Don’t Forget About the Red Swan - By David Stockman
Given the anti-Trump feeding frenzy, we continue to believe that a Swan is on its way bearing Orange. But if that’s not enough to dissuade the dip buyers, perhaps the impending arrival of the Red Swan will at least give them pause.
The chart below comprises a picture worth thousands of words. It puts the lie to the latest Wall Street belief that the global economy is accelerating and that surging corporate profits justify the market’s latest manic rip.
What is actually going on is a short-lived global credit/growth impulse emanating from China. Beijing panicked early last year and opened up the capital expenditure (CapEx) spigots at the state-owned enterprises (SOEs) out of fear that China’s great machine was heading for stall speed at exactly the wrong time.
The 19th national communist party Congress scheduled for late fall of 2017. This every five year event is the single most important happening in the Red Ponzi. This time the event is slated to be the coronation of Xi Jinping as the second coming of Mao.
Beijing was not about to risk an economy fizzling toward a flat line before the Congress. Yet that threat was clearly on the horizon as evident from the dark green line in the chart below which represents total fixed asset investment.
The latter is the spring-wheel of China’s booming economy, but it had dropped from 22% per annum growth rate when Mr. Xi took the helm in 2012 to 10% by early 2016.
There was an eruption as dramatized in the chart. CapEx growth suddenly more than doubled in the one-third of China’s economy that is already saturated in excess capacity. The state owned enterprises (SOE) in steel, aluminum, autos, shipbuilding, chemicals, building equipment and supplies, railway and highway construction etc boomed.
However, you cannot grow an economy indefinitely by building pyramids or any other kind of low-return/no return investment – even if the initial growth spurt lasts for years as China’s had.
Ultimately, the illusion of Keynesian spending gets exposed and the deadweight costs of malinvestments and excess capacity exact a heavy toll.
If the investment boom that was financed with reckless credit expansion is not enough, as was the case in China where debt grew from $1 trillion in 1995 to $35 trillion today, the morning-after toll is especially severe and disruptive. This used to be called a “depression.”
It was as if a switch had been flicked on by Mr. Xi himself, SOE CapEx soared back toward the 25% year-over-year rate by mid-2016, keeping total CapEx hugging the 10% growth line.
China’s propagated spurt in global trade and commodities was artificial and short-term. It was done to flatter China’s rulers at the 19th party congress.
Now that a favorable GDP glide path has been assured, China’s planners and bureaucracy are already back at it trying to find some way to reel in its runaway credit growth and bloated economy before it collapses.
Downside Surprises in China Are Virtually Baked In
The sell-by date has expired on this latest China credit impulse, as evident in the chart below. During the first quarter of this year, total social financing (bank credit plus shadow banking loans) reached the incredible rate of $4 trillion per annum. That’s nearly one-third of China’s entire GDP.
The figure scared the daylights out of leadership in Beijing, who have now moved forcefully to reel in China’s debt machine.
What is coming down the pike is the great China Debt Retrenchment. Expect a global braking motion that will get underway once Mr. Xi dramatically consolidates his power at the 19th party congress.
This has the potential to drastically weaken the global economy – and the impact on corporate profits should not be underestimated.
The Red Swan Has Now Gone Berserk
Half of the world’s GDP growth since the 2008 crisis has been in China, and that, in turn, was purchased by the greatest credit eruption in recorded history.
As China’s nominal GDP was more than doubling from $4.6 trillion in 2008 to $11.2 trillion in 2016, its national leverage ratio soared from 175% of GDP to 300% in less than a decade.
There’s reason to seriously doubt that Beijing can bring the Red Ponzi to a soft landing. It cannot and will not permit the nation’s debt load to quadruple again during the next eight years, meaning that China’s days as the world’s ultimate stimulus machine are over.
The fading of the most recent China growth impulse will soon reveal that most countries, to adapt Warren Buffet’s famous metaphor, have been swimming naked from a fiscal perspective. It has left the world vulnerable to a renewed wave of funding crises as the ECB and other central banks attempt to launch monetary normalization.
In sum, during the last 19 months the Red Ponzi propagated a false upturn in the global economy that is already decisively reversing. This comes at the same time that central banks of the major developed world economies are finally bringing their printing presses to a halt.
The major central bankers have finally recognized that at $22 trillion on central bank balance sheets have become egregiously extended. China is the epicenter of the world’s two decade plunge into central bank monetary fraud and credit explosion. They have deformed and destabilized the very warp and woof of the global economy.
So, yes, even as the Orange Swan stumbles toward the Donald’s White House, there is a Red Swan following closely behind.