Posts Tagged ‘Wen Jiabao’

Black Swans lurking because Uncle Sam has less margin for error

Tuesday, March 16th, 2010

Yesterday, we can’t help but notice newspapers headlines reporting that China’s Premier Wen Jiabao warned of a double-dip recession in the global economy. The reason is simple- governments all over the world are expected to scale back their ‘stimulus’ spendings for fear of price inflation and/or blowing a bigger hole in their budget. This goes to show that the word ‘stimulus’ is a weasel word that only has value as a propaganda tool. As we wrote in Will governments be forced to exit from ?stimulus??,

In fact, the word ?stimulus? is the most misleading word in economics lexicon because it conveys the idea of a surgeon ?stimulating? a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch.

If the right word is used (e.g. “crutch,” “prop up”) to describe the counter-productive government policies of spend, spend and spend, then it will do wonders to increase the economic IQ of the masses (see Are governments mad with ?stimulating??). Consider this very simple chain a logic:

  1. Someone is falling.
  2. You place a crutch to prevent him from falling.

Isn’t it plain common sense to see that once you remove the crutch, that person will crumble? From this, it follows that government crutch (‘stimulus’) lifts government expenditure to a higher plateau. Once we have bigger government, it is very difficult to shrink it as the difficulty currently faced by Greek government shows. Consequently, with a government budget already in deficit, there’s very every chance for it to go deeper into debt. Sooner or later, the bond vigilantes will doubt the credit worthiness of the government, which means the interest rates on government debts will rise, which in turn makes debt servicing even harder. Eventually, this will result in a currency crisis.

This time, governments are cornered with very little margin for error. As Moody’s warns about diminished margin for error on U.S. debt reported,

Cutting back on public spending too soon risks a double-dip recession, Moody’s said, while leaving stimulus measures in place too long could lead to a sharp rise in interest rates “with more abrupt rating consequences a possibility.”

Wherever there’s very little margin for error, Black Swans (see Failure to understand Black Swan leads to fallacious thinking) will be lurking. You see, it is open knowledge that the United States government is heading towards where Greece is in right now (see Currency crisis: UK, Japan and US). What if, there’s another macroeconomic shock? It could be a meltdown in the Credit Default Swap (CDS) market, trade war with China, another wave of mortgage default (see Next wave of defaults to come?), or something else. With the United States government already stretched thin on faith and credit, any additional macroeconomic shock that requires further faith and credit of Uncle Sam will simply be unavailable.

GoldMoney. The best way to buy gold & silverTo understand what we mean, consider what a typical bond vigilante will be thinking. The only reason why he is still lending money to Uncle Sam is because Europe is a worse debtor. Since it is open knowledge that the US is heading towards a Greek tragedy, he knows that it is only a matter of time he will stop lending to Uncle Sam (assuming that Uncle Sam remains unrepentant of his spendthrift ways). But what if Uncle Sam is hit with an unexpected huge bill (macroeconomic shock) today? Will he continue to lend to Uncle Sam? Perhaps he may even demand his money back straight away? After all, if he worries whether Uncle Sam can repay his debt in 10 years time, wouldn’t that unexpected bill bring forward the day of reckoning? Or perhaps that will be trigger for giving up on Uncle Sam?

That’s where another macroeconomic shock can potentially descend into a USD currency crisis. We are not saying it will happen. But given that we are in a situation whereby the margin for error is getting smaller and smaller, it pays to watch out for Black Swans.

Is China going to allow its banks to fail in the upcoming (potentially gigantic) wave of bad debts?

Tuesday, March 9th, 2010

Last month, we reported that Marc Faber commented that China is going to slow down in 2010 (see the video in Is China going to dump their excess metal stockpiles?). The question investors should ask themselves is that whether China is going to slow down to say, 3% to 6% GDP growth or is it going to crash?

