Gold futures in the December contract are down $8 this Friday afternoon in New York currently trading at 1,214 hitting fresh nine month lows while still trading far below their 20 and 100 day moving average telling me that the trend is to the downside as the U.S dollar hit 2 year highs against many of the foreign currencies pressuring the commodity markets and especially the precious metals this week.
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The chart structure in gold has improved dramatically and if you took my original recommendation and sold the breakout at 1,278 make sure you place your stop 10 day high which currently stands at 1,243 an ounce and that will improve in the next several days as the next major level of support is 1,180 & if that price level is broken prices could slide rather dramatically.
Gold prices settled last Friday at 1,216 finishing slightly lower for the trading week as volatility has certainly increased as prices were up $20 a couple of days back on the news of the coalition & the United States bombing ISIS but then prices came right back down as I still think lower prices are ahead as there’s no reason to own gold right now especially with a very strong U.S dollar so continue to play this to the downside making sure you place your stop above the 2 week high.
TREND: LOWER
CHART STRUCTURE: IMPROVING
Silver futures are trading far below their 20 and 100 day moving average settling last Friday at 17.84 going out this Friday in New York around 17.55 finishing down about $.30 hitting a 4 1/2 year low as the U.S dollar continues to pressure silver and the rest of the precious metal complex.
If you took my original recommendation several months back when prices broke 20.44 which was the 4 week low continue to place your stop above the 10 day high which currently stands at 18.85 and that will start to improve late next week as the chart structure will tighten up, but I still believe prices look vulnerable even at these multi year lows.
The trend is your friend in the commodity markets and the trend in the U.S dollar is clearly higher and that’s pessimistic all commodity prices, but if you have missed this trend sit on the sidelines as you have missed the boat as you do not want to chase markets that is why I like to find the trend as early as possible as my rule states a 4 week high or a 4 week low has to occur before entering.
TREND: LOWER
CHART STRUCTURE: IMPROVING
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Saturday, September 27, 2014
Friday, September 26, 2014
The SEC makes it clear....we are going to pay more, here's our strategy
Today I read a news article from our trading partner Doc Severson at Trading Concepts about a proposed Securities and Exchange Commission rule that could boost trading costs.
Here’s the deal:
Due to market instability, the SEC wants to require all trading venues – exchanges, automated trading systems and dark pools – to submit alternative plans for operations in case of a system breakdown. In its proposal, the SEC said estimated initial costs could be as high $242 million, with another $191 million in annual costs.
So, if approved, who will these added fees eventually fall on?
Yep, you guessed it . You and I ... the traders.
Remember how Doc Severson’s first training video showed you what government involvement is doing to the market?
Well, as you can see, more regulations just keep lining up. Just about every big player in the trading world has been affected. Again, if you’re using strategies that worked in the past and now aren’t seeing the profits you want, your lack of success isn’t all your fault. You simply need to adjust your approach to accommodate today’s market.
Try Doc’s Fractal Energy Trading for Weekly Options program for the next 30 days.
Believe me, you’ll be happy you did.
See you in the markets,
The Gold ETF Trader
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Top Dividend Plays – Profit in a Bull Market, Protect Yourself in a Bear Market and Collect Dividends Along the Way!
When your babysitter knows that the market is on a roll, there is no question it’s a bull market! It may also be time to keep an eye out for a correction.
No one knows when a correction will take place and you don’t want to miss gains in a bull market.
So what do you do?
Easy! Continue buying good companies with outstanding fundamentals, but look for “defensive” sectors and throw in some outstanding dividend payouts for good measure.
In this complimentary INO.com special report they reveal an ETF that’s loaded with the best and most consistent dividend paying companies. And here’s the best part: all of the companies listed in this ETF have to boast a record of increasing dividends for at least 20 consecutive years (not a typo).
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The Gold ETF Trader
So what do you do?
Easy! Continue buying good companies with outstanding fundamentals, but look for “defensive” sectors and throw in some outstanding dividend payouts for good measure.
In this complimentary INO.com special report they reveal an ETF that’s loaded with the best and most consistent dividend paying companies. And here’s the best part: all of the companies listed in this ETF have to boast a record of increasing dividends for at least 20 consecutive years (not a typo).
