Tags: David Stockman | China | bubble | economy

China's Market Isn't Fixed, Bubble Will Keep Imploding

By    |   Friday, 10 July 2015 12:16 PM

China’s stock market is purportedly all fixed and the last two day’s 10 percent bounce is just the beginning. Goldman Sachs has already reiterated that the whole thing is on the level, and that China's red-chip stocks again will be taking flight, as Bloomberg reports:

“China’s biggest stock-market rout since 1992 has done nothing to erode the bullish outlook of Goldman Sachs Group Inc. … Kinger Lau, the bank’s China strategist in Hong Kong, predicts the large-cap CSI 300 Index will rally 27 percent from Tuesday’s close over the next 12 months as government support measures boost investor confidence and monetary easing spurs economic growth. Leveraged positions aren’t big enough to trigger a market collapse, Lau says, and valuations have room to climb.”

Right. The Chinese economy is in an obvious deepening swoon and companies on the Shanghai exchange had a median price-to-earnings ratio of 60 times before the recent break.

But no matter. Not only does everything financial race the skyscrapers to the sky in the land of red capitalism, but also valuation upside is apparently whatever the comrades in Beijing want it to be.

Says Goldman’s chief stock tout for China: “It’s not in a bubble yet.”

Why? Because “China’s government has a lot of tools to support the market.”

The confident Lau was still in diapers when the late Chinese leader Deng Xiaoping proclaimed that it was glorious to be rich — or stated differently, when Deng set aside Mao Zedong’s mistaken maxim that power comes from the barrel of a gun in favor of the thoroughly modern notion that prosperity comes from the end of a red-hot printing press.

That’s the heart of the matter. Lau and perhaps 50 million other Chinese punters believe that growth and wealth are gifts of the state.

They believe red capitalism works because the comrades in Beijing are always ready to inject “whatever it takes” by way of stimulus, guidance, controls, ever more debt and now, apparently, prison sentences, to keep the bubble expanding.

Vaporized Wealth

That millions of Chinese citizens are being annihilated financially is hardly surprising. After all, the $3.5 trillion lost in the four weeks since the June 12 peak was pure casino wealth. It didn't even exist as recently as March 17.

That’s right. The Shanghai composite reached the 3,500 level exactly 60 trading days before hitting the June 12 high of 5,180. What amounted to a 50 percent gain in no time ended up as a 30 percent loss in even less time.

There is no need to be pedantic about this. There is no known form of honest economics in which a $3.5 trillion bubble — equal to 35 percent of gross domestic product — can go through a birth and death cycle in a mere 80 trading days.

Nor should anyone in their right mind believe that the Shanghai/Shenzhen casinos have any resemblance to an actual stock market.

During Wednesday’s plunge it seems that trading in 1,350 of the 2,900 companies listed on these exchanges was halted by the companies themselves. Another 750 listings were halted after hitting the 10 percent limit on declines.

Yes, you can apparently stop a selling panic, at least momentarily, when 70 percent of the names go radio silent — especially when, at the same time, the heavy hand of the state suddenly morphs into the shape of a mailed fist.

Sell Stock, Go to Jail?

Stated differently, the desperate comrades in Beijing threw open the People’s Printing Press of China to fund ostensibly unlimited margin loans while simultaneously opening the doors to a cavalcade of paddy wagons instructed to round up anyone with the temerity to sell a stock.

And in case the meaning of mobilizing the gendarmes was not self-evident, every company that sold stock in the past six months got a personalized order to buy back these same shares.

All of this desperate action, of course, is only suppressing the problem, not solving it.

The trading suspensions, which cast doubt on authorities’ pledge to give markets a greater role in the world’s second-largest economy, mean that the Shanghai Composite Index’s 5.9 percent tumble on Wednesday was probably understated.

Investors who got stuck in their positions are turning elsewhere to raise cash, fueling the biggest drop in a month for Chinese government bonds.

Desperate Comrades

The regulatory authorities in Beijing are so desperate that they are allowing investors to answer margin calls by pledging the millions of empty, vastly over-valued apartment buildings that Chinese punters were earlier lured into buying. Now that scam would make even Charles Ponzi envious.

Are these people out of their minds?

China is a debt powder keg of about $28 trillion. According to the bean counters at McKinsey & Co., upwards of $21 trillion of that was created in the past 90 months — during which time China’s economy expanded by only $5 trillion.

Apparently, even the comrades in Beijing had gotten a tad nervous about the sustainability of creating $4 of debt for each $1 of new GDP. Indeed, their “reform” plan was to unleash “market forces” and to encourage companies to shed their mountains of debt by raising equity capital in a vibrant stock market.

The stock market got vibrant all right. During the past year, several hundred billion dollars of new equity was raised with initial public offerings and secondary share sales.

But the debt pea was just being moved under another shell.

Soaring Margin Debt

Chinese investors borrowed heavily from brokers to buy more stock – margin debt soared by five times in less than a year. Nothing like this has occurred anywhere in the world since, well, 1928-1929 on Wall Street.

The debt-fueled mania that underpinned America’s Great Crash turns out to be tame by comparison. That’s because margin debt supplied by stock brokers is only part of the broader picture.

It appears that China’s out-of-control shadow banking system provided again as much, and without any rules as to collateral maintenance or the financial capability of borrowers.
So, compute the sum of combined margin loans from brokers and shadow bankers and express the result in dollars. What you get is about $800 billion — of which upwards of $600 billion was advanced in just the past 12 months!

