Interpreting information in China’s stock markets

Anyone who reads my blog is already likely to know the story. Until the market peaked on June 12, with the Shanghai Composite at 5,178, China had experienced a stock market boom that saw the Shanghai index rising in what seemed like a straight line by more than 135% in one year. The boom seemed almost inexplicable from a fundamental point of view. The market soared as growth expectations for the Chinese economy fell, corporate profitability was squeezed, and banks, who dominate the index, saw a sharp rise in NPLs. What’s more, during this period it was increasingly clear that China’s declining GDP growth was still overly reliant on excessively rapid credit growth, and that to get control of the latter the former would have to drop a lot more.

Although the market peaked in mid-June, the panic really began some time in the first week of July (July 7 is now being referred to by some as China’s “Black Tuesday”), by which time, however, the market had already lost nearly one third of its value. Since late June Beijing had implemented a series of measures to stop the decline, none of which had the desired effect, and by the weekend of July 4-5 there was a sense of complete desperation as the regulators reached for wholly unprecedented attempts to control the fall.

The stock market panic seems to have ended on July 9, when the Shanghai markets closed up 5.8% on the day, followed by strong gains the following Friday and Monday, but Tuesday’s 3.0% decline set hearts fluttering again, and the nervousness did not abate over the next three days as stocks continue to rise, but not without drama. For now I think we can safely say the panic is finally over, but none of the fundamental questions have been resolved and I expect continued volatility. Because I also think the market remains overvalued, however, I have little doubt that we will see at least one more very nasty bear market.

Either way the panic and the policy responses have opened up a ferocious debate on China’s economic reforms and Beijing’s ability to bear the costs of the economic adjustment. Among these costs are volatility. Rebalancing the economy and withdrawing state control over certain aspects of the economy, especially its financial system, will reduce Beijing’s ability to manage the economy smoothly over the short term but it may be necessary in order to prevent a very dangerous surge in volatility over the longer term.

Sunday’s Financial Times included an article with the following:

Critics of the measures unleashed by Beijing last week argue that they point to a fundamental tension at the heart of China’s political economy that a free-floating renminbi would test even more severely. The ruling Chinese Communist party, they argue, is ultimately incapable of surrendering control of crucial facets of the country’s economic and financial system. As one person close to policymakers in Beijing puts it: “The problem with this system is that it cannot tolerate volatility and markets are all about volatility.”

It’s not just that markets are about volatility. It is that volatility can never be eliminated. Volatility in one variable can be suppressed, but only by increasing volatility in another variable or by suppressing it temporarily in exchange for a more disruptive adjustment at some point in the future. When it comes to monetary volatility, for example, whether it is exchange rate volatility or interest rate and money supply volatility, central banks can famously choose to control the former in exchange for greater volatility in the latter, or to control the latter in exchange for greater volatility in the former.

Regulators can never choose how much volatility they will permit, in other words. At best, they might choose the form of volatility they least prefer, and try to control it, but this is almost always a political choice and not an economic one. It is about deciding which economic group will bear the cost of volatility.

But one way or another there will be an enormous amount of volatility within the Chinese economy, not just because it is a relatively poor developing country, which have always been more volatile economically than advanced countries, but also because it is so highly dependent on investment to generate growth. Hyman Minsky argued that economies driven by investment are extremely volatile and overly susceptible to changes in sentiment, and he is almost certainly right.

During the market panic I posted a number of short (1,500 character maximum) messages for my clients on a service available to them through Global Source, who administers my newsletter. I thought in this blog entry I would reproduce the July 8-10 messages in their entirety because they focus on a technical aspect of the Chinese markets that I think is extremely important to understand if we want to understand why volatility is not going to go away. The key point is to distinguish between the types of investment strategies that investors follow (which I discuss more explicitly in my 2013 book on China and in a November 24, 2013, blog entry) and to understand the different ways in which they interpret new information.

The more widely dispersed the investment strategies, and the greater the range of interpretations by which new information is assessed, the more stable a market is likely to be. In China not only is the market wholly speculative, for the reasons I discuss in the blog entry, but even among speculators there seems to have been a dramatic convergence in the way they interpret information. Because this has only been reinforced by the recent behavior of the regulators, it is almost inconceivable to me that we will not see more highly disruptive movement in the Chinese stock markets:

Here are the July 8-10 short messages I posted to clients:

July 8 – China’s markets are unpredictable but mechanical

China’s Spinal Tap stock market is a volatility machine whose every knob has been turned to eleven. Value investors lack the tools they need to project or value cashflow, and so cannot play their stabilizing role no matter what policy enticements are implemented. Policy interventions undermine the regulatory stability that value investors crave, and because the many interventions include attempts to suppress the disruptive impact of shocks, a powerful and poorly-understood consequence is, paradoxically, to magnify the impact of especially large disruptive shocks. With already high expected volatility mechanically jacked up by perhaps the highest margin levels ever recorded, and by the popularity of the investment “strategy” of riding what everyone knows to be a bubble (and of course bailing out just before it bursts), and the events since Friday should be easy to understand, if no less depressing.

If I had to bet I’d bet that a desperate Beijing will wheel out enough firepower eventually to stabilize the markets, but as I describe in my 2001 book, The Volatility Machine, many years of one-way price movement (the 2007-08 stock market disaster being among the few widely-shared exceptions), has left China with the typical developing-country national balance sheet and financial system in which automatic stabilizers are rare and sharply self-reinforcing mechanisms common.

It is important to understand just how mechanical the market collapse has been. By “mechanical” I don’t mean, unfortunately, that if you’re smart enough you can figure out where it is going. You can, however, figure out what might matter and how different outcomes will affect the economy. You should also understand that a recovering market is likely to be highly path-dependent, although much less so should it fall much further.

July 8 – What policies can stabilize the market?

We must avoid the tendency to think of interventions aimed at stabilizing markets as being independent of the structure of the market. In my Peking University seminar I warn my students that because most of the world’s leading economists have been directly or indirectly trained in a tradition that French social scientists, although not French economists, refer to ominously as “Anglo-Saxon”, there is a tendency for us, even Beijing policymakers, to default automatically to an American or British context.

The Chinese stock markets however operate under very different conditions. In a speculative market with few value investors, policies aimed at boosting prices by increasing the present value of discounted future cashflows are largely irrelevant. Given economic expectations that were already weak, and can only have been weakened further after the events of the past few days, prices are still far too high to justify purchasing on value unless interest rates drop much further.

This is why I am not especially impressed by policies, like interest rates cuts or attempts to cut the cost of stock purchases, that are implicitly aimed at encouraging value investors to step up their purchases. We know that increasing the economic value of expected cashflows can cause speculators to step up their purchases, but it is important to understand why. Speculators will purchase in response to policies directed at increasing economic value only if they anticipate a consequent increase in buying by value investors.

July 8 – What might cause speculators to buy?

Broadly speaking speculators buy or sell assets for two reasons:

  • Some event is expected to cause, either for technical or fundamental reasons, a near-term change in the supply of or demand for an asset large enough to affect prices, even if only temporarily, and they transact in anticipation of that price change. This event can include technical factors, for example, a change in margin account rules, as clearly happened in China last week, or the impact of MSCI inclusion on foreign purchases, which until it was rejected last month was among the most often-cited reasons for buying Chinese stocks. This event can also include fundamental factors, for example higher-than-expected growth may set off speculative buying if it is expected to increase purchases by value investors.
  • Some event, in China the most obvious of which is government signaling, provides a reason for speculators to assume a collective response. Even if the signal has no economic value, for example an editorial in the People’s Daily extolling share purchases as patriotic, speculators will assume that the editorial sets off a self-consciously collective response that becomes self-reinforcing.

There are at least two important qualities that characterize speculative markets. For a value investor the decision to buy or sell depends on his interpretation of a piece of news, while for a speculator it depends on his expectation of the collective interpretation of a piece of news. The former can range widely while the latter tends to converge very quickly. This means that while small changes in the way news is interpreted or in market sentiment will have a limited impact on overall supply or demand in a market dominated by value investors, a market dominated by speculators is extremely sensitive to changes in the way news is interpreted or in market sentiment.

July 8 – What can the government do to move markets move in China?

  • Because China’s market is highly speculative, policies that are directed at improving the fundamental value of stocks will have almost no impact on market prices.
  • Uncertainty is currently so high that it will have sharply undermined the ability of speculators to agree collectively on how to interpret signals, or on how to judge the impact that technical or fundamental events will have in causing supply to drop or, more importantly, demand to rise.
  • Because the obverse policies are blamed for setting off the collapse, some policymakers believe that relaxing rules on margin, or lowering its cost, will have the reverse impact and will stabilize the market. It will not. Such policies can accommodate speculative purchases, but they cannot start the purchasing process until speculators are convinced.
  • Speculators will only return to the market if they can be credibly convinced that prices are going to rise, or are credibly convinced that a floor has been established. (The risk is that this might set the stage for another sharp rally.)
  • Recent events have seriously undermined the credibility of government signaling.
  • I suspect, consequently, that the only way to create a credible floor, or to create credible expectations of rising prices, is by “brute force”. Beijing must force entities under its control, or entities it can influence, to buy shares until all uncertainty is removed.

July 8 – Does the Chinese stock market crash matter?

It is hard to argue that the stock rally had any significant positive economic impact, so some analysts argue that it collapse will not impact the economy either.

This may be true in a direct sense. But there are three important ways the stock market decline might matter. The first is direct. The combination of the rally and the crash may represent a significant shift in wealth from poorer Chinese to richer Chinese. This must cause total consumption to drop, although the amount will depend on the magnitude of the shift, of which we have no information.

Second, and indirectly, if the market crash causes perceptions of economic uncertainty to rise, households might respond by cutting back on consumption.

Third, and also indirectly, if the crash undermines Beijing’s credibility, or confidence in its ability to manage the economy, it could undermine the financial sector, which relies very heavily on the high credibility Beijing enjoys. This is the least likely but most damaging potential impact.

Of course the longer it takes for Beijing to stabilize the market the more its credibility is likely to be undermined. In a worst case scenario Chinese households may blame their losses on their having invested in the stock market because of what is widely perceived as very active cheerleading by policymakers.

July 9 – Should the government have intervened?

After a terrifying beginning with Shanghai down 3.2%, markets turned around dramatically and Shanghai closed up 5.8% on the day. But 194 more companies suspended trading today. Over half of all companies now don’t trade. As I suggested yesterday, it wasn’t the subtle measures that proved most effective but rather outright bans on selling and large concerted buying, including share buyback pledges from nearly 300 SOEs.

Is this the end of the “correction”? Maybe, but only the foolish know for sure. I still think Beijing will eventually halt the slide and set off another rally, but not because there is value at these prices. The rally has always been about excess liquidity and the widespread belief that Beijing’s guarantee now extends to the stock market, and I think with last week’s and this week’s intervention Beijing has invested too much of its credibility to back down.

But the intervention hasn’t been without controversy. In an angry article in Caixin Ling Huawei argues that there had been no threat to the country’s financial system, and that “only a systemic risk that threatens financial stability justifies a government bailout”. Yesterday I pointed out that unless value investors are confident that they have reliable information and understand the rules of the game, they will refuse to participate. Beijing’s intervention, Ling argues, can only have undermined whatever confidence there might have been.

But intervene they did, so now unless Beijing can disentangle the market’s performance and its own credibility, the choices seem limited. Is disentangling possible? I don’t know, but if it is, someone very senior will have to take responsibility for some pretty big decisions.

July 9 – Why do financial crises happen?

  • Financial crises are analogous to bank runs. They occur when the liquidity needed to bridge the gaps created by mismatches between assets and liabilities suddenly becomes unavailable. Insolvency by itself is not a sufficient condition, and only leads to a financial crisis when it causes creditors to refuse to roll over liabilities that cannot be serviced out of assets.
  • Financial crises can be triggered by a wide variety of events, some seemingly trivial, but they require the following conditions:
  • Significant asset and liability mismatches within the country’s balance sheet and financial system, usually exacerbated by highly pro-cyclical mismatches that reinforce exogenous shocks (because highly pro-cyclical entities outperform during periods of economic expansion, there is a natural sorting process in which the longer such periods last, the more a country’s financial system will be tilted towards pro-cyclicality).
  • A period in which mutually reinforcing slower-than-expected economic growth and faster-than-expected credit growth create rising uncertainty about the allocation of debt servicing costs.
  • A transmission mechanism from the trigger event into the financial system, for example a fall in the price of assets can cause a surge in non-performing loans, or it can cause households to cut back on consumption.
  • When these conditions are in place, even a small shock can directly or indirectly (in the latter case by forcing agents to respond adversely to a rise in uncertainty), trigger a self-reinforcing series of events that spiral out of control.

