SCO members both a de facto remonetisation of gold, and a solid reason to want higher prices for it in US dollar terms, so that it buys more.

This creates a dilemma for the US. If she escalates her attacks on Iran, she threatens the interests of China, India and other SCO members. At this stage it is too early to judge the political reactions of the SCO members to this threat, but there are broadly two possibilities: either military or economic.

It is too early for China to fight a currency war. She is developing her internal market, and in time the SCO will provide her with the most powerful captive market since the British Empire. However, she still depends on declining markets in the West for much of her economic activity. However, the reason she has accumulated gold and encourages her citizens to do so as well is ultimately to transfer wealth from the West.

The Iranian situation is already undermining the position of the dollar as the international currency in the context of pan-Asian settlements, because oil is simply more important. Attempts over the years by western central banks to bluff us out of gold ownership have given China and its SCO affiliates a tremendous wealth-transfer windfall, as we may be about to discover. That’s what the geo-politics of gold is actually about, and it is a pity our leaders seem to be blind and deaf to it.

This article was previously published at