As an added bonus, you’ll also receive their favorite dividend stock. This stock boasts a mind blowing dividend record backed by some of the strongest fundamentals around.
Don’t miss out, just click here to view this complimentary report today!
See you in the markets!
The Gold ETF Trader
Monday, September 8, 2014
Free Webinar: How to Beat the Market Makers Using Weekly Options
Click Here to get your reserved spot, they go fast!
In this free webinar John Carter will discuss…..
* How to determine the safe levels to take weekly options trades
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The Gold ETF Trader
What does a “good” Chinese adjustment look like?
By John Mauldin
People of privilege will always risk their complete destruction rather than surrender any material part of their advantage. Intellectual myopia, often called stupidity, is no doubt a reason. But the privileged also feel that their privileges, however egregious they may seem to others, are a solemn, basic, God-given right. The sensitivity of the poor to injustice is a trivial thing compared with that of the rich.
– John Galbraith, The Age of Uncertainty
Malinvestment occurs when people do stupid things with free money. One of the characteristics of malinvestment is its dominance; i.e., other investments have little chance of competing. Malinvestments always bust and end in liquidation.
– Joan McCullough, writing yesterday in her daily commentary
I contend that Xi and Li are the most radical leaders of the Chinese nation since Deng Xiaoping, with the emphasis being on Xi. He is shaking up the current power structure by going after some of the entrenched leaders for corruption. He has earned rebukes from a former president for his actions in op-eds in the Financial Times. This is extraordinary pushback and clearly shows that what is happening is beyond the normal regime-change shakeups we have seen in China.
Make sure you catch this weeks video "What Market Makers Don't Want You to Know".....Just Click Here
For today’s Outside the Box, we turn to my friend professor Michael Pettis to get his latest take on China. Michael’s biography describes him as a “Wall Street veteran, merchant banker, equities trader, economist, finance professor, entrepreneur – iconoclast – Michael Pettis is a unique individual living and working in China, at the heart of the world’s most exciting and vibrant economy.” He is certainly all that and more and just an all-around fun guy to hang out with. I mean, where else do you get a professor who also helps found an indie rock club in Beijing? I should note that he is a professor at Peking University’s Guanghua School of Management. He is published everywhere and gets to talk to “everyone” in China. So I pay attention to what Michael Pettis says when it comes to China. Michael writes a free blog but also has a subscription service that you can get to on his website.
He posted a blog on Monday asking the question, “What does a ‘good’ Chinese adjustment look like?” Which of course assumes there might be a bad Chinese adjustment.
And while the consequences of a smooth transition would be important for those who live in China, the consequences if Xi and Li get it wrong would be significant for the world. We need to be paying attention. This piece is a good overview of what “we” would like to see happen. But as Michael points out, there are some in China who very much don’t want our favored scenario to play out.
For most of the Western world, summer is officially over with the beginning of September, although technically the equinox will not arrive for another 20 days. For the most part, I enjoyed a lazy Labor Day (apart from the obligatory workout), ending with a cookout by the pool with family and friends, joined by David Tice (formerly of the Prudent Bear and my neighbor in the building) and his crew.
My kids gave me a lot of grief because I mentioned Henry’s birthday last week as being his 31st. It is his 33rd. In my defense I at least got the birthday part right. I cannot believe how fast my kids are growing up / have grown up. To see them interacting as adults is both pleasurable and unsettling. I don’t feel any older than they look, although my body complains every now and then and more than it used to. But I know that technically speaking I am anywhere from 29 to 45 years older.
But for the nonce I think I will ignore the technical part and go with my feelings. At least until reality issues a true wake-up call.
Your not ready to give up the game analyst,
John Mauldin, Editor
Outside the Box
Outside the Box
Stay Ahead of the Latest Tech News and Investing Trends...
Each day, you get the three tech news stories with the biggest potential impact.What does a “good” Chinese adjustment look like?
By Michael PettisMichael Pettis’ China Financial Markets
I have always thought that the soft landing/hard landing debate wholly misses the point when it comes to China’s economic prospects. It confuses the kinds of market-based adjustments we are likely to see in the U.S. or Europe with the much more controlled process we see in China. Instead of a hard landing or a soft landing, the Chinese economy faces two very different options, and these will be largely determined by the policies Beijing chooses over the next two years.