July 9 – Does size matter?

The Chinese stock market panic is unlikely to trigger a financial crisis in China, but not, as many argue, because of its relatively small size and narrowly dispersed ownership. What matters is that although nationally there are significant mismatches between assets and liabilities among individual institutions and within particular sectors of the financial services industry, and these mismatches are highly pro-cyclical, China is protected from crisis by its relatively closed capital account, its high level of reserves, and most importantly of all, the fact that much of the mismatch between assets and liabilities are resolved on a system-wide basis through Beijing’s implicit or explicit guarantee of most components of the country’s financial system.

China is protected from the risk of financial crisis, in other words, mainly by Beijing’s credibility, which remains very high. Without this credibility, more than three decades of rapid growth accommodated by a financial system designed for credit expansion has left the country with what would otherwise be an extraordinarily vulnerable balance sheet.

Inevitably as the country unwinds the balance sheet mismatches, debt has grown more quickly than expected and the economy more slowly in a mutually reinforcing process. This will continue as Beijing rebalances the economy, temporarily increasing the country’s underlying vulnerability until it is able to rein in credit growth and resolve the uncertainty about how the growing gap between debt servicing costs and debt servicing capacity is assigned. As long as the credibility of the implicit Beijing guarantee is maintained, however, I think that while China suffers from excess debt, it is unlikely to suffer from balance sheet instability.

There are two important implications. First, policymakers must ensure that protecting Beijing’s credibility is a priority. Second, investors must ensure that they evaluate changes in credibility accurately.

July 10 – A collective decision to rally

With the market up 5.2% by 1 pm, I think the “correction” is over. Analysts have pointed out the many reasons for skepticism, most importantly, I think, that over half of the listed companies have suspended trading in their shares. The full buying power that Beijing can command, plus the return of speculative buying, has been concentrated on a sharply reduced supply of shares.

So how can we take the market’s revival seriously? Much of the buying was forced, and there were formal and informal restrictions on selling. One of my Chinese friends complained (although he went long early Thursday afternoon): “It is illegal to sell and illegal not to buy, so how can prices not go up?”

In other words neither fundamental reasons (i.e. improvements in value) nor even technical reasons (i.e. more demand than supply) justify confidence that the panic is over and prices will rise next week. It was as if prices were simply legally required to rise, and so they did, and because this legal requirement cannot last, while technical imbalances still favor selling, you might think that the panic is far from over.

But this is a speculative market in which the way information is interpreted has converged tremendously, and it seems that the reaction of the regulators and two good days have provided strong enough a signal to allow a collective interpretation. If today were not Friday, I would bet heavily that prices would surge again tomorrow, but because it is Friday, Chinese investors have two days in which to let the confusion and panic of the past two weeks gnaw away at their confidence in their collective response. If Beijing keeps a tight lid on the news and prevents anything from undermining this perception, I suspect that prices will defy the technical imbalance and rise all week.

July 10 – The Shanghai Composite and the Keynesian beauty contest

For months I have been arguing that the most worrying source of volatility in the Chinese stock market was not its speculative nature nor even the unprecedented use of margin. It was the large share of Chinese investors whose strategy was to ride what they believed to be a bubble. This to me is why the fall was so terrifyingly swift and so hard to contain.

Why? Because a well functioning market requires a wide range of investment strategies and, even among investors with similar strategies, it requires information to be interpreted in a wide range of ways. If investment strategies converge, the impact of new information also converges.

In China we saw a remarkable convergence in investment strategies and in the way information was interpreted. As Keynes explained with his beauty contest example, it is as if while players differed as much as ever on how they define beauty, they agree on how beauty is fashionably defined and know instantaneously of any change in fashion. The consequence is that they always select the same “winner”, and every change in fashion causes an immediate change in selection. This can only cause volatility to explode.

It is too early to say, but the extent and ferocity of the market break and the panicked response of the regulators may result in even further convergence. If the rally is restored I have little doubt that the regulators will take steps to try to limit volatility. Margin, for example, will never be allowed to reach the extent that it had (and this has implications for credit growth, by the way), and a little sand might be thrown into the machinery, perhaps by raising transaction taxes or forcing wider bid-offer spreads. But we shouldn’t overestimate their impacts. If Beijing is able credibly to revive the rally – a big “if” – we will want to watch closely whether once again most investors are cynically riding what they believe to be a bubble.

What next?

So where do things stand now? It is pretty clear to me that Chinese investors recognize that they have collectively decided that the correction has ended and that prices are going to rise. In a speculative market this is all it takes for prices to rise.

But while this recognition seems quite solid, in fact there are a number of factors that can quickly undermine it, and what matters is not new information the suggests prices must fall but rather just new information that undermines confidence in the strength of the consensus. This may not seem as important a distinction but in fact it is. It doesn’t necessarily take bad news to cause prices to fall again. News that undermines our confidence that there is widespread agreement about our collective consensus is enough to do that.

What worries me most is that many of the measures employed by the regulators to halt the panic are unorthodox enough, to put it mildly, that they can introduce all kinds of new convexities and implied options that we don’t fully understand. As we begin to recognize and understand them, however, these might be enough to undermine confidence in our widespread agreement about having reached a consensus.

I realize this is very abstract, but it might help make things a little clearer to consider one of the best-known of the measures employed over the desperate weekend of July 4-5. This measure is described in a recent article in Caixin, which describes a meeting held by the CSRC involving the heads of China’s 21 largest brokers:

After the sit-down, the firms announced in a joint statement that to stabilize the stock market they would spend at least 120 billion yuan combined to buy exchange-traded funds linked to blue-chip stocks listed on the Shenzhen and Shanghai bourses. Moreover, the firms pledged to hold all stock that had been bought with their own money until the index reached at least 4,500 points.

The CSRC ordered the firms to hand over that 120 billion yuan to the China Securities Finance Corp. (CSF), a four-year-old agency co-founded by the country’s major securities and commodity exchanges and clearinghouse to finance brokerage firms’ margin trading and short-selling business, the person said. They were told the money would be used for stock purchases.

At the meeting, the person said, a disagreement arose over how the securities firm’s funds would be managed. One executive proposed forming a committee with representatives from securities firm to make all investment decisions, but that idea was rejected.

All money transfers from the firms were to be completed by 11 a.m. the following Monday, the person who attended the meeting said. The firms complied. Then on July 8, as part of the CSRC strategy, the CSF said it would set aside 260 billion yuan to finance stock purchases by the 21 securities firms.

Why would this matter? Because if brokers are holding large amounts of shares that they are eager to sell, but cannot do so until the index hits 4,500, this creates a barrier, or at least a speed bump, at around 4,500 whose impact as the market races up is hard to determine. This acts effectively as a kind of call option that investors must give away any time they buy stocks while the index is below 4,500.

Here is how I tried to explain it in the discussion following one of the messages I posted above:

How meaningful it is that brokers might not be permitted to sell until the index is above 4,500? If this is a serious constraint, it means that if you buy the index (and this is also true of individual stocks but messier to figure out), you are effectively giving away a call option struck at 4,500.

So how would you value this short position in the implied call? Put differently, would you buy at 4,090 if you thought your upside were capped at 4,500 (up 10%) and your downside “capped” by these put options you correctly see the government giving away? Would you buy at 4,290 (up 5% to get to 4,500)? I have no idea, and I suspect the regulators don’t either, but I am pretty sure you won’t ever pay 4,500 until you think the implied option is about to expire, in which case you’d buy as much as you could get your greedy hands on.

With all that has happened this market could be jam-packed with implicit options, which means trading patterns are going to be very hard to figure out at first. I still think the panic is over – for now, anyway – but mostly because we aren’t smart enough to be uncertain about what is being signalled. On the other hand it is 1:30 a.m. in Beijing, so maybe I am getting way too metaphysical about it.

As an aside, my reference to “these put options you correctly see the government giving away” is in response to a client’s comment that Beijing’s determination to keep the market from falling creates a series of implied put options which investors are long, but there is enough uncertainty about these implied options that it is hard to know how they will impact the market and, more importantly, when they will be “withdrawn”. There are implied options everywhere in this mess of orthodox and unorthodox measures to prop up the markets, and their impact must be to distort convexity in complex ways and to increase volatility, not because of their direct impact on the market but rather because they are complex enough to cause investors to wonder about the robustness of the collective investor-base interpretation.

Protecting Beijing’s credibility

In this market, you buy because you believe that everyone has agreed on the collective interpretation of government signaling. Anything that undermines the confidence you have in the collective interpretation must undermine your decision to buy, and in fact because everyone is watching everyone else, at some point, this can become a collective decision to sell.

Before closing, I want to expand on this part of one of the July 9 messages I sent out to my clients:

China is protected from the risk of financial crisis, in other words, mainly by Beijing’s credibility, which remains very high. Without this credibility, more than three decades of rapid growth accommodated by a financial system designed for credit expansion has left the country with what would otherwise be an extraordinarily vulnerable balance sheet.

I discuss this more in a July 14 OpEd piece I did for the WSJ where I argued that:

In many ways, China is primed for an economic crisis. As the economy performs below expectations quarter after quarter while the debt burden surges, slow growth and rising debt are being tied together in a mutually self-reinforcing process—almost the definition of an unstable balance sheet. There is so much pressure within the financial system right now that twice in the past two years attempts at deregulation have been followed by market disruptions.

We shouldn’t have expected otherwise. History suggests that developing countries that have experienced growth “miracles” tend to develop risky financial systems and unstable national balance sheets. The longer the miracle, the greater the tendency. That’s because in periods of rapid growth, riskier institutions do well. Soon balance sheets across the economy incorporate similar types of risk.

It is not just developing countries that do this, of course. In 1978, during a lecture at NYU, Paul Volcker described the US economy in a way that is very familiar and almost standard for central bankers:

A long period of prosperity breeds confidence, and confidence breeds new standards of what is prudent and what is risky. For a while, the process is self-reinforcing, sustaining investment and risk-taking. But it may also contain some of the seeds of its own demise: eventually natural limits to some of the trends supporting the advances are reached and the advance cannot be sustained so easily…Financial positions are extended and the economy has become more vulnerable to adverse and unexpected developments.

This process is far more technical and systemic than most people realize, and more than is implied in Volcker’s speech. The point is that during expansionary periods it is normal for economic agents to find themselves mismatching assets and liabilities in such a way that the financing gap – the gap between debt-servicing costs and cash flows generated by long term investment – can easily be refinanced by eager bankers (who have learned that excessive optimism is rewarded), in ways that systematically increase profitability. The whole financial system tends to incorporate these kinds of mismatches.

During the contraction phase, however, it suddenly becomes costlier to refinance the gap, and the practice of mismatching assets and liabilities causes debt, not profits, to rise. If the mismatch is severe enough, the balance sheet must lead almost inevitably to crisis – unless government credibility is high enough to guarantee that the mismatch will always be refinanced and the accompanying surge in debt can be absorbed (usually by the government).

That is why defending Beijing’s credibility is key. Conditions will deteriorate, growth will slow more than expected, debt will rise faster than expected, and the refinancing gap will create huge uncertainty about its resolution. Beijing must consequently resist any temptation to expend credibility, which includes taking on debt, unless the alternative is a financial system collapse, or, as Ling Huawei put it in his Caixing article, “only a systemic risk that threatens financial stability justifies a government bailout”.

Two years ago almost to the day we saw a similar sequence, in which minor financial-sector reform was followed by explosive growth in leverage as banks responded “creatively” to the reform. When the regulators tried to reverse the rapid credit growth they accidently triggered the credit crunch of June 20, 2013, in which interbank rates soared to 30% (and probably much higher).

The financial system is structured in a way that makes it increasingly difficult to withstand the slowing growth and rising debt burden that is all but inevitable over the next 3-4 years. The historical precedents suggest that Beijing will be overly confident about its ability to manage rising financial instability, but this creates the risk that at some point it will not be able to do so. This is the real cost of the stock market debacle, both as the stock market soared, largely on the back of the implicit put option Chinese investors thought Beijing had granted them, and even more so when Beijing responded to the panic by committing its full credibility to the existence of this put. As I explained in the WSJ article:

The next two to three years are vitally important. In the best case scenario, Beijing will continue to rebalance its economy and to restructure the country’s balance sheet and financial system. Yet this cannot happen except under much slower growth. Because the debt will burden will continue to rise for at least another four or five years, Beijing will be tested more than ever. To defend itself from crisis, it must become increasingly stingy with its protection.