Now that’s 6 percent of GDP mainlined right into casinos that are 80 percent comprised of mom-and-pop retail investors.

Communist Bubble

That the resulting bubble has burst and made a mockery of Beijing’s market-based reform plans is evident enough.

What is truly frightening is that China’s authorities are so desperate that they are now attempting to reflate the very same speculative bubble that brought their financial system to the brink.

What is even more telling, however, is that the clueless ramblings of a naïve kid just out of the London School of Economics gets the Goldman Sachs imprimatur. And that embarrassing state of affairs is the key to the global financial calamity just ahead.

As Nixon might have said, “They are all Keynesian statists now.”

Once upon a time, the grey beards of Wall Street would have been horrified by the printing press economics of today’s central banks. They would have had no trouble seeing that China is the greatest eruption of unsustainable debt, wasteful construction and rampant speculation in human history. It has precisely nothing to do with capitalism or any possible form of sustainable economic growth and wealth creation.

Immense Overcapacity

In the process of taking its debt from $2 trillion in the year 2000 to $28 trillion at present, in fact, China has erected an endless string of uneconomic public facilities and industrial white elephants that boggle the mind.

For instance, it has 1.1 billion tons of steel-making capacity — 400 million-500 million tons more than its domestic economy will ever be able to use on a sustained, sell-through basis. In fact, its “excess” steel capacity is greater than the total steel industries of the U.S., Europe and Japan combined!

Likewise, it ramped up a cement industry of 2 billion tons that is double or triple what will be needed when its construction of empty apartment buildings, unused airports, carless highways and bridges and pointless high-speed rail lines finally comes to an end. Indeed, during the three years ended in 2014, China produced more cement than did the U.S. during the entire 20th century.

The parade of excess capacity and white elephants is virtually endless and includes copper products, aluminum, solar panels, construction machinery, ship-building and every manner of consumer goods. That used to be called “malinvestment,” and it’s what happens when central banks flood the world with uneconomic credit and governments override every semblance of financial discipline and honest calculation through endless bailouts and safety nets for gamblers.

Commodity Crash

Now China’s domestic hothouse has reached the limits of credit fueled asset expansion. The great maw of its absurdly overbuilt industries is already heaving up deflationary gales on world markets. Its iron ore and steel industries, for example, are literally crashing and flooding markets with more cheap steel than has ever before been imagined. As Bloomberg reported:

“Ore with 62 percent content delivered to Qingdao sank 5.1 percent to $49.60 a dry ton on Tuesday, falling for a ninth day to the lowest since April 13, according to Metal Bulletin Ltd. Prices entered a bear market on Monday, dropping more than 20 percent from a June high. On the Dalian Commodity Exchange, futures plunged 7.2 percent to a record low on Wednesday, while the August contract on Singapore Exchange Ltd. fell to $42.20.
The trend echoes a similar one in steel in the second half of last year, when Chinese exports of excess supplies sent prices tumbling 30 percent. The nation’s aluminum industry quadrupled in the past decade with smelters churning out record amounts of the metal used in everything from packaging to car bumpers.
Metals including nickel and silver on the Shanghai Futures Exchange fell to their daily limits, while rubber entered a bear market. The volume of copper traded was almost six times the three-month average. Steel rebar and iron ore, as well as eggs, sugar and soybean meal dropped to the lowest level allowed by their exchanges.”

Beijing’s profoundly stupid attempt to keep the Ponzi going by levitating the stock market is now coming home to roost domestically, as well. An increasing number of car buyers in China are canceling their purchases and risking forfeiture of their down payments after the recent stock-market rout.

According to Cui Dongshu, secretary-general of China’s Passenger Car Association, auto sales fell last month for the first time in more than two years:

“The plunging stock market is essentially a meat grinder, shredding money meant for buying cars.”

Economically Illiterate Thug


The firestorm now engulfing China’s stock market will shake the regime itself. China’s current maximum ruler, Xi Jinping, is self-evidently an economically illiterate thug. Accordingly, there is no measure he will not try in order to arrest the current meltdown.

But as Quartz reporter Gwynn Guilford noted, Xi has put the regime on the line. When the current desperate measures finally fail, China could well descend into social and economic chaos:

“By urging households to buy stocks, Xi has put his credibility — as well as that of the Communist Party — on the line. The stimulus measures’ failure may incite outrage among those very mom-and-pop investors who have lost everything. Though it’s impossible to tell what might ignite it, mass social unrest in China would shake the entire world.
The downside of that wager is profound indeed. The government’s creation of the Chinese bull market has disproportionately benefited state-owned companies — and therefore the Communist Party — by replacing government-guaranteed debt with equity. That equity, of course, has been funded by the little guy — the second, and much bigger, part of the problem. When the state press and government officials began pumping stocks about a year ago, they essentially made a promise to protect the savings of tens of millions of households.”

The ramifications of regime failure in China are surely inestimable. But one thing is certain. The present worldwide faith preached by Goldman and its imitators in the ability of governments and their central banking branches to keep the bubble expanding will suffer a fatal rebuke.

None too soon.

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DavidStockman
China's stock market is purportedly all fixed and the last two day's 10 percent bounce is just the beginning. The firestorm now engulfing Chinese stocks will shake the regime itself.
David Stockman, China, bubble, economy
2037
2015-16-10
Friday, 10 July 2015 12:16 PM
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