Beijing can manage a rapidly declining pace of credit creation, which must inevitably result in much slower although healthier GDP growth. Or Beijing can allow enough credit growth to prevent a further slowdown but, once the perpetual rolling-over of bad loans absorbs most of the country’s loan creation capacity, it will lose control of growth altogether and growth will collapse.
The choice, in other words, is not between hard landing and soft landing. China will either choose a “long landing”, in which growth rates drop sharply but in a controlled way such that unemployment remains reasonable even as GDP growth drops to 3% or less, or it will choose what analysts will at first hail as a soft landing – a few years of continued growth of 6-7% – followed by a collapse in growth and soaring unemployment.
A “soft landing” would, in this case, simply be a prelude to a very serious and destabilizing contraction in growth. Rather than hail the soft landing as a signal that Beijing is succeeding in managing the economic adjustment, it should be seen as an indication that Beijing has not been able to implement the reforms that it knows it must implement. A “soft landing” should increase our fear of a subsequent “hard landing”. It is not an alternative.
Surprisingly enough, until the announcement last month that Zhou Yonkang was under investigation, Premier Li has been pretty insistent that China will make its 7.5% growth targets, even as many analysts have lowered their expectations (Moody’s and the IMF are now saying that 6.5% is a possibility), and it is clear that President Xi is taking far more responsibility for and control of the economy than any recent president. My guess is that as the problems of the real estate sector kick in, with lower prices causing a drop in real estate development, which matters for employment, we are likely to see additional stimulus spending aimed at managing the threat of unemployment and, perhaps more importantly, at managing the possibility of rising anger among provincial elites as the glorious prospect of easy money continues to retreat.
This, to me, is the explanation for the rather surprising insistence by Premier Li in June that 7.5% GDP growth was a hard target. GDP targets are part of domestic signaling about the expected pain of adjustment. I suspect that lower growth targets are likely to generate greater opposition.
Certainly it does seem that growth has temporarily bottomed out. According to this June’s Financial Times, “Expenditure by local and central governments in China jumped nearly 25 per cent from the same month a year earlier, a sharp acceleration from the 9.6 per cent growth registered in the first four months of the year, according to figures released by the finance ministry,” and HSBC’s Flash PMI index suggests for the first time in six months that there has been an expansion in manufacturing, although the flash index is, of course, preliminary and may be revised.
Can Beijing rein in credit?
I have written many times before that what will largely determine the path China follows is the political struggle the Xi administration will have in imposing the needed reforms on an elite that will strongly resist these reforms – mainly of course because these reforms must necessarily come at their expense. As an aside my friend, Ken Miller, with whom I was having a very different discussion last week, just sent me one of his favorite John Galbraith quotes (from The Age of Uncertainty) that seemed apropos.
People of privilege will always risk their complete destruction rather than surrender any material part of their advantage. Intellectual myopia, often called stupidity, is no doubt a reason. But the privileged also feel that their privileges, however egregious they may seem to others, are a solemn, basic, God-given right. The sensitivity of the poor to injustice is a trivial thing compared with that of the rich.
The first stage of China’s growth story, which occurred mainly during the 1980s, consisted of liberalizing reforms that undermined the Communist elite and which were strongly opposed by them. Because power was highly centralized under Deng Xiaoping, however, including a loyal PLA, he and the reform faction were nonetheless able to force through the reforms.
The next two stages of growth, I argued, required policies that had a very different relationship to the interests of the Chinese elite. Because they involved the accumulation and distribution of resources to favored groups whose role was to achieve specific economic targets, they helped to reinforce the wealth and power of a new elite, many of whose members were, or were related to, the old elite. Not surprisingly this new elite strongly supported the growth model imposed by Beijing during these stages.
The fourth stage, I argued, is the stage upon which we are currently trying to embark. In an important sense it involves liberalizing reforms similar politically to those that Deng imposed during the 1980s, making it vitally important to their success that the current administration is able to centralize power and create support to overcome the inevitable opposition, which it seems to be doing.