 

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92 Comments

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  1. Its funny how the whole world has suddenly given so much importance to what almost every pro knows is a casino, the Shanghai (and Shenzen etc) stock markets. In great bull market runs, it is common for there to be large pull backs in the beginning of the move, you only know after a sustained period of higher highs or lower lows if there is a longer term change in trend. So the next few weeks will be crucial to see where the medium term is likely headed.

    But I agree on your point about the PRC’s credibility. Confidence is a tricky ‘animal spirit’. you wouldn’t want to lose it on account of the mostly irrelevant stock market the govt’t was fueling in order to sell more bank shares to the public

    • I can’t ever seem to figure out market direction very well, but your comments about higher highs/lower lows are interesting. Ever since the first major pullback, I always thought the Chinese government would “stabilize” (artificially) the situation, which is exactly what happened. I don’t think the market will stabilize the next time they try to do something like this.

      The Fed is also about to begin its tightening cycle, so that could significantly change things. Once the Fed starts raising rates, I have difficulty seeing how the BRICS (minus India) don’t absolutely come crashing down. It seems to me the world is already entering part 2 of the depression. Countries like Canada, Australia, and other commodity exporters are gonna see their currencies get completely wiped out. Many of the asset bubbles in places like Canada and Australia are starting to burst too. These signs aren’t good.

      • Suvy, we’ve been hearing the Fed is about to tighten for three years. Wage growth in the U.S. is negligible. There is slack in the labor force (not measured in the unemployment rate) as well as industrial capacity. And of course another year of Eurosclerosis. Thank you Germany!

        I think you answered the question of whether the Fed will raise rates in 2015. The global economy is a disaster and easier money across the globe is necessary. They might talk a lot about it and do things that suggest their hawkish tone, but nothing material will happen. Some people criticize the Fed as encouraging currency wars (the seemingly endless cycle of countries relying on weak currencies to stimulate growth from trade at the expense of their trade partners). In reality the global economy is so weak what Bernanke and Yellen have done is forced every major economy to maintain easy money in order to stimulate demand until sustainable growth returns.

        • The ay you write, Phil, is as if Fed has a choice to raise the rates or not. In reality, the market does it for them. And Fed follows.
          Read what Paul Volcker wrote when he was forced to raise the rates to the moon during his tenure.

          • They do have a choice in this regard. There’s no inflationary pressure to raise rates. Personally, I think they’re crazy, but that’s just me.

            The Volcker situation was a strange one and much of it had to do with oil shocks and the way the bad debts were resolved in the 70’s. Those circumstances do not apply now.

          • Volcker said that it was the market, not the Fed, that controls short-term interest rates during a time when the Fed was mistakenly attempting to stablize M1, and had knowingly but unwillingly caused rates to soar and pushed real rates to their highest levels ever. The contractions that followed were so long, sharp, and repeated that both the Reagan White House and the Congress were furious with the Fed and attacked them publicly, and for the first time ever a group of conservative Republicans and goldbugs were negotiating with the small group of liberal Democrats that had long pressed for legislature to hobble the Fed to join forces.

            Volcker, in other words, was writing and lecturing about the inability of the Fed to control short-term interest rates (no one ever believed the Fed could control long-term rates directly) because he desperately needed to duck criticism. Many years later, after Volcker had been lionized as the slayer of inflation, his arguments changed substantially and he admitted that the Fed had systematically forced up interest rates.

            Several members of his Board of Governors claimed in memoirs and other papers that it was indeed a Fed decision to raise short-term rates, and they did just that, but it wasn’t because they were determined to slay inflation but rather because they were stuck with targeting M1. Although above average M1 growth had been more than neutralized by a sharp drop in M1 velocity, bond markets were so fixated at the time on M1 that if they didn’t continue tightening they would have lost what little credibility remained after the debacle of the mid-1970s.

            Ironically because the Volcker Fed had committed in 1978-79 to target the money supply, and not interest rates which had been their practice since Benjamin Strong, and they were desperate to regain credibility with the markets, they got caught in their own trap. Once they promised that they would target M1, the very sick-of-the-Fed financial markets began judging them on M1 growth.

            When declining rates, from their punishing highs in the late 1970s, caused a shift in NOW accounts, which caused M1 to rise in a non-expansionary way (i.e. velocity fell, but they couldn’t prove this until after the fact because velocity is derived and not observable), M1 became useless, but the financial markets nonetheless judged them on that basis.

            The worry was that if even if it was the right thing to do, loosening money and forcing rates down when M1 was growing faster than target might cause inflationary fears to reignite and bond prices might fall anyway. They hoped that if they looked tough and credibility returned rapidly it might cause bond prices to rise and long-term rates to decline fast enough to kickstart the economy. credibility has never been repaired so quickly in history and it didn’t happen in the 1980s.

          • You say that Phil writes “as if” the Fed has a choice in raising rates, but if you are going to call someone out in that patronizing way you’d better be right or you’ll look a little silly. Phil is right. The Fed is pretty good at determining short-term rates, has even fixed them for long periods, and can almost always determine their direction, and this is true for most central banks that ignore the currency and some that don’t.

            Read any account of how open market operations works on a daily basis from dozens of books and articles and memoirs. Every day the head trader is given instructions on where the Board wants Fed funds to trade that day, and every day he retires or expands money continuously, mostly through repos I assume, to keep FF within the range.

            You don’t even have to understand how the Fed works. Just look at historical charts for nearly any benchmark rate you like, from 1917 to the present, and it is pretty obvious that there have been many times when volatility in the benchmark is so low that it must have been suppressed. Add to that a chart that shows real rates and the discount rate, and it is more obvious than ever that the Fed decides most of what happens with short-term rates.

            I know in the 1970s many of the gold bugs had a theory that central banks didn’t manage interest rates, not even short term rates, because these were set by supply and demand in the money markets. I don’t know why they didn’t think that controlling the supply was exactly one of the ways the Fed set interest rates, along with signalling, which depended on how credibly they had controlled rates in the past. I also don’t know why the gold bugs didn’t see that the discount rate usually preceded market rates fairly accurately, with the exceptions occurring mainly in times when there were sharp and unexpected changes in velocity, which happened a lot in the 1980s. Even the gold bugs finally, every time they turned away from their conspiracy theories for a day or two, had to notice the empirical evidence.

          • What Jack Post says is correct.

            Johny,

            Remember that a central bank can control either the short term money-market rate of interest, the monetary base, or the rate of foreign exchange. A central bank can control either the short end of the curve, the monetary base, or the FX rate by buying and selling securities on the open market. Right now, the Fed is controlling the monetary base, but Yellen wants to push short end rates higher and will probably soon start to do so.

            In the case of the inflation of the 70’s and 80’s, Volcker chose to control the monetary base (much like the Fed is actually doing right now) instead of the rate of interest. As Jack Post said, Volcker tightened the monetary base which caused the short term money-market rate of interest to soar as the yield curve inverted.

          • Jack Post,
            thank you for clarifying it.
            As far as being patronizing, Dodgson, I think it is all in your head.
            I want to see how Fed will keep the rates steady, if it so decides, when there is a raging inflation in the country. That is what I meant.

          • Johny,

            “Raging inflation” comes when there’s rising consumption and falling inflation. Inflation also depends on a supply-side structure of an economy. There’s also different types of inflation with each one having different impacts. It’s not just like the US is gonna enter hyperinflation. Hyperinflation or very high levels of inflation is related to issues of war, major supply-side pressures like improper food transport, collapse in infrastructure, famine, etc.. You’ve gotta be careful making these comparisons.

          • I agree with you Johny. The Fed only has so much control over rates. With a world awash with savings and a lot of it flowing into the U.S. financial assets, the long-end of the yield curve is ridiculously low. The market is telling us there is too much cash (savings) and not enough interesting investment opportunities. So how is the Fed going to raise rates? It won’t matter even if they tried.

            Is there anyone here who still thinks hyperinflation in the U.S. is an imminent threat? With globalization, the excess capacity that exists around the world would swoop in and meet any pick up in demand in the U.S. that could not be met my local producers.

            Yellen is blowing smoke about raising rates and trying to appease the Fed hawks. I won’t criticize her intelligence. She certainly lacks gravitas and I’m not saying that because she is a woman.

            Johnny & Suvy, I think we are all saying similar things about rates and the Fed’s ability to control them.

          • I agree that with globalisation excess capacity can be mopped up easier but a crises can still easily happen. Hyperinflation? Well everyone seems to have been proven wrong about inflation after QE 1,2,3 failed to ignite crazy inflation but you never know. I mean what if the states decided to do QE4 and print 1 trillion a month indefinitely. That sum seems way to high, but I think we would all agree that this could cause high inflation and maybe even hyperinflation if people lost confidence in the Feds control. Krugman has said in the past that he thought 85 billion a month was too low and wanted to spur inflation with a larger amount.

          • That should be:
            *Inflation arrives when you have rising consumption with falling production.

          • Suvy,
            hyperinflation is also related to lack of trust in specific currency. Even though right now the US dollar looks very respected, I do believe that the global financial system which is based on irredeemable currencies, is inherently unstable system. If you studied dynamic systems, I am sure you know that any substantial disturbance that is big enough can bring inherently unstable system down.
            And do not get me wrong, I am not blaming any one in particular. It is a complicated issue for sure. But having your savings almost exclusively in someone else debt like most of today producing countries do, is wrong, both from moral and practical point of view.

          • The current monetary system is unstable. We’ve got the world’s largest debtor country being the world’s most powerful military entity in world history in peacetime. That clearly can’t be stable.

            I’ve done lots of work in dynamical systems, but there’s not much of a risk of hyperinflation in the US. Britain pushed debt/GDP ratios to well over 200% and I think it even reached >300% at various points.

            The problem with government debt in a scenario like this isn’t inflation. It’s that you can get liquidity expansions that turn into speculative booms. You can get an unproductive transfer of resources that can create massive increases in cash flow pressure. We’ve seen high levels of government debt before relative to GDP, but this can go on for quite a while.

            I’m not saying that the debt doesn’t need to be resolved, but I’m saying that these problems don’t necessarily have to be resolved via inflation. In a world of collapsing commodity prices, there’s not gonna be inflation for a while.

            I’d also like to add that we have to look at the term structure as well with regards to government debt. I think the Treasury should immediately start to try and refinance all of the short term debts on a much longer term basis (10-30 years) ASAP as the short term debt comes due. I think a bigger problem is the term structure of the financing than the government debt itself per se.

        • I think Yellen is a fool. How someone like her got in charge of the Fed is a complete joke. These guys don’t understand the problems. They’re just a bunch of academic economists who can’t think about anything with any sort of rigor.

          USD is way too strong, the entire world is in a state of depression, commodity prices are collapsing, but Yellen wants to raise rates?! Maybe I’m missing something, but I don’t think Yellen understands the real problems. We need a new monetary system, not academics running one of the most important institutions in the world.

          • biggestbrotherofthe mall

            Yellen is not a fool. Or certainly no more than her predecessors or you or I Suvy. However the Fed is between a rock a hard place and an even hard place.

            Low growth and real interest rates being near zero, ZIRP having diminishing marginal effect the longer it continues, the amount of bonds on the Feds balance sheet being so large some fear a lack of liquidity in the bond market ( situation to be rapidly rebalanced as Beijing posing as Belgium sells quantities in order to finance further credit and asset misallocation at home, including the stock market refi) and its ability to do anything when the next bond market triggered US economic collapse circa 2016.
            So the US is not in any position to claim free markets at present when ZIRP has been just as interventionary as Beijing in the stock market.

            However that said since 2008 the US has actually deleveraged significantly. The US stock market will crash shortly and it will not be bailed out. The bigger risk is that ZIRP while appropriate as a bail out is a very disruptive long term policy – see the turmoil in bond markets.

            Back in China though the problems are way larger. If Beijings credibility is all that underwrites a credit market out of control then the longer it continues the bigger the crisis and the absence of institutions which enable orderly bankruptcy or social security for the wiped out will cause political instability. And that is the biggest risk to world order.

            Beijing needs to liberalize but slowly and with minimal market distortions. Maybe the Remimbi wont get reserve status this year. Its too soon. Beijing also needs to move towards democracy in an orderly fashion. The alternative is economic collapse and political upheaval.

          • Not sure where you got information that the states has deleveraged significantly? USA public debt was 8 trillion in 2007 and today it’s 18 trillion. Macro trends estimates that at the end of 2007 total debt to gdp was around 340% and today is around 330% to gdp. This is barely a deleveraging and the trend is up, with the housing bubble 2.0 getting into full swing and government borrowing increasing every day.