We will come to the question later. But first, the current mainstream forecast believes that China will grow 8% to 9% in 2010. Why? Because last Friday, Premier Wen Jiabao announced that he is targeting growth to be 8%.? China is the only country in the world where the government knows in advance what the GDP growth figures will be. If they declare that target for GDP growth is 8%, it will be at least 8%. The question is (1) how much the statistics are tortured and fudged to get arrive at the intended figure and (2) the quality of the GDP growth.

Now, here comes the question: will China crash in 2010/2011?

We don’t know the future, but this is a possibility. According to Marc Faber, the reason is because the Chinese government is clamping down on rampant credit growth. For debt-addicted Western economies, a significant slow down in credit growth will have serious negative impact on the economy. Correspondingly, a clamp down in credit growth will have unpredictable results to the Chinese economy.

The clamp down in credit growth is part of bigger picture. Unlike prior to 2008, China seems to be getting more serious about restraining the economy from overheating. All they have to do is to look across the ocean and look at Japan as an object lesson for not reining in credit and asset price bubbles early on. Since today’s Chinese economy is still developing (unlike the developed Japanese economy in 1990), the consequences of a burst bubble will be much more damaging than Japan’s long-term stagnation. Two months ago, in Chinese government cornered by inflation, bubbles & rich-poor gap, we were pondering what will China choose- voluntary slow-down or an involuntary inflationary melt-up.? As we wrote,

But there will be a day when they have to tackle the inflation problem.

There are signs that the Chinese government is getting more serious about doing so. However, it must be noted that the Chinese government is still on a capitalistic learning curve. That’s why the government’s economic edicts veer from one extreme to another extreme, which is pretty erratic (and authoritarian) relative to Western standards. There’s a chance that they may make a misstep and crash the economy.


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One very important development was reported yesterday: China is nullifying loan guarantees of local governments (see China to Nullify Loan Guarantees by Local Governments). To understand the implication of this, a little background is necessary. China’s local governments are not allowed to borrow directly. In order to raise funds for the stimulus infrastructure projects, they set up special investment vehicles to borrow from banks. Then they guarantee the debts of these vehicles. Through this means, Northwestern University Professor Victor Shih calculates that local governments have already accumulated RMB 11 trillion (US$ 1.7 trillion) in outstanding debt, with RMB $13 trillion (US$ 1.9 trillion) in available credit lines, belying China?s deceptively low reported levels of public debt (see Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?). In one swoop, the central government’s planned edict will nullify the loan guarantees and ban future ones.

Now, since many of the stimulus projects were not creditworthy by themselves in the first place, the removal of local government guarantees implies that many of these debts will become bad debt. According to Professor Victor Shih, a crackdown on such loans at the end of 2009 could trigger a ?gigantic wave? of bad debts as projects are left without funding. Not only that, ?By striking the fear of God into lenders, regulators hope to get them to turn off the [credit] tap,? said Patrick Chovanec, a professor at Tsinghua University in Beijing.

Since this is a serious systemic risk to the Chinese banking system, how will the central government deal with the likely gigantic wave of bad debts? We don’t know. But in 1998, it allowed Guangdong International Trust & Investment Corp (GITIC), a major bank, to collapse. According to Bloomberg,

The 1998 collapse of Guangdong International Trust & Investment Corp., which borrowed domestically and overseas on behalf of southern China?s Guangdong province, left creditors including Dresdner Bank AG of Germany and Bank One Corp. in the U.S. with $3 billion of unpaid bonds. It marked the first time that Chinese authorities failed to bail out one of the nation?s state-owned trusts.

Our guess is that, some of the hundreds of less important (or less well-connected) Chinese banks could be allowed to fail.

Only time can tell.

Nations will rise against nations

Sunday, March 15th, 2009

A few days, as reported widely in the news media, Chinese Premier Wen Jiabao said at a press conference that

We have lent huge amounts of money to the United States. Of course we are concerned about the safety of our assets.