This is why, even though Beijing doesn’t seem to have yet gotten its arms around the problem of excess credit creation, I nonetheless think it is moving in the right direction. For now I would give two chances out of three that Beijing will manage an orderly “long landing”, in which growth rates continue to drop sharply but without major social disruption or a collapse in the economy. In this issue of the newsletter I want to write out a little more explicitly what such an orderly adjustment might look like.
Will financial repression abate?
Very low interest rates had several important impacts. First, because they represented a transfer from net savers to net borrowers, they helped to exacerbate the split between the growth in household income (households are net savers) and the growth in GDP (which is generated by net borrowers), and so led directly to the extraordinary imbalance in the Chinese economy in which consumption, as a share of GDP, has declined to perhaps the lowest level ever recorded in history.
Second, by making credit extremely cheap for approved borrowers, it created among them an almost infinite demand for credit. Financial repression helped foster tremendous growth in economic activity as privileged borrowers took advantage to borrow and invest in almost any project for which they could get approval.
Third, when China desperately needed investment early in its growth period, this growth in economic activity represented real growth in wealth. But low interest rates, along with the moral hazard created by implicit guarantee of nearly all approved lending, led almost inevitably to a collapse in investment discipline. Financial repression has been the main explanation for the enormous misallocation of capital spending we have seen in China during the past decade.
This is why understanding financial repression is so important to understanding the way in which China will adjust. There are two ways to think about the “cost” of financial repression to net savers. The least sophisticated but easiest to explain is simply to look at the real return on loans and deposits. In this case you would subtract the appropriate deflator from the lending or deposit rate.
In the US we usually use CPI inflation as the deflator, but for many reasons this won’t do in China. Consumption is a much lower share of GDP in China than in the US or anywhere else, so that it is less “representative” of economic activity, and there is anyway a great deal of dispute about the rate at which the consumption basket is actually deflating (Chinese households seem to think it seriously understates inflation). I prefer to use the GDP deflator, which until about 3-4 years ago was in the 8-10% region and currently runs around 1-2% or even less, depending on the period you are looking at.
Using the GDP deflator suggests that the real rate for savers has been very negative for most of this century until the past three years – with savers implicitly losing perhaps as much as 5-8% of their real savings every year. It also suggests that the real rate for borrowers has also been negative, perhaps by 1-3% for most of this century. Clearly these interest rates are too low, especially for a very volatile, poor, and rapidly growing economy.
The more appropriate measure of financial repression is not the deflator, whichever one we choose to use, but rather very roughly the gap between the nominal lending rate and the nominal GDP growth rate, the latter of which broadly represents the return on investment within the economy. Until a few years ago nominal GDP grew at around 18-21% while the lending rate was around 7%.
This is a huge gap. In this case the “cost” of financial repression to households was the gap between nominal GDP growth and nominal lending rates, plus an additional 1-1.5% to account for the larger than normal gap between the lending rate and the deposit rate. This is because in China the gap between lending and deposit rates during this century has been much higher than in other developing countries, probably as part of the process of recapitalizing the banks after the last banking crisis at the turn of the century.
If you multiply the sum of these two gaps by the total amount of household and farm deposits (very roughly around 80-100% of GDP a few years ago, when I last checked), you get an estimate of the total transfer from the household sector to banks and borrowers. Because I think China’s nominal GDP growth has been overstated by a substantial amount because of its systematic failure to write down bad loans, I usually have subtracted 2-4 percentage points from the nominal GDP growth rate before I did my very rough calculation. This was how I got my 5-8% of GDP estimate for the amount of the annual transfer from households to savers. This of course is a huge transfer, and can easily explain most of the decline in the household share of GDP over this period.
It is worth noting by the way that a recent widely-discussed study by Harry Wu of the Conference Board claims the China’s average GDP growth from 1978 to the present was not 9.8% but rather 7.2%. The main reason for the revision, according to Wu, is that the GDP deflator had been significantly underestimated which, if even partially true, means real interest rates were even lower (more negative) than I have assumed.
There is some controversy about whether it is true that the nominal lending rate should be broadly equal to the nominal GDP growth rate. In fact most studies of developed countries suggest that over the medium and long term this is indeed the case. UBS tried to show that this was not applicable to China and did a study several years ago showing that among developing countries this relationship didn’t hold. Their studies suggested that among developing countries nominal lending rates had on average been around two-thirds on nominal GDP growth rates (although China, at around one-third, was still well below anyone else’s at the time).