            Beijing does need to be more liberal but this will produce some big market distortions by letting the housing bubble pop and the stock market pop. But they can’t bare the pain so once things start to look a bit ugly they step in and support. Once the market gets settled and stabilised they tighten a little bit. Then volatility sets in again and they loosen. This has been the path for the last couple of years now. I think they will continue on this path but one day they will make the stock market even more overvalued than today, or the construction sector will finally get the message that it’s over and people will leave the sector in a hurry. At this point and with an ever higher debt level they will be forced to let a large adjustment happen. Even though the Chinese financial crisis has been slowly happening for a couple of years now people will finally see it is real and accept it. But this will be a good thing, with unemployment probably only ticking up a little bit and hopefully the end to this massive asset misallocation and as Michael says, increasing the Chinese peoples share do gdp and ensuring they don’t get stuck in the middle income trap.

          • I don’t think ZIRP or lack of it fixes anything. What we need is a new monetary system and that’s something Yellen refuses to address. She is absolutely a fool. What do you think about Yellen’s opinion on “price/equity ratios”?

          • biggestbrotherofthe mall

            Laurent – you are right
            http://www.imf.org/external/pubs/ft/wp/2015/wp1535.pdf

            Its almost back up to where it was pre financial crisis! It had gone down last time looked but obviously I hadnt looked lately.

            Not good eh?

          • Yeah not good. When I speak to friends and family (Who don’t know too much about finance) they believe what they read and watch in the mainstream media that stocks are at all time highs and the American and global economy is all good. We’re in recovery.. 2008 was a blip and never to be repeated, a once in a century event. Global debt to global gdp is now about 30 percent higher than in 2007. We were saved from a depression in 2008 by making debt higher and keeping interests rates lower for longer. With the fed funds rate around 6% from 95-2001 the bubble popped. The federal funds rate at 6% for around 7 years popped that bubble. After declining to 1% the Fed funds rate made it back up to 5% for only a bit over 1 year from 2006 before causing the GFC. Now at 0 % for 6 years, how much will it take to cause the next crisis? All America did was kick the can down the rd. Jim Rogers believes that we will have another crisis in the few years and because interest rates are already low globally, debt is already high globally, this next crisis will be the one that we can’t lower rates or substantially increase debt to save us.

          • Suvy,
            Yellen is definitely not a fool. Would you please stop with throwing names around?
            She is in position when there is a huge pressure on her to both raise the rates and to keep them at where they are.

          • Johny,

            How am I “throwing names around”? Yellen is an academic economist by training who’s completely missing the real issue. She doesn’t recognize the real risks. The problem isn’t whether there’s pressure for her to raise rates or not; the real problem is that there isn’t any pressure to reform the monetary system except for the “extremists”.

      • The FED Always follows the 3 month T-bill rate. My personal expectation is that that rate won’t go up any time soon. So, the FED won’t raise rates any time soon as well. Although Turkey in early 2014 provides – IMO – a good example of what could happen here in the US. Turkey was forced to jack up short term rates massively to support the currency. So, WHEN (Not IF) the FED raises rates then I expect to a rate hike of say 400, 600, 800 basispoints. After all, both the US & Turkey are running a CA deficit.

        With this story in mind, Mrs. Yellen with all her talk of raising rates, SEEMS to see a financial development we’re are overlooking. What kind of development raises the attention of the FED and what are we overlooking ?

    • But wasn’t it the government who gave the stock market that importance in the first place? My understanding of the story is that they’ve been vigorously promoting the market for some time now. If so, it would be difficult for them to pull away from it so easily. So they tied their credibility to it well before the crisis.

      This leads me to ask why they started down this road in the first place. Was it really to create a way for companies to refinance their debt? Given this is true, then 1) they decided debt was a big enough problem to do this and, 2) they may no longer have this option for financing debt.

  2. Professor Pettis, I know this is not relevant to your article, but I have nowhere else to submit a general comment or send you a message, so I am doing it here. Have you read this book? http://press.princeton.edu/titles/9312.html
    It is amazing how the debates about the industrial decline of the country, especially relative economic decline (relative to Germany and the USA, both of which erected protective tariffs against British exports, while Britain adhered dogmatically to free trade), is hauntingly familiar to the USA today, faced with unfair competition from Japan, South Korea and China primarily. Joseph Chamberlain was the tariff reform champion. Even brilliant and mainstay figures as Lord Salisbury and Arthur Balfour questioned free trade: “In spite of any formula, in spite of any cry of Free Trade, if I saw by raising the duties on luxuries, or threatening to raise it, I could exercise pressure on a foreign power, inducing it to lower rates and give relief, I should pitch orthodoxy and formulae to the winds and exercise pressure.” –Salisbury. The book sets forth the positions of Chamberlain, the free traders who wanted orthodoxy – status-quo, and Arthur Balfour, the Prime Minister in 1903, who wrote a masterful analysis of the situation in a memorandum entitled “Economic Notes on Insular Free Trade,” which I downloaded and have begun reading. Keynes wrote of the memo: “The Economic Notes on Insular Free Trade is one of the most remarkable scientific deliverances ever made by a Prime Minister in office. It wears well and bears re-reading. I think that economists today would treat Balfour’s doubts, hesitations, vague sensing of trouble to come, polite wonder whether unqualified laissez-faire is quite certainly always for the best, with more respect, even if not with more sympathy, than they did then.”

    Chamberlain himself argued things that are so eerily similar to the situation we face today in the USA that it gave me goose bumps reading it, e.g., “whereas at one time England was the greatest manufacturing country, now its people are more and more employed in finance, in distribution, in domestic service… I think it is worthwhile to consider – whatever its immediate effects may be-whether that state of things will not be the destruction ultimately of all that is best in England, all that has made us what we are, all that has given us prestige and power in the world.” He went on to tell London’s bankers that in the short run, the net effect of the changes would be to leave Britain more divided between rich and poor and less self-sufficient, “richer and weaker.” Over the long run the country could not survive as merely a “hoarder of invested securities” if it was not also the “creator of new wealth.” He went on: “…are you entirely beyond anxiety as to the permanence of your great position?… Banking is not the creator of our prosperity, but is the creation of it. It is not the cause of our wealth, but it is the consequence of our wealth; and if the industrial energy and development which has been going on for so many years in this country were to be hindered or relaxed, then finance, and all that finance means, will follow trade to the countries which are more successful than ourselves.”

    Ultimately, I think Balfour’s position of raising retaliatory tariffs on protectionist countries in order to negotiate a reduction of theirs for ours to create a fairer playing field was more workable than Chamberlain’s cry for Imperial Preference, since walling off Britain and her colonies from competition, even legitimate competition, could exacerbate a lack of innovation and upgrading of plant and equipment, technique, etc. and lead to possibly even more decay, not to mention the problematic politics involved. Essentially, Chamberlain’s position, while I agree with all of his arguments on the problems with free-trade while others practices mercantilism, would amount today to what might seem a general, across the board raising of tariffs in the USA against all other countries, while Balfour’s position would amount to strategic raising of duties or retaliation in some measure against currency manipulation by China and others and other stealth protectionist practices which give them an unfair advantage at the expense of our manufacturing base, perhaps by taxing their purchase of our treasuries in proportion to the degree of currency manipulation or something like that, i.e., counter-intervention in the currency markets. That Balfour identified the problems, saw the future and prescribed what would seem to the best solution over 100 years ago without any historical precedent (as Britain was THE first industrial power and the first to face these issues), which nowadays we have plenty of, is astounding to me and merely highlights his unmitigated brilliance as a thinker with a genius analytical mind.

    Nothing happened though because of the lack of political will to do anything, the opposition of vested multinational business and financial interests and fear of political fallout splitting parliamentarian parties. Indeed, the whole tariff debate split the conservatives and brought in the staunchly free-trade liberals, collapsing Balfour’s government. Again, this is incredibly, eerily familiar today, down to the Democratic Party splitting into pro-TPP and anti-TPP camps. History really repeats itself.

    • biggestbrotherofthe mall

      Free trade is well and good but the “free” is one sided in both the situation you describe and then with the US and China.

      Stupid. Tariffs have their place. Particularly as the US is almost uniquely positioned to be a self sufficient economic entity! Watch us back out of the middle east now we can be energy independent. This Iran deal is to was to appease Israel – and their ingratitude is because they sense its a fob off before abandonment.

      Now the US is trying with the TPP to exclude China so it doesnt have to bring manufacturing home. Still bullied along by the “free” trade pundits.

      • I generally agree with you on all of the economic issues, but when you started veering into diplomacy it was more speculative. As Pettis has pointed out, if we start fighting back against mercantilism by counter-intervention in the currency markets, then the US Dollar will start to lose its reserve status and countries like China will necessarily have to hedge or keep their currency undervalued by buying other countries’ currencies like the Yen and the Euro, and we know these countries actually stand up to such manipulation. It will induce volatility, but most of the problems will be China’s and it can mainly only help us, and at the end of the day, all I care about is my country, the USA. China is smart though. They see what happened to Japan after the Plaza Accord, which seemed to have exacerbated and/or accelerated economic stagnation through forced increase in valuation of the Yen relative to the Dollar. They will not make that mistake and just let us continue to be led by dummies…

        • Gregg

          It is a system, so while only caring about this or that, fair enough, held, as the structure is defined, the linkages exist. But why is it important for the US to have the reserve currency.

          As I see it, another country needs to stand beside the US, providing the impetus for global development, this could have been China. But for all the other reasons, written by others before this posting, and the fact that China will require a couple of decades to a consumption led model, the system will alter. There will be some turmoil, and then everyone will forget all the post WWII and 1960’s post-modern continental sociological garbage, and ranks will draw back up around the driver of the global multilateral system which likely enabled more peace and prosperity than any will have had the ability to imagine (as the alternatives were never experienced). Regardless of what those who are concerned of debt levels imagine, there will be ways through this for the advanced world, problem is the system had been pretty good at developing countries, advancing the status of humans in a world vastly increasing in population and enabling levels of cooperation in a world that had only ever been ruled by thieves, tyrants and warlords before as men languished in universal serfdom globally. This, progress, and inevitably the ability to ensure as peaceful a world as has been possible is what is really at stake. This while morons dance around their narrow-minded ideological premises of previous era’s.

          • There’s one factor I think you’re missing in your analysis, which is the transmission of events across borders, which can transfer risk faster than ever before in world history. With that being said, I tend to agree that the developed world will be relatively okay, but I’m not so sure about other parts of the world.

            In many places after decolonization, fertility rates exploded. Many of these countries either import food or have very fertile lands. In the former case, it works great when shipping/transport costs, security costs, and financial costs are cheap, but what about when they’re not and you gotta protect your own trade? What if you’re reliant on commodity exports to pay for food or usable energy (like gasoline or LNG)? This is the position of much of the Middle East.

            With regards to high fertility rates in fertile lands, many of these countries are stuck in the “Malthusian trap” where rising incomes are met by rising populations so standard of living increases are held in check. The classic example would be India after independence–and although the problem has largely resolved itself in most Indian states (particularly in the South and West) many states still have these issues. In Nigeria, the population in 1950 was ~35 million, but it’s projected to be ~300-350 million by 2050. Having a tenfold increase in population every 100 years is not sustainable and will not lead to increases in living standards.

            All of Africa is basically becoming a mine for the rest of the world to use as it pleases. To be honest, I don’t think there’s a lot of hope there. I feel the same way for most of Latin America sans Mexico.

            Water is becoming a real constraint in many areas. In places like California, it’s actually less of an issue because 90% of the water is used in agriculture for exotic crops. The US and places like California are also rich so they can turn to desalination and build desalination infrastructure (they already are). The problem is what about the poor world that lacks the political stability, wealth, or institutions to construct and maintain such expensive kinds of infrastructure.

  3. I have personally refused to invest in Chinese stocks and or funds that held Chinese stocks. Forgetting the valid and important concerns about accounting and governance for a moment, I have been concerned about the casino nature of the Shanghai market for years.

    I have worked with highly-educated Chinese working in the U.S. Inevitably a discussion about stock market investments will come up among finance professionals. I would ask them what their rationale would be for buying a Chinese stock and the common refrain would typically be that word is that the right people were buying in. There wasn’t even a hint of inside information you could hang your hat on.

    Is there a new government contract?

    No.

    Is someone making a bid for the company?

    No.

    So why are you buying it?

    I know people who say the time is now to buy.

    Isn’t that risky?

    No, I don’t plan on holding it for more than a few months.

    These were MBA educated Chinese who had extensive knowledge of cash flow analysis who bought stocks without any regard to cash flow and earnings. They weren’t even aware of a positive event coming up in the near future. They thought they were in the know with the right people who knew where a stock was going.