To be honest, I am a little bit worried and I would like to … call on the United States to honour its word and remain a credible nation and ensure the safety of Chinese assets.

Those words, when translated into English in writing, sound bland. But if you watch what he said in full video in the original language, then you will be able to appreciate the immense gravity of the situation from the tone of his voice.

But dear readers, you must understand that Premier Wen was just stating the obvious. There’s nothing new in what he said. All you have to do is to turn back to what we wrote in December 2006 and read Will the US dollar collapse? and Awash with cash?what to do with it? to see the big picture of what’s going on for years. As we wrote back then,

Lately, we are again hearing that central bankers are murmuring about diversifying their foreign reserves away from the US dollar. Does it mean that there is an imminent liquidation of their US dollar reserves? Well, this is not the first time they murmured about it and it is definitely not in their (including the Federal Reserve?s) interest to see a collapse of the US dollar. The Chinese, with their US$1 trillion of reserves, would not want to see their stockpile of US dollars to lose significant value.

That paragraph was written in the final days of 2006. Today, China’s US dollar reserve had doubled from they had more than 2 years ago. The major difference between today and back then is the emergence of the Global Financial Crisis (GFC).

Thanks to the GFC, the status quo, which had been running for decades, is stressed towards a breaking point (but who knows, perhaps that inevitable  breaking point could still be delayed for longer before an almighty snap happens). There are far too many contradictory and conflicting interests among nations.

For the US, as we said before in How is the US going to repay its national debt?, is facing a situation in the coming decades of having to pay a colossal amount of public debt. The public sector is facing a massive debt many times its GDP from the unfunded Medicare and social security liabilities. With the GFC, the US government is transferring more and more private debt to the public sector through bailouts, handouts and stimulus. It is either the US mobilise its monetary printing press to massively inflate away (i.e. print copious amount of money) all these debts or they face up to the reality that they are bankrupt and go through the cold turkey of an almighty deflationary collapse (read: almighty depression). If the US chooses the former, China will be furious because that will be doing the very opposite of what Premier Wen called on the US to do, namely to “honour its word and remain a credible nation and ensure the safety of Chinese assets.”

Unfortunately, the big problem is that the US (along with countries like Australia and UK) has been de-industrialising and hollowing out its economy for a very long time, while the China has been doing the opposite. To put it simply, the US is consuming more and more while China produces more and more. This gross imbalance has been playing out for too long. With the GFC, the US consumers are effectively bankrupt and cannot borrow any more to buy from China. China has lost its biggest customer and is in trouble too.

The coming G20 Summit will be filled with countries with conflicting agendas. The US (and UK) wants more stimulus (and of course, bailouts when required), which can only happen if they print money (i.e. devalue the US dollar), which is as good as spitting on China’s face. Europe (headed by Germany and France) wants the focus to be on regulations and prevention, which means they are less keen on stimulus and bailouts. This is because the latter will involve the tax-payers of countries like Germany rescuing the tax-payers of other EU nations. China, on the other hand, wants an overhaul of the current world order so that they can have more power and say to better reflect their status as America’s creditor. Obviously, the US will not like that because that will mean they have to voluntarily descend for an ascending China.

There are plenty of temptations to take the easy way out. For example, if the Chinese expect the US to inflate away their debts by printing money and thereby, devaluing the US dollar, they will be likely to devalue their RMB in order to continue the process of hollowing out the US economy. The US (and the Europeans), in response, could impose trade barriers on Chinese imports. The Chinese could retaliate by dumping their holdings of US Treasuries. Remember, these are just examples of what may happen and they are by no means predictions. But we trust that you get the idea here.

Therefore, outwardly, the world may be at peace. But inwardly, we believe there will be jostling for power, influence and resources between the major nation blocs. Bigger nations will use smaller nations as pawns, international armed non-state groups will intensify their activities and inter-ethnic conflicts will arise. We have no doubt that there will be plenty of Black Swans appearing in the days to come.