I had a real problem with their sample of countries however. Their sample included a lot of small OPEC countries, who necessarily had high growth and low interest rates when oil prices were high, as well as a lot of Asian countries that followed the Japanese development model and themselves practiced financial repression, which of course made them pretty useless as points of comparison. Neither group of countries, in other words, could help us determine what a “normal” interest rate is compared to nominal GDP.
But regardless of the debate, the point to remember is that when the nominal lending rate is much below the nominal GDP growth rate, two very important things happen. First, it helps eliminate capital allocation discipline. If GDP is growing nominally at 20%, for example, and you can borrow at 7% (which was the case in China for much of this century), you should rationally borrow as much as you can and invest it into anything that moves, no matter how poorly thought out the investment. Imagine a totally ineffective investor, or one whose incentives do not include earning a reasonable return on capital, who manages to earn on his investment only half of nominal GDP. This would be a pretty poor use of capital.
Adjusting the repression gap
Under these conditions it should be no surprise that borrowers with access to bank credit overuse capital, and use it very inefficiently. They would be irrational if they didn’t, especially if their objective was not profit but rather to maximize employment, revenues, market share, or opportunities for rent capture (as economists politely call it).
The second point to remember is that in a severely financially repressed system the benefits of growth are distributed in ways that are not only unfair but must create imbalances. Because low-risk investments return roughly 20% on average in a country with 20% nominal GDP growth, financial repression means that the benefits of growth are unfairly distributed between savers (who get just the deposit rate, say 3%), banks, who get the spread between the lending and the deposit rate (say 3.5%) and the borrower, who gets everything else (13.5% in this case, assuming he takes little risk – even more if he takes risk).
This “unfair” distribution of returns is the main reason why the household share of income has collapsed from the 1990s until recently. I calculate that for most of this century as much as 5-8% of GDP was transferred from households to borrowers. The IMF calculated a transfer amount equal to 4% of GDP, but said it might be double that number, so we are in the same ballpark. This is a very large number, and explains most of why the growth in household income so sharply lagged the growth in GDP.
This was why financial repression, although useful in the early stages of China’s growth period because it turbocharged investment, ultimately became one of the county’s biggest problems once investment no longer needed turbocharging. For many years nominal GDP growth in China was 18-21% and the official lending rate was around 7%. This, combined with widespread moral hazard, had inevitably to result in both tremendous misuse of capital and a sharp decline in the consumption share of GDP (as the household income share declined) – both of which of course happened to a remarkable degree in China.
In the last year or so, however, the official lending rate has risen to 7.5% and nominal GDP has dropped to 8-9% (and just under 8% in the first quarter of 2014). This changes everything in China. First, it is now much harder for borrowers to justify investment in non-productive projects because they can no longer count on the huge gap between nominal GDP growth and the lending rate to bail them out of bad investments. Of course this also means a dramatic slowdown in economic activity, but because this slowdown is occurring by the elimination of non-productive investment, the slowdown in Chinese growth actually represents higher wealth creation and greater real productivity growth. China is getting richer faster now than it did before, even though it looks like wealth creation is slowing (the difference is in the slower required accumulation of bad debt).
Second, the huge transfer from net savers to net borrowers has collapsed, so that growth in the future must be far more balanced. Over time this means that households will retain a growing share of China’s total production of goods and services (at the expense of the elite, of course, who benefitted from subsidized borrowing costs) and so not only will they not be hurt by a sharp fall in GDP growth, but their consumption will increasingly drive growth and innovation in China.
Interest rates are still too low, but not by nearly as much as in the past, and over the next two years as nominal GDP growth continues to drop, the financial repression “tax” will be effectively eliminated. When this happens solvent Chinese businesses will be forced to use capital much more productively, and slowly they will learn to do so. In that case the PBoC will be able to liberalize interest rates (although not without tremendous political opposition from those that have depended on having great access to very cheap capital for their wealth) without worrying about either the deposit rate of the lending rate surging.