    • ‘They thought they were in the know with the right people’ – welcome to China – the problem is, in most cases they might be right. it’s hard to describe to people who haven’t lived in the country just how dysfunctional so much of the economy really is

      • I remember when I ran into this college kid who was studying in the US and he was from China. I was repeating the creed we preach here: high Chinese growth has created imbalances where a few crony elite have gamed the system. He completely agreed and we seemed to be in agreement that Xi Jinping needs to get GDP growth down and transfer resources to households. I was impressed by him.

        As for the Chinese equity market, it’s extremely rigged. I think there’s a lot of opportunity playing those markets though. “Investing” in the Chinese equity market is a sucker’s bet.

  4. I think almost all of the companies listed on the Chinese stock exchange are complete scams. Many of them are complete junk. I sent someone some companies listed on the exchange and told him they seemed like a total scam. He responds, “I think they’re all frauds.” This was about 6 months-1 year ago.

    I can only imagine someone that trades these markets daily. If you play your cards right, it’s the perfect opportunity to get rich. Especially in markets as rigged or as speculator driven as the Chinese markets, you can really set yourself up quite well. Unfortunately for the kids/guys without high school degrees borrowing massive amounts of money to buy stocks, I don’t think it’s gonna end well. To the seasoned veteran or the sharp guy able to gain convexity from these markets, it’s an opportunity.

  5. When the real estate bubble burst, the politburo tried to create a stock market bubble. Now that is bursting too, the communists in charge are running out of bubbles to blow. Now when the BIG ONE finally comes and the Chinese economy collapses, as it eventually must, the geo-political bubble surrounding China will collapse too and the nation will join USSR in the dustbin of history. We will be reminded once again that central planning by committees of “wise men” just don’t work in the long run. I guess the corrupt Communist party elite is getting their apartments in Sydney and Vancouver ready and keeping all those helicopters/private jets close by. They will come in handy when the end comes and it may come a lot sooner than what many people think.

  6. Suvy, I dont know if the housing bubble in either Canada or Auz will crash. Hard to see ppl defaulting on mortgages there without a really big rise in unemployment, which I dont see without a worldwide depression. The main adjustment is going to be through the currency, which is taking place already. Perhaps they will go to 50-6o cents on the dollar, like they were in the early 2000’s. I dunno.

    But the good thing for both those countries is 1) they are nice places to live 2) they are still cheaper than London/ NYC etc. Betting against property in a world of low rates, QE and too much money I dont think is a good idea.

    • Suvy, I dont know if the housing bubble in either Canada or Auz will crash. Hard to see ppl defaulting on mortgages there without a really big rise in unemployment, which I dont see without a worldwide depression.

      Well, I’m not sure there won’t be (isn’t) a depression, and I think you are ignoring the possibility of the central banks losing control over the yield curve (or contagion from counterparty loans to Austrian banks…)–perhaps justifiably, but I guess the assumption should probably be articulated. All that aside, though, all the money that is currently going into (sur)real-estate has to come from somewhere. Where is it coming from? Maybe I’ve completely misunderstood Michael’s blog over the last six months or so that I’ve been reading it, but one of the clearest lessons I’ve got from it is that excesses in one area (ie, overpriced Canadian and Australian real-estate) have to be balanced by dearths in something else, somewhere else. Michael in this blog entry pointed to Shanghai markets growing by 135% over the last year despite deteriorating fundmantals. Well, real-estate has also grown (although not quote that much) at a rate that greatly exceeds any income increases over the time.

      So far, the two arguments in favour of this continuing are “commodities” and “China”. Neither of these arguments seem to hold water at the present moment.

      The main adjustment is going to be through the currency, which is taking place already. Perhaps they will go to 50-6o cents on the dollar, like they were in the early 2000’s. I dunno.

      OK, but (I really, really hope I’m getting this correct, btw) presumably the dropping currencies will allow more exports. Who is going to import those increased exports? There aren’t a whole lot of booming countries right now that I know of, and the ones that I am aware of are far too small to absorb them (and too far away, likely).

      Incidentally, I have no idea how to determine how much a country can export before the importing countries “force” it to stop (via tarrifs or whatever), so maybe this can continue. However, when I hear people who can’t afford to make car payments talking about their brilliant recent house purchases (“I gotta do it before interest rates go up!”), I get a little skeptical…

      But the good thing for both those countries is 1) they are nice places to live 2) they are still cheaper than London/ NYC etc.

      One could have said the same thing about Greece (or Spain. Or Japan or the US once upon a time…Or…Well, you get the idea)

      Again, I’m not an economist, and I could be wrong on all this. I would be much more comfortable with your view if I had some set of data or logical arguments to point to continuing real-estate increases, though…

      • I think people are missing one side of the equation when people focus on “What is so and so country going to export?” or “Who are they going to sell more exports?” Don’t forget the import side of the equation. Eventually a weak Canadian Dollar or Australian Dollar will cut into imports and foreign travel. Suddenly, that family in suburban Toronto decides to visit Vancouver instead of San Francisco. Those shopping trips to New York don’t look so good. Granted Canada and Australia are not the most diversified producers, but their consumers will find domestic substitution and conservation wherever they can. Canadian consumers at some price point will just cutback on their consumption of certain foreign goods. An economic slowdown will just reinforce this decline in consumption.

        • Don’t forget the import side of the equation. Eventually a weak Canadian Dollar or Australian Dollar will cut into imports and foreign travel. Suddenly, that family in suburban Toronto decides to visit Vancouver instead of San Francisco. Those shopping trips to New York don’t look so good.

          OK, but under what conditions would such a cut in imports in either country translate into real-estate prices continuing to rise?

          • I don’t think anyone here thinks that Canadian or Australian real estate is a good investment right now. As someone here already mentioned though, it’s hard to predict a crash because of low interest rates supporting the market. I personally don’t know how elastic Canadian and Australian employment demand is. Employment levels seem to be currently holding up fairly well in both countries.

            Anyone who has seen a real estate crash up close and personal know it’s like watching a slow motion car crash. It can take 18-24 months to play out after the market has peaked. Houston set record home prices and sales volumes towards the end of 2014 after really not experiencing much pressure in the 2008-2009. With the crash in oil prices, you have some people say that home prices must drop here and some who say everything’s fine. My eye sees a slow build up in home inventory with sellers stubbornly trying to stay close to 2014 prices. I think sometime next year the sellers who need to sell will drop prices further and then the downward trend will be firmly established. We are still in the early stages here where sellers and realtors futiley try to hold the line against market forces.

          • biggestbrotherofthe mall

            Vancouver/Sydney real estate is a very good investment for those needing to get cash out of China, or Russia, or Burundi. The sheer quantity of this is part of rebalancing at the macro level but its hellish destabilizing at the local level. These cities will end up like London – full of empty houses owned by the mega rich. Prices dissassociated from local wages. As someone said these people are not hedgefund rich but gangster rich, tyrant rich, despot rich. Their ugly world is not controlled by the open market because they didnt make their money that way.

            So there will be a local rebalancing as there has been in the UK where the English leave London for second tier cities. A hollowing out as the center of the cities become real estate banks for illicit gains.

            That wont stop until every one signs up to the Hague and someone finances going after these people.

    • I think we’re in the middle of a worldwide depression that’s about to get worse. So yes, I do think you see a sharp rise in Australian unemployment and you will see stagflation-like effects in Australia due to its position as a heavy commodity exporter. Basically, you’ll see a falling currency, falling production, rising unemployment, and higher input costs in Australia and most other heavy commodity importers.

      • Yeah don’t get to convinced that Aus and Canada won’t slow more. People in Australia are quite convinced that we won’t have a recession. Because we haven’t had a recession since 1991 a lot do people believe, actually believe that Australia won’t have a recession ever again. People that graduated high school in the 90s and are between20-40 years old have never been in a recession in adult life and honestly think that the aud being at parity to the usd, all the purchasing power that comes with it and property prices doubling and tripling and the windfall of cash that the commodities boom brought is “normal”.

        Australia’s auto industry is vacating Oz in 2016/2017 with around 50,000 estimated jobs in Victoria gone because we lost competitiveness. We are decending the well documented capex cliff where energy/mining projects are declining 25% year on year. 2015/2016 capex is supposed to decline to near levels not seen since our last recession in 1991.

        And Canada, well we are all seeing that it looks like they are in a technical recession for Jan-June.
        These things often take time to play out. In the States property started to decline 06 but it wasn’t till 08 it capitulated. Australia and Canada have visible problems in 2015 but it may not be till 2017 (give or take) that they actually have a crises or semi crises.

  7. Dear Prof. Pettis,
    Thank again for sharing your insights into the workings of the Chinese stock market and its economy, in general.

    I am in the camp that the Chinese government has abandoned its so-called rebalancing (I will go as far to say it was ‘all talk and no action’).
    And sticking with actions, I believe they planned this equity bubble for a long time. They set in place the motion of creating an overseer of margin trading in 2010, the allowance of short-selling and the ability for individual to open up to 20 trading accounts.

    The main reason is the high level of debt at the corporate sector. According to Reuters, it has reached $16.1 trillion, or 160% of China’s GDP, which is twice the level of the U.S.
    S&P has estimated it could rise to $28.8 trillion by 2020.
    Recently, Anne Stevenson Yang has pointed out that the rise in the Chinese equity market is more to do with the government tapping in the equity market to raise cash because debt ratios, measured in all ratios have become too high.
    In my view, the government wants to tap into Chinese household savings to save its SOEs and to continue its ‘investment-driven’ model. The AIIB and one road one belt, both involves infrastructure of some kind.
    In order to do this the household sector is likely to be holding the debt while the SOEs will receive fresh capital (cash) by issuing new shares, IPOs (there have been 225 newly-listed companies, since 2014) and insiders selling shares to the market.
    NB. The free-float in the Chinese market is equal to 33% of GDP when the market peaked, whereas the average free-float in the developed market stood at 100% of GDP. So insider selling is a high probability.

    The mentioned of 21 brokerages being encourage to buy shares and not sell until it reaches 4,500 does act as a call option. However, Beijing can easily announce a new goal post and say 5,000, or 6,000 in an attempt to encourage speculative bets while the insiders secretly sell.

    P.S. I cringe ever so slightly when you mention ‘value’ in the Chinese market because I believe the reports on SOEs are state-subsidized through taxes. (LOL) And the Profits in the banking sector remains high despite property and commodities prices falling, as well as understating its NPL.

    Happy to hear your thoughts and thanks for your genuine insights.

  8. Dear Michael,

    “The market is wholly speculative.” What nonsense. When Western commentators who have never visited China indulge in such wild generalizations it is perhaps forgivable, but for someone who has worked in China this is a shame. So in this large and complex economy there are no good companies and no sensible, hard-working investors? Anyone who works in China is well aware of the risks and problems here, but to ignore the real progress being made, in state-owned industry reform and financial deregulation, is to play into the hands of the bears that dominate western press about China and have left Western institutions massively under-invested in China. You also write as though the Chinese government is unique in intervening in the asset markets – what about QE, Tarp, Twist etc? What about “all it takes” Draghi? A more nuanced approach might be helpful…

    Regards
    Chris

    • I think you’re being unfair. There’s no need to interpret Pettis’ comments as a condemnation of the whole country. The market is speculative at this time, just as the American market was speculative before the crash in ’29 , or perhaps during the dotcom bubble. It doesn’t mean there aren’t good companies or investors in any of these markets. But, if you want to deny that China’s markets are speculative right now, then let’s see your justification for its recent value.

      The intervention however, can’t be considered the same. Western governments don’t dictate how and when people invest in the same manner as China’s. Pettis explains why this intervention is unorthodox, not that intervention itself is unique.

      As an aside; do you see the irony in criticizing the ‘wild generalizations’ about China by criticizing ‘Western commentators’?

    • There are two links to an earlier blog entry that defines speculative investment, Chris Ruffle, and I am not sure why you decided not to read the definition if you don’t understand how financial markets work. On the assumption that your statements are really questions, let me explain. A fundamental market is one in which investors allocate capital by discounting at an appropriate discount rate the long term cashflows they expect the business to generate. Fundamental investors try to purchase economic value, but in many markets there are no, or very few, fundamental investors, usually because, among other things, the market lacks good and reliable economic and accounting data, the corporate governance structure is non-transparent, and regulators and local and central governments constantly intervene for reasons that cannot be described as economic. These markets tend to become dominated by speculative traders, who trade over the short term for technical reasons, usually on the basis of expected changes in short-term supply and demand factors.

      In the twelve months before the crash, Shangahi soared by 135% even as the economy slowed sharply, corporate profits dropped, cashflow profits dropped even more and are often negative, and NPLs rose dramatically. On the other hand local government-backed newspapers wrote articles implying that the government supported rising markets, and that buying shares was patriotic, and these were widely interpreted as pure signalling. What is more, during this time the availability of margin exploded. Most investors who I spoke to made it very clear that they believed the market to be in a bubble, but that they thought government signalling indicated it sill had legs. As soon as the break came, it quickly turned into a total rout that required enormous efforts by the government to stabilize. Can you explain why the events of last year, and especially of the last month, convince you that the Chinese markets are not speculative? It seems to have had the opposite effect on every one else, and any Chinese investors who were not already convinced now seem firmly convinced that Chinese markets are highly speculative. Where are they wrong? In which sector do you think buying and selling responded mainly to changes in fundamentals?

      By the way you also say that I write “as though the Chinese government is unique in intervening in the asset markets”. Can you explain exactly which part of my essay gave you that idea? I did refer to “unorthodox” measures, such as large scale prohibitions on selling, police investigations into sellers, the suspension of roughly 50% of all the companies on the exchange, and if this is what you mean by my suggesting that these are unique forms of intervention, can you tell me in what major markets, or even minor markets, the regulators commonly use these techniques of intervention? Your saying that I write “as though the Chinese government is unique in intervening in the asset markets” strikes me as totally nonsensical, but I’d be happy to be corrected.

      • In the twelve months before the crash, Shangahi soared by 135% even as the economy slowed sharply, corporate profits dropped, cashflow profits dropped even more and are often negative, and NPLs rose dramatically.

        Perhaps Shanghai was more than 75% undervalued 12 months ago, and value investors have just now recognized the easy money to be had going forward?

        (I’m kidding…Although I do wonder why this drop hasn’t really spread to other countries to the same extent if the wealthy were able to transfer much of their wealth to Hong Kong, Singpaore, Australia, etc–presumably they would need at least some of it back at some point?)

      • hehe!

        I think i read somewhere, (not sure where) about a weird historical example – i think it was Pakistan and I think the article was in the FT, but it talked about the more unhealthy longer term effects of some extraordinary measures (which the article identified as being less extreme than the Chinese measures recently brought in). Professor Pettis, do you have any perspective on the Pakistan experience? I always enjoy reading when you draw on historical comparisons!

    • biggestbrotherofthe mall

      Chris, Nonsense!? No idea should be censored but if people are frankly rude they should be!

  9. The focus always is on the policy response to the panic, which invariably involves various forms of government put protection. This is the dominant economic dogma which passes for the lessons learned from the Great Depression. It is on display wherever you look: Fed put, BoJ put, ECB put, BoE put, Riskbank put, Swiss National Bank put, RBA put, Bank of Canada put, now PBoC put and many more.

    The focus never is on the prevention of the unsustainable asset bubbles, which are invariably encouraged by policymakers and invariably result in said panics, by identifying and dealing with their primary causes.

    You end up in this totally surreal discussion about the credibility of pyromaniac firefighters.

  10. Chris Ruffle: “So in this large and complex economy there are no good companies and no sensible, hard-working investors? ” I re-read this post very carefully and no where did I find Michael asserting that “there are no good companies” in China; nor did I find him asserting that all Chinese investors are witless and lazy. Is your comment “nuanced?” Perhaps you could explain this: why between 2003-2006, with gdp growing >10% the “stock market” in China FELL steadily for 3 years?

  11. Prof. Pettish,

    There are some similarities about your balance-sheet thoughts and what Soros talked about. Therefore, I’d like to ask for you opinion on what he said “When I see a bubble forming I rush in to buy, adding fuel to the fire.That is not irrational.”.

    • I am not sure there is too much to say about a very short snippet, but Soros often talks about looking for reflexive processes, when the balance-sheet structure of the market can force it into moving one way or another, and then betting in the direction implied. For those who think in terms of systems and have an intuitive feel for balance sheet structures, this can be a very profitable strategy. People often discuss the market as if it depended on changes in investor psychology, but I have always been more impressed by the mechanical nature of much balance sheet performance. I suspect Soros at least partly agrees, and if he does, I interpret him to mean here that when balance sheets seem to be lined up in one way or the other, he tries to take advantage

      • Actually his theory and yours are quite the same. In one book of about financial crisis in US/EU he says that you need an hair cut, structural reform and growth oriented bonds. He says that the in one northern EU country mortgage market didn’t collapse since 70 at least. Because creditors and sellers have aligned interests.

        Prof do you know a book where i can find strong mathematical materials about reinforcing processes?

        • In the early 1990s I know that I went through a number of books and articles on the mathematics of feedback processes, Cedric, but my memory has never been very good and I cannot remember titles. You might want to do searches on words like “reflexivity”, “feedback”, and “pro-cyclical” and see what you get. One suggestion however: if you are interested in this topic mainly because you want to improve your understanding of finance and economics, you probably should focus on trying to understand as intuitively as possible the basic mathematics of how these things work, and not worry too much about taking the mathematics too far. Usually, as these feedback processes occur in the real world, we simply don’t have data with high enough levels of precision for us to do very sophisticated modelling and, more importantly, the ways these processes occur can be so complex and with so many moving parts that it is hard enough just to see all the relevant mechanisms, let alone model them accurately. But once you get the basic intuition of how feedback mechanisms work, both positive feedback in which volatility is exacerbated and negative feedback in which it is muted, you will start to see them everywhere.

          My second suggestion is on how you incorporate them into your thinking. We know that increasing or reducing volatility affects value, partly because we value stability, of course, but also because there are “breaking points” at which the changes in value are discontinuous. To put it in a less abstract example, if I have assets and debt, and the value of one or both sides of my balance sheet is volatile, the range of outcomes when my assets are worth more than my liabilities might be very different from the range of outcomes when my assets are worth less than my liabilities. As you know almost any time there is a sharp discontinuity, which I call “a kink in the payout curve” in my classes, you can probably find one or more implied options buried in there. This means that you can model the impact of volatility on changes in value by using basic option theory, although once again these are complex “options” with many moving parts (and usually with no specified expiry date) and so there is little additional value in applying option theory much beyond the basics.

          If you train yourself to identify feedback mechanisms and implied options, I promise you will find them everywhere, and they will, I think, profoundly improve your ability to understand the economy as a system. Because so few economists seem to think this way, it will be to your great advantage if you do and you can find yourself making predictions that seem crazy to most people but almost inevitable to you. But the key, and this is probably true much more widely, is to get a deep and intuitive understanding of the basics (feedback loops, options, and probability theory) and not worry too much about knowing the advanced stuff. This may seem like a strange thing to say, but it is much, much easier to find people who understand the advanced stuff than it is to find people who understand the basic stuff intuitively.

          • You will find the research / contributions by Didier Sornette ( physics, geophysics, complex systems ) very interesting.

            He studied rocket fuel tank failure’s, earth quake forecasting before modeling financial crisis using his knowledge and predicted many financial meltdowns beforehand.

            But a large part is the herd effect and viewing some of his charts he uploaded in white papers / video’s show the volatility spikes within the chart if viewed from afar near the crisis point. Looking at it in a complex way is needed as many drivers converge at once and only one small issue can trigger a massive failure.

        • biggestbrotherofthe mall

          Cedric: Control Theory

          • I do know control theory. But i think it’s not really the good one. If it was the one all investor would know it, because it’s an old theory.
            If you take the fact that investor should have different scenario for the same asset, clearly it doesn’t exist in control theory where you study feed back loop between fixed objects.
            But more than that this theory is made for energy like variables. An energy in physics is a things that you cannot create or destroy. And with fixed quantity even if its shape change. The only one I know in economics is current account(total current account equal zero). Doesn’t make much sens to have a control theory on non energetic variable because, these are the only one to follow a pattern cause consequences. If you have a current account surplus somewhere you have current account deficit somewhere else.
            BUT in a bubble people only buy for speculative reasons. This mean you cannot find reason of buying outside the bubble itself. To me it’s the main reason you can’t really know when market should crash

            If you have successful examples which work with control theory i would be very interested to know them.

  12. Professor Pettis,

    I want to thank you for your generous coverage on this topic for the public to view. It’s a delight to read as the depth of your knowledge is truly invaluable in understanding the global economic situation!

    George Soros recently wrote an article in which I am sure you are aware of with regards to China and USA needing to partner with one another in world to avoid world war.

    To my understanding from reading your work, the world has a lot to gain by accepting China into their international financial system albeit at a slow and controlled pace. Of course, China’s reforms go hand in hand with international integration as their current institutional structures will not be conducive to successful reforms and the help of international capital markets will greatly help facilitate those much needed reforms.

    Therefore, would I be correct to assume that Xi Jinping must redistribute much of the power he has gained directly or indirectly to international institutions as a part of this reform process? Hence, why Soros suggested that this was a vital time to foster trust and understanding and to compromise with certain of China’s demands if it means that China will allow itself to integrate more deeply into the international framework and rule of law?

    If Xi does not redistribute the power he has accumulated, particularly in the financial sector, it seems that meaningful reforms will be almost impossible. It seems that if China want’s to have an open capital account through joining the SDR basket and slowly opening up, that would almost inevitably lead to volatility and instability for the Chinese economy, yet it would benefit China over the long run because of the financial reforms that would follow. This would require enormous cooperation between China and the U.S. if it were to succeed.

    I think this situation can also go badly in which China closes itself up to the world and we miss this opportunity to integrate the Chinese economy into the global framework. I believe Anne Stevenson-Yang’s book goes into this scenario but I’ve yet to purchase her book as there is no physical version. I have read your review on Amazon though and plan to purchase the digital version sometime soon.

    Military conflict and social conflict will of course prevent the redistribution of Xi’s centralized power so the world is really at a vital juncture. Are you optimistic on these reforms taking place? I suppose this is too big of a question to answer right now and we may just have to wait to see.

    One last question though. Will the real estate bubble pop regardless of whether or not reforms take place?

  13. Prof. Pettis,
    What will be the impact to the rest of the world from the various Chinese problems you mention — market/financial volatility, slowing reforms, debt accumulation and slowing growth? Could we get a weakening Chinese currency as a method of borrowing growth from abroad? Especially if there is a shortfall in the “credibility” asset.
    Thank you,
    Krishnan

    • Could we get a weakening Chinese currency as a method of borrowing growth from abroad?

      Why would other large countries allow China to continuously run ever-larger trade surpluses given the current state of most of their own economies? Also, how would this help in the long run if it just increases the internal imbalance (capacity is not the problem, I don’t think…)?

  14. Prof. Pettis, thanks much for this trenchant analysis. I’ve long been a fan of your thoughts on China — they are always rational and well-considered. Warm regards.

  15. China also has a lot of professionals who have trained at the leading U.S. and UK universities and financial institutions, and they are more than qualified to understand credit risk and portfolio techniques”
    Could it be that you are being a tad too modest, Michael? So if they did not train in the U.S. and U.K. they would not understand credit risk?
    Very interesting.
    What about studying economics in Peking University today? Would it work for them?

  16. Dr. Pettis,

    I’m no economist, but it seems you outlined the business cycle pretty clearly towards the end of your post. Thanks for that.

    Thinking about your words, I think there are two things we need to get a better understanding of:

    1. In the short term, what poicies should a country such as China, being at the edge of the boom –> bust cycle, do to minimize damage and level off at the ‘natural’ economic level so they can proceed on a more stable path.
    2. For the long term, I would very much like to hear your thoughts on how countries could design policies that create ‘just right’ growth levels that provide stable levels of sustainable growth. I.e. how to determine what the natural level of economic activity, what is too much / little, and what policies would contribute to counter highly cyclical growth.

    I know this sounds a bit like central planning, and I’m not condoning that. Just what would help countries minimize pain and maximize their growth in a way that is sustainable.

    Or perhaps is attempting to banish the business cycle not advisable?

    I’m really sad you apparently took me off of your mailing list, but I still enjoy and get a lot out of reading your blog. Please keep it up.

    • I am not sure you can design “just right” growth. Perhaps you can in principle design a system of incentives such that businesses and individuals are more likely to take advantage of existing resources in the most productive way, and this must include financing mechanisms and property rights that maximize the social value of intellectual and physical property while at the same time maximizing incentives to create more productive intellectual and physical property. Some people argue that this means effectively creating the ideal Adam-Smith economy of an infinite number of competitive agents who are free to innovate, none of whom, including the government, are important enough to create institutional distortions. But you quickly realize that these are mutually contradictory goals: Eliminate all institutional distortions and you eliminate the ability to enforce property rights, and while this might increase the value of the some or most of the existing stock of assets, it would also probably reduce the future value of assets by, among other things, reducing innovation and investment aimed at improving capital stock. Eliminate all institutional distortions and you also eliminate rules that prevent businesses from lying or otherwise taking advantage of credibility generated by someone else, and if you reply that requiring total transparency might solve this problem, then you need an agent powerful enough to enforce transparency. Eliminate all institutional distortions and you make it impossible, or at least much harder, to protect commonwealth assets or to invest in projects that create externalities that are greater than the ability to capture those externalities — for example it is hard to capture the full social value of creating a first-rate primary education system, or enforcing an optimal pricing structure in any industry with returns to scale.