There is, however, one group of wasteful borrowers for whom higher interest rates will not represent a more careful approach to borrowing and investing and these, of course, are borrowers that are already effectively insolvent or otherwise unable to repay loans coming due. In that case as long as they can borrow they will do so, no matter the interest rate. It is not clear to me how many such borrowers exist, but I’d be surprised if there weren’t an awful lot of them. These borrowers can only really be disciplined by constraining credit growth and eliminating government support, including implicit guarantees, but this might not be happening.
One of the ways Beijing seems to be reducing the pain of more expensive borrowing (relative to nominal GDP growth) is to loosen credit in a targeted way. We have heard talk of targeted bond purchases although it is not yet clear what exactly Beijing plans to do.
An article in Caixin suggests that regulators may also be trying to relax the loan to deposit constraint:
The China Banking Regulatory Commission (CBRC) will change the rules for figuring the loan-to-deposit ratio so banks can have more money to lend to businesses, an official with the regulator says. The requirement that the ratio not exceed 75 percent – meaning banks cannot lend more than 75 percent of their deposits out – would remain the same, but the way ratio is calculated would be adjusted, Wang Zhaoxing, deputy chairman of the CBRC, said June 6.
The regulator would consider broadening the scope of deposits to include “relatively stable” funds that are not now used to calculate the ratio, he said. He did not say what the funds could be, and added that a precondition for doing this was keeping the money market stable.
So what does “good” rebalancing look like?
Another one of the great distortions that led to China’s current imbalances was the very low growth in wages relative to productivity. This too has improved. The surge in wages in 2010-11, and their continued relatively rapid pace of growth, has reduced this distortion significantly, especially as it is becoming increasingly clear that productivity growth has been overstated in recent years.
Most importantly, with nominal GDP growth rates having dropped from 20% to 8-9%, the greatest of all the distortions, the interest rate distortion, has been the one most dramatically to adjust in the past three years. This is why even though many people I respect are still insisting that China has not really rebalanced, I am moderately optimistic that in fact China is adjusting as quickly as could be expected. Credit growth remains a serious problem, but the forces that put China in the position of relying on excess credit growth have genuinely abated.
And it is this abatement of the great distortions that have caused growth to slow so rapidly, and although we haven’t seen much evidence of significant rebalancing yet, it should take a few years for the effects fully to be worked out. Chinese growth is less dependent than ever on the hidden transfers from the household sector, and these transfers both encouraged massive waste and created the imbalances that required this massive waste to continue.
China is still vulnerable to a debt crisis, but if President Xi can continue to restrain and frighten the vested interests that will inevitably oppose the necessary Chinese economic adjustment, he may in the next one or two years be able even to get credit growth under control, before debt levels make an orderly adjustment impossible.
It won’t be easy, and already there are many worried about the politically destabilizing impact his measures may have. The Financial Times, for example, had the following article:
Mr Xi came of age in that turbulent time and watched as his elite revolutionary family and everything he knew were torn to pieces. Now it seems it is his turn to wreak havoc on the cozy networks of power and wealth that have established themselves in the era of “socialism with Chinese characteristics”. In recent weeks, the president’s signature campaign against official corruption appears to have spilled into something more significant and potentially destabilising for the increasingly autocratic regime.
If China can reform land ownership, reform the hukou system, enforce a fairer and more predictable legal system on businesses, reduce rent-capturing by oligopolistic elites, reform the financial system (both liberalizing interest rates and improving the allocation of capital), and even privatize assets, 3-4% GDP growth can be accompanied by growth in household income of 5-7%. Remember that by definition rebalancing means that household income must grow faster than GDP (as happened in Japan during the 1990-2010 period).
This has important implications. First, the idea that slower GDP growth will cause social disturbance or even chaos because of angry, unemployed mobs is not true. If Chinese households can continue to see their income growth maintained at 5% or higher, they will be pretty indifferent to the seeming collapse in GDP growth (as indeed Japanese households were during the 1990-2010 period). Second, because consumption creates a more labor-intensive demand than investment, much lower GDP growth does not necessarily equate to much higher unemployment.
A “good” and orderly adjustment, in other words, might look a little like this:
1. GDP growth must drop every year for the next five or six years by at least 1 percentage point a year. If it drops faster, the period of low growth will be shorter. If it drops more slowly, the period of low growth will be stretched out. On average, GDP growth during President Xi’s administration will not exceed 3-4%.
2. But this does not mean that household income growth will drop by nearly that amount. Rebalancing means, remember, that household consumption growth must outpace GDP growth, and the only sustainable way for this to happen is for household income growth also to outpace GDP growth. If consumption grows by four percentage points more than GDP, Chinese household consumption will be 50-55% of GDP in a decade – still low, but no longer exceptionally low and quite manageable for the Chinese economy. This suggests that if investment growth is zero and the trade surplus does not vary much, 3-4% GDP growth is consistent with 6-7% household income growth. It might be in principle possible to pull this off if Beijing is able to transfer 2-4% of GDP from the state or elite sector to the household sector by reforming the hukou system, land reform, privatizations, and other transfers, but of course we shouldn’t assume that this level of household income growth will be easy to maintain once investment growth, and with it GDP growth, drops sharply.
3. What about employment? If investment growth falls sharply, especially investment in the real estate sector, it should cause unemployment to surge, which of course puts downward pressure on household income growth as well as on consumption growth, potentially pushing China into a self-reinforcing downward spiral. This, I think, is one of the biggest risks to an orderly adjustment. The good news is that if large initial wealth transfers to households can kick start a rise in consumption, growth driven by household consumption, especially growth in services, tends to be much more labor intensive than the capital-intensive investment growth that too-low interest rates have forced onto China. A transfer of domestic demand from investment to consumption implies, in other words, that employment growth can be maintained at much lower levels of GDP growth.
4. What about the debt, which is the other great risk to an orderly and successful Chinese adjustment? There are two things China can do to address its substantial debt problem. First, it can simply transfer debt directly onto the government balance sheet so as to clean up banks, SOEs and local governments, thus preventing financial distress costs from causing Chinese growth to collapse. As long as this government debt is rolled over continuously at non-repressed interest rates, which will be low as nominal GDP growth drops, China can rebalance the economy without a collapse in growth. This, essentially, is what Japan did in the 1990s.
The problem with this solution is that it is politically attractive (no wealth transfers from the elite to ordinary households) but it does not fundamentally address China’s debt problem, but rather simply rolls it forward. In that case the burgeoning government debt will itself prevent China, once the economy is rebalanced, from ever regaining rapid growth. I have previously explained why the debt burden can prevent growth in my discussions of why I do not think Abenomics can succeed, if by success we mean raising inflation and real GDP growth. What’s more, if a relatively poor, volatile economy like that of China cannot bear the debt levels that a country lie Japan can bear, it is not clear that this solution will work even during the rebalancing period.
A real solution to the debt problem, in other words, may involve initially a transfer of debt onto the government balance sheet, but ultimately Beijing must then take real steps to lower debt relative to debt capacity. This may involve using privatization proceeds to pay down debt, higher corporate taxes, and even higher income taxes if other forms of wealth transfer are robust enough to support them, but one way or another total government debt must be reduced, or at least its growth must be contained to less than real GDP growth.
5. Although it may be hard to see it in the economic ratios, or in any real restraint in credit expansion, in fact Beijing has already taken serious steps towards rebalancing, although it may take a few more years to see this in the consumption share of GDP. The three most important of the transfers that created the imbalance have all reversed. The currency may still be undervalued, but not by nearly the extent it has been in the past, wages have risen quickly in recent years, and, most importantly by far, the financial repression tax has collapsed, and even nearly disappeared, which it will do fully in the next two years as nominal GDP growth continues to fall (as long as the PBoC does not reduce rates by much more than one or two percentage points over the next two years). Even the much-ballyhooed decision to improve the environment represents a partial reversal of one of the sources of the household share imbalance.
All of these mean that the hidden transfers that both generated spectacular growth in economic activity (if not always in economic value creation) and the unprecedented drop in the household income share of GDP no longer exist, or do so to a significantly reduced extent. It will take time for the elimination of these transfers to work themselves fully though the economy, but we are already seeing their very obvious initial impacts in the much lower GDP growth numbers, even as credit creation remains high.
Credit creation remains the great risk to the economy. It is still growing much too quickly. I think there are few people in Beijing who do not understand the risk, so my guess is that political constraints are the main reason that credit has not been more sharply reduced. I believe that the president cannot allow too sharp a contraction in credit growth until he feels fully secure politically, and for me the pace at which credit is brought under control is, to a large extent, an indication of the pace of the process of power consolidation.