      But once you agree that certain institutional distortions are good for long term value creation then you face the problem that the economy is a dynamic system with strong learning capacity, so that even if you could design the optimal set of institutional distortions, it would almost immediately become sub-optimal as the economy adapted and developed. This brings us back to Minsky when we think of the financial sector. The optimal financial sector must allow for enough value destruction to impose discipline, but not too much, and as the economy evolves from the agricultural economy of mid-19th-century California or the industrial economy of mid-19th Century New York to the information economy of early 21st century California or the creative/design economy of early 21st Century New York, is it even conceivable that the financial system that created the optimal amount of value destruction for the former will also create the optimal amount for the latter?

      I will not even pretend that I know the answer, but remember that while there are clearly advantages to economic stability, and we know the many ways in which economic and financial instability can be extremely damaging to wealth creation, on the other hand in the past two centuries the periods of greatest technological innovation were almost always also periods of financial excess, asset bubbles, and foolish capital misallocation, and there is some evidence that from the Renaissance onwards, the fastest growing countries and regions in Europe and North America were never those that enjoyed the most stable financial sectors or even the most stable currency systems, but were in fact countries or regions that were relatively poorly served by their financial and monetary systems (for example few have been able to explain why the US was the most astonishingly productive country in a period of great economic advances for Europe and North America even though the US probably had the most unstable financial sector of any major rich country and a currency system that barely functioned to maintain the value of savings, and this outperforming economy and under-performing financial and monetary system held even against British colonies that were similarly endowed socially, legally, culturally, and physically, like Canada and Australia).

  17. Hi Michael,

    That was a great article, best one this year for me! Exerts from your newsletter services were great, very informative during the Chinese stock crash- maybe I should subscribe..

    So it sounds like you believe this Chinese rebalancing, then support, then rebalance, then support again could continue for the next few years as they move toward total rebalancing in a zig zag method.

    If they do stabilise the stock market, bring back confidence, bring in another flock of speculators who take stocks on another run though 2016 could that eventual collapse have a larger impact than the one we just experienced?

    Laurent

    • It is likely, Laurent, but not necessary (and thanks for the kind words). It depends on what the regulators do as investors return to the market and on how their actions might stabilize or further destabilize the financial system. Hyman Minsky argued that regulating markets in order to protect the financial system from disruption could actually increase instability in the longer term. If economic agents believe that the regulators will absorb certain types of risks, they are increasingly likely to mismatch assets and liabilities in such a way so as to take advantage of this implied protection, and this will increase the overall riskiness of the system to the point where regulators might no longer be able to manage it. For example by providing sufficient liquidity to institutions during a crisis and effectively making a credible commitment to continue doing so, regulators are also encouraging financial institutions to ignore liquidity risk and eventually to drive liquidity premiums to zero, which means that the financial sector will be far more willing than otherwise to take on illiquid assets and fund them with risky short-term money. That was the insight Minsky expressed in his famous claim that stability is itself destabilizing. By the way Perry Mehrling’s book on central banking argues that one of the main causes of the 2008 crisis was a series of regulatory steps that seemed to imply that in efficient financial markets the liquidity premium is correctly zero. .

      I think Minsky is absolutely correct, but I don’t think most regulators understand why, or perhaps if they do, they themselves have incentives that make them willing to reduce volatility and risk in the short term even if it increases instability in the longer term. If the regulators respond to the crisis by trying to impose stability, they may just make the ultimate crisis more disruptive if Chinese banks “innovate” around the new regulations or implied protection by taking on riskier positions. If, however, the regulators respond by imposing counter-cyclical mechanisms, and especially if these mechanisms kick in on the way up, and not just on the way down, Chinese stock markets will behave less disruptively to the real economy.

      • Hi Michael,

        Yes, so true. Minsky was right, and this seems to be the way it works these days. Apart from the occasional exception such as Icelands reaction to the GFC or Scandanavia in the 1990s this seems to be the norm. Like you say, they have incentives that make them avoid the short term pain..

        I do feel that central bankers/treasurers are too close to the politicians. With central bankers having the added pressure of targeting unemployment and if the economy or markets start to sour I think the emails/phone calls and meetings must be savage not to mention the public and media blowing up situations. Maybe they know in the long run they shouldn’t tamper but they are incentivised and are probably scared themselves.

      • biggestbrotherofthe mall

        Thats why dogma condemning either unfettered capitalism or any form of centrally planning is unhelpful. In the ideal world both open markets and planning would dynamically seeking the perfect balance. Hard in practice but at least its a goal. The tricky part for China is to be moving away from central planning while on the way trying to find a balance.

  18. Thanks Prof Pettis for more insight into China. Stepping back from the panic in the stock market however, i am curious on your thoughts on the size of an ideal stock market for a country. Equity financing provides a stabler form of financing for companies (non-inverted liabilities on balance sheets)
    In the usa, stock market is ~125% of GDP, and venture capital, convertible bonds provide the bulk of financing for commerical enterprises.
    in euroland, the banks provide over 70% of financing through traditional loans, and stock market capitialization is about 60% of gdp.
    Corrupt russia has a stock market with about 30% of GDP.

    now China has just surpassed 100% stock market capitalization- $10 trillion before settling back in the panic.

    Rather than thinking of the stock market as a casino as described in the comments, what if we view the stock market as a healthy way for companies to raise capital and engage in risk taking commericial activities (some people forget that business is risky), then a large stock market should be a development goal for healthy and dynamic economic activity.

    Imagine a country with a stock market at 500-1000% of GDP. and less corporate borrowing by bonds, and bank loans. Maybe China could lead the world forward by enhancing it stock markets- and somehow recycling its enormous debt pile of loans and bonds into equity. foreign investors seem to have an insatiable appetitite for chinese companies- they should sell the debt liabilities to them, and lower the leverage, if not the nominal value of the debt.

  19. Dear Michael Pettis,

    In your July 9 message “Why do financial crisis happen?” inserted in this article, you identify the causes of the current stock market panic as the combination of significant asset and liability mismatches and rising uncertainty about debt servicing capacity. “Financial crisis are analogous to bank runs” indeed, in that financing long-term investments with short-term money – whether term loans with on-sight deposits or equities with on-demand margin debt – is fundamentally an illiquid and unstable asset – liability structure.

    As currently set-up, the fractional reserve credit system transforming short-term cash balances into longer-term assets is intrinsically illiquid and unstable and must by necessity be backstopped by the Government. Not only in China where “much of the mismatch between assets and liabilities are resolved on a system-wide basis through Beijing’s implicit or explicit guarantee of most components of the country’s financial system” but in fact everywhere. With the undesirable consequences in terms of moral hazard, malinvestments and distortions in wealth and income distribution.

    Hence the question: is it possible and, more importantly, is it desirable to design a monetary, credit and financial system that minimizes the asset – liability mismatch of the overall balance sheet of the economy? If yes, how would this new system look like?

    In the last paragraph of your answer to Dave G above, you seem to suggest that technological innovation is stimulated and the pace of real productivity growth is enhanced by an unstable and speculative monetary and financial system. To me, the pro-cyclical creation and destruction of short-term money by the margin-based credit system to fund real long-term investments certainly makes economic growth more volatile but it is not obvious that it makes real productivity growth faster across the cycle than if it were fully funded by genuine term savings (assuming the incentive structure, ie. the reward for successful investments, is unchanged). Indeed, it’s not clear to me what incentives to innovate and take risks would be lost and what financing would be missing if the balance sheet structure of the economy was less “inverted”? In fact, your above answer to Dave G seems to some extent contradictory with your “Inverted balance sheets and doubling the financial bet” article where you wrote: “When debt levels are low or when the liability structure of an economic entity is stable, then it is indeed the case that growth is largely an asset-side affair” (ie. a more productive use of assets drives growth). “But when debt levels are high enough to affect credibility, or when liabilities are structured in ways that magnify exogenous shocks, growth can be as much a consequence of changes in the liability side of an economy as it is of changes in the asset side. At the extreme, for example when a company or a country has a debt burden that might be considered “crisis level”, almost all growth, or lack of growth, is a consequence of changes in the liability structure”. And while you say “there is some evidence that, from the Renaissance onwards, the fastest growing countries and regions in Europe and North America were never those that enjoyed the most stable financial sectors”, you also write in the “Inverted balance sheets” article “that both orthodox economic theory and government policy-making ignore the way liability structure can overwhelm the impact of asset-side management is surprising given how strong the historical confirmation”.

    So, this question of whether or not it is desirable to design a more stable monetary and financial system to minimize the asset and liability mismatch of the overall balance sheet of the economy does not seem properly settled. The question is in fact very rarely raised even. Yet, it seems to me that this is a rather crucial question facing not only China but in fact most countries at this stage. It could therefore be helpful to clarify the thinking here. Notwithstanding the lengths to which the Chinese intervention went, the various shapes and forms of Government put protection everywhere, their varying degrees of credibility and whether the rock is harder or not than the hard place are already abundantly discussed in a daily deluge of commentaries, so it is a bit tired as a topic anyway.

    Thank you

    • It is a question that we don’t ask often enough, DvD, but we should wonder just how much stability is optimal. Clearly either extreme is undesirable. Too much stability means that too little risk-taking is happening, and as long as there is no perfect foresight a perfectly stable financial system can only be one in an economy in which there is no growth and no innovation. An extremely unstable and chaotic financial system is also likely to mean an economy with no growth. There is consequently a kind of Laffer curve in which value creation is maximized at some point between totally stable and totally unstable. Not all instability is equal, of course. I suspect that systems that effectively subsidize risk takers and producers at the expense of savers is positive for wealth creation as long as the implicit subsidy is not so great that it sharply discourages savings or that it encourages users of capital to invest in projects that are value destroying. I am sure this can be modelled and mined for insights into what an optimal financial system might include, and perhaps someone has already done it, but it is a mistake to think that stability in the financial system is an absolute good, and the more you have the better off you are.

      • Thank you.

        It all depends what we mean by “risk-taking”.

        If by “risk-taking” we mean savers taking credit or equity risk by lending to or financing entrepreneurs or companies taking business risks that will play out over a certain period of time, then we agree that the credit and financial system should accommodate such risky transactions.

        If by “risk-taking” we mean taking short-term cash balances to lend on a long-term basis or provide equity financing to the exact same counterparties and projects as above but earn an extra interest spread for the maturity mismatch or an extra return on equity for the leverage and duration risks, then that’s much more debatable.

        Again, it is not clear to me how reducing the asset – liability mismatch of the credit and financial system by reducing the confusion between on-sight cash balances (money) and term savings would reduce in any way the incentives to innovate and take business risks and / or the amount of financing available for such purposes.

        Qualitatively, such financing would still carry credit or equity risk as the case may be depending on the outcomes of the underlying ventures.

        As for some level of subsidizing risk takers and producers at the expense of savers being desirable for wealth creation, it again depends what we mean by “savers”. If by “savers” we mean agents hoarding cash balances, then i agree. If by “savers” we mean agents taking term credit risk or equity risk on economic projects, then i disagree for these agents are themselves risk takers effectively participating in the producers ventures. What it boils down to is not to give incentives to cash hoarding versus productive deployment of savings involving risk-taking. This can be achieved without the credit and financial system having to run any asset – liability mismatch, for instance by not remunerating cash balances in the presence of a bit of inflation (see below), ie. by steadily depreciating the value of cash balances over time. Such cash would be entirely covered by base money and will only be for transactions purposes, not for interest-earning lending purposes which would be done separately from term savings on a matched duration basis.

        Quantitatively, a frequent argument is that the overall volume of credit and equity financing might not be sufficient and might therefore constrain economic growth if the financial system is restricted in its capacity to create purchasing power ex-nihilo (which might be desirable to make the system more stable by reducing the erratic swings of money creation and destruction resulting in a succession of economic expansions and contractions). For instance, in the 2014 annual report of Credit Suisse, you can read “if both sets of [capital] requirements are overly restrictive, it will curtail global economic growth…” (p.6). It could very well be the case that a bit of monetary inflation is beneficial for productivity growth in case of downward rigidities in overall price and wage levels and / or because deflation provides an incentive for unproductive cash hoarding. Say the +2% annual CPI inflation target of most central banks indeed corresponds to this optimum. Together with annual productivity growth of say +2% and population growth of say +1%, it means a target money supply growth of +5%, which can always be fined tuned if need be. How does a steady pace of +5% annual money expansion result in less innovation and less growth overtime than an unsteady pace of say +10% annual money creation during the expansion phase of the cycle followed by -2% annual money destruction during the contraction phase of the cycle, equivalent to the same +5% p.a. across the cycle? Not clear to me. Such system will of course remain dynamic, hence fluctuating: velocity of money and the desired level of cash balances will keep changing based on shifts in psychology even with steady money supply growth ; there will still be burst of optimism and waves of pessimism ; new technologies, products and services will keep emerging and old technologies, products and services will keep falling into obsolescence ; there will still be winners and losers in every markets ; there will still be kids in their parents garage inventing the future ; some markets will still be tightly supplied and prices will rise faster than average while other markets will still be abundantly supplied and prices will rise slower than average or even decline ; weather patterns will still influence agricultural output ; some companies will still be well managed and thrive while others will make mistakes and go bust ; some people will still save little while others will save more ; the stock market will keep fluctuating ; there will still be successful IPOs and accounting shenanigans ; some people will still be hired and some people will still be made redundant ; there will still be things that are in fashion and others neglected ; etc. In other words, it will still be a lively and risky world out there. A small excess of money creation will still be there to facilitate downward adjustments. But, the financial system will still be far from risk-free, even more so as these Government put protections will be removed as no longer necessary. Only the extent of economic fluctuations will be less than the sharp boom-bust patterns induced by the credit system as currently set-up. Could this be a net negative for productivity growth? Not clear to me.

        The contrast between the ever more widespread and intense efforts to backstop the system by extending Government put protection to more and more components (bank deposits, credit markets, now equity markets) and the apparent lack of efforts to think about a possibly better system is at least noticeable. After all, the conclusion that the current system is as close as possible to optimal stability as per your Laffer curve analogy is not well established and might even seem a bit far-fetched in light of the on-going developments of the past 7 years. Perhaps a lack of risk-taking and innovation from policymakers? Or too much subsidies to connected parties at the expense of genuine risk takers and producers?

  20. Michael,

    Thank you for another thoughtful read. I have come to truly enjoy reading your blog. Two things add great value for me: Your responses, often dry and merciless, to trolls and your recommending reading. The past few blogs have linked both blogs – I wish I would have known about the Enlightened Economist sooner- and books.

    I have three questions.

    Is your humor always dry and why has your writing recently changed to reflect it? For example, on your April 11th post, you wrote about “much-hyped initiatives aimed at transforming the global trading regime but that now languish in obscurity, known primarily for absorbing university graduates from very prestigious schools who have failed their other job interviews.” Your blog has recently been good for a chuckle.

    Do you prefer to eat rice or noodle dishes?

    Do you prefer, in China, bars that serve beer or cocktails?

    Again, because it’s worth restating, I am enjoying the blog. Thanks for the insightful reading.

    Pierce Norton

    • Thanks, Pierce.
      a) I have always included what I thought were jokes, but they usually fail to get noticed.
      b) It depends on the dish.
      c) I don’t think I have ever been to a bar that serves only one or the other.

  21. And then they say China and US are two different countries, while in fact, they are both doing the same. In China, the Communist Politbyro is underpining the market, in US it´s the FED. FED is the american Central Planning Committee these days. The only question remaining to answer is which bubble burst first. But maybe they will burst simultaneously. We are about to find out soon, I would say.

  22. Great article Michael. I found your thoughts on the structure of the Chinese stock market fascinating (all momentum traders and no fundamental investors) as markets only started to make sense to me when I started thinking about the positive and negative feedback mechanisms.

    One question arose in my mind after reading it – it seemed to me that the initial impulse to the Chinese stock markets was the “Shanghai Through Train”, the connection of the Hong Kong and Shanghai stock exchanges. Had I been cleverer I would have seen this coming as it seems to me a classic bit of rent seeking behaviour around new infrastructure, in exactly the same way a new motorway stimulates the two cities it connects. Obviously, the initial impulse creates price momentum which attracts speculators in a runaway positive feedback mechanism. Is this nonsense on my part, or am I fumbling about looking in the right places?

  23. What about the NPL’s always rolled over with longer term financing since the asian flu crisis till today ? What about the longer term issues of deflation in the consumer driven model because of technology wiping out job’s / ie: facing developed nations projected forward into China’s transition into this space ? What about the ” pro-cyclical trap ” that was talked about in 2009 that was never addressed with a ” one off ” revaluation and now we sit 6 years latter and trillions added onto this issue ….. ?

    And Michael I would argue the exact opposite has taken place. A almost short-term 5 year plan of transitioning from a massive export driven manufacturing economy is now reverting back into priming the pump with more credit AFTER telling the entire population / world you would avoid the mistakes of history by others before it regarding over capacity and consumer driven economics.

    This stock market bubble bursting in all it’s off balance sheet driven glory with interest driven loans, hidden hand assumptions, trillions vanishing as GDP lost upwards of 10% because of this ” intervention ” ( that’s cost duration is still open-ended. As the economy slows, commodity super cycle implosion lurches forward, over capacity issues draw global nation into trade wars ie: closing off markets as Donald Trump has already started pounding this war drum meme very early in his run as this issue will surly gain traction in the next few years as every nation needs internal job growth. The hot money outflows covered by Michael and Victor Shin in the past clearly show how fast and unrelenting it can become in short order as history in many nations have proven money flows ALWAYS happen as the confidence is lost in expected return on said funds or said confidence being exposed as the water receding lays bare the classic naked emperor.

    So what is the foundation of this ” confidence ” in the PBoC made of ? As the global deflation in a securitization bubble that started in ernest starting in the early 90’s ( lifting all boats ie: bloated asset prices / manufacturing expectations ) IMO we are still in the very early innings in a debt hurricane as the last 7 years have been the calm center induced only because of more debt / cramming down of interest rates keeping the back wall of said hurricane ripping everything apart not moored down by sound debt financing and finding these moorings at a personal, city, state, sovereign level are very few and far between.

    So I just can’t see how the smart money or the joe-six within China can still muster this confidence as the next 5 year plan is tossed into the dustbin at the slightest hint of trouble. The tried and true debt issuance card is pulled as the diminishing returns of said issuance at these nose bleeds levels of debt / GDP ratio’s have played out time and time again throughout history, revisited in white papers ect …….

    This time can’t be different as said foundation is made of sand and sand alone. Once the top 1% start the hot money outflows ( 4 trillion + ) me thinky problems unfold at a pace not imagined, anticipated and the blow-back within the mainland will be swift and truly spectacular with it’s longer term implications.

    • supposedly xi’s anti-corruption drive is furiously clawing back money that corrupt officials have laundered overseas. It’s clawing back trillions from off-shore heavens.

    • China’s intelligence agency keeps tab on all the 1%ers, so they cant escape easily.

  24. How much pounding can the GDP take with more debt issuance / obligations as the drawdown on treasuries has already started in a big way ? As Michael pointed out many moons ago, around 2 trillion of these treasuries cover the large money center banks regarding share’s.

    We are seeing in realtime issues Michael talked about in 2009-2010 play out and we are at historic debt / credit levels never seen by another economy in history.

  25. Australian professor Steve Keen (now working in London) has a truly excellent presentation in which he compares – among more debt related topics – credit growth in several countries (Britain, Japan and China).
    – Turns out that british & japanese credit growth in the 2nd half of the 1980s was about equal.
    – Chinese credit growth after 2009 even exceded japanese credit growth in the 1980s.

    http://www.debtdeflation.com/blogs/2015/07/09/will-we-crash-again-ftalphaville-presentation/
    (the presentation can be downloaded as well).

    • British credit growth is weird because London is a worldwide financial center. When shit hits the fan, you see massive capital inflows and foreigners will accumulate British assets. We need to be careful on the British numbers; there are too many idiosyncrasies to use direct comparisons. I’m not saying it’s not an issue, but we need to be careful.

      • – The ratio Debt-to-GDP is in the UK higher than here in the US.
        – British mortgages are financed by short term interest rates and those short term rates came down in the early 1990s. They almost went down by some 30 to 50%. That with favourable british demographics and companies that weren’t leveraged that much saved the UK from a Japan style economic disaster in the early 1990s.
        – A german company can ask for help to get financing from a London based firm. But the official creditor can be an irish subsidiary of that german company, and then the loan/bonds can be quoted on a exchange in e.g. Luxembourg.
        So, London, as a financial center is a red herring when it comes to british credit growth.

        – In the 2nd half of the 1980s japanese economic growth was at 6%. And companies were financially prepared (think debts) for that to continue well into the 1990s. But a worldwide recession and japanese economic growth in the 1990s of only 1% destroyed the profitability of those japanese companies.

    • biggestbrotherofthe mall

      Great presentation by Steve Keen. A lot to ingest and digest there. Certainly makes sense to look at three not 2 dimensions and dynamic not static. And Krugman did miss the last crisis completely even when us mortals were getting 4 credit card applications sent to us every week and offers of free money and mortgages.

    • – There’re A LOT OF other more videos available with Steve Keen (e.g. on YouTube). In all videos he expresses the same ideas.
      – A LOT OF people (incl. Steve Keen ??) overlook the fact that workers received in the 1960s & 1970s wage increases at or above inflation. From the early 1980s onwards workers/employees received wage increases below inflation. That’s – IMO – the reason why there was a “Great Moderation” (Bernanke et al.

  26. Corporate profits are crashing :
    Rate cuts are for the financial system / Debt holders as cuts not being passed on from the banks :
    Asian imports into China are crashing :
    Commodities crashing / Vale cutting output 30 -40 % ect :
    Total social financial market index within China down 27% Year over Year :

    Real GDP ? It’s not 7% : The only possibility ahead is a yuan / renminbi devaluation and the ” smart money ” / top 1% understand this. Hot money outflows / Dead Ahead –

  27. China’s market just crashed another 8.5 %

    The red lights are flashing code red within China. The epicenter of this meltdown will be the financial complex now reeling with trillions spent propping up the market as the PBoC has also flooded the banking complex with fresh capital. China’s factory gage / index just crashed now at 15 month lows.

    China is funneling hundreds of billions of dollars / trillion yuan into it’s interbank lending markets. Never forget the ” zombie ” companies chewing up capital with no return what so ever, destroying future growth potential. In 2011, Victor Shih uncovered the facts the local government financing vehicle’s ( LGFV ) debt was upwards of 20.1 trillion yuan 50% of GDP in 2010. If you step back and analyze the ” big picture ” with the equity market unexpectedly requiring 10 – 15% of GDP intervention. The PBoC has for the most part purchased the market ( nationalized ) it with over 40 interventions within a 5 week period.

    IMO you have complete panic from the top down as the Politburo has lost total control. The hard landing has come the only question is how much longer they can hide the truth before they are overwhelmed with hot money outflows. The truth can be hidden for only a short time as the perfect storm has washed ashore. The rocket ship ride of the US Dollar ( it is only getting started ) in conjunction with hot money / capital outflows will trigger massive volatility across all of China. A confluence of events have forced all this upon the PBoC as global events turned against them all at once.

    The red light’s are flashing, the warning sirens are wailing it is only a matter of time until all confidence is lost in a solution as nobody has one. Painted into a corner as pandora’s box has been opened on the other side of the room.

    • biggestbrotherofthe mall

      Sober Look. You would have to be right. If the figures are to be believed at all, and they probably understate, debt is more of a disaster in China than anywhere else on earth. Maybe the Politburos haste to stand mano a mano with the reserve currency status of the US has hastened the lack of control you describe.

      However while the Politburo may have lost TOTAL control that is not to say that they have totally lost control. Dont forget there is no alternative – no opposition party to swing to next election in a show of voter petulance and rearrange the deck chairs on the Titanic.

      Clearly they are not set up to deal with the rebalancing at all. But the US seems to think that it can just swing its manufacturing to Mexico and Vietnam etc, not realizing, I think that it survived the last crash due to China/US ying yang and this time the whole world is in yang yang yang together and the down cycle is going to be scary.

      I am trying to think how it may play out. I am sure somewhere on earth their is a latter day George Soros who has it worked out!

  28. Falling demand in China forces mining companies to shed A LOT OF jobs. Take e.g. Anglo American. It wants to shed some 35% of it employees in the coming years.

    http://www.wsj.com/articles/miners-shed-thousands-of-jobs-as-commodities-prices-slide-1437740084

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