The best-case scenario
As regular readers know I am not very comfortable making predictions, preferring instead to try to understand the structure of an economic system and work out logically the various ways in which that system can evolve. The description above is one of the ways in which it can evolve, and because I think this is probably the best-case scenario, I thought it might prove useful as a way of framing thinking about the adjustment process for China.
One caveat: This is not necessarily the best-case assumption. I can make certain assumptions, which I haven’t made because I believe them to be implausible, although not impossible, that lead to a better outcome. If the global economy were to recover much more quickly than most of us expect, and, much more importantly, if Beijing were to initiate a far more aggressive program of privatization and wealth transfer than I think politically possible, perhaps transferring in the first few years the equivalent of as much as 2-5% of GDP, the surge in household income could unleash much stronger consumption growth than we have seen in the past. This could cause GDP growth over the Xi administration period to be higher than my 3-4% best-case scenario.
The amount of the direct or indirect wealth transfer from the state sector to ordinary households is, I think, the most important variable in understanding China’s adjustment. The pace of growth will be driven largely by the pace of household income growth, which will itself be driven largely by the pace of direct or indirect wealth transfers to ordinary Chinese households. If we could guess this right, much else would almost automatically follow.
Academics, journalists, and government and NGO officials who want to subscribe to my newsletter, which sometimes includes potions of this blog and sometimes does not, should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who want to buy a subscription should write to me, also at that address.
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The article Outside the Box: What does a “good” Chinese adjustment look like? was originally published at Mauldin Economics
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Thursday, September 4, 2014
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How is Doug Casey Preparing for a Crisis Worse than 2008?
By Doug Casey, Chairman
He and His Fellow Millionaires Are Getting Back to Basics
The Mining Report: This year's Casey Research Summit is titled "Thriving in a Crisis Economy." What is the most pressing crisis for investors today?
Doug Casey: We are exiting the eye of the giant financial hurricane that we entered in 2007, and we're going into its trailing edge. It's going to be much more severe, different and longer lasting than what we saw in 2008 and 2009. Investors should be preparing for some really stormy weather by the end of this year, certainly in 2015.
TMR: The 2008 stock market embodied a great deal of volatility. Now, the indexes seem to be rising steadily. Why do you think we are headed for something worse again?
DC: The U.S. created trillions of dollars to fight the financial crisis of 2008 and 2009. Most of those dollars are still sitting in the banking system and aren't in the economy. Some have found their way into the stock markets and the bond markets, creating a stock bubble and a bond superbubble. The higher stocks and bonds go, the harder they're going to fall.
TMR: When Streetwise President Karen Roche interviewed you last year, you predicted a devastating crash. Are we getting closer to that crash? What are the signs that a bond bubble is about to burst?
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Missing the 2014 Casey Research Summit (Thriving in a Crisis Economy) could be hazardous to your portfolio.
Sept. 19-21 in San Antonio, Texas. |
TMR: Isn't that a function of low interest rates?
DC: Yes, it is. Central banks all around the world have attempted to revive their economies by lowering interest rates to all time lows. It's discouraging people from saving and encouraging people to borrow and consume more. The distortions that is causing in the economy are huge, and they're all going to have to be liquidated at some point, probably in the next six months to a year. The timing of these things is really quite impossible to predict. But it feels like 2007 except much worse, and it's likely to be inflationary in nature this time. The certainty is financial chaos, but the exact character of the chaos is, by its very nature, unpredictable.
TMR: Casey Research precious metals expert Jeff Clark recently wrote in Metals and Mining that he's investing in silver to protect himself from an advance of what he calls "government financial heroin addicts having to go cold turkey and shifting to precious metals." Do you agree or are you more of a buy-gold-for-financial-protection kind of guy?
DC: I certainly agree with him. Gold and silver are two totally different elements. Silver has more industrial uses. It is also quite cheap in real terms; the problem is storing a considerable quantity—the stuff is bulky. It's a poor man's gold. We mine about 800 million ounces (800 Moz)/year of silver as opposed to about 80 Moz/year of gold. Unlike gold, most of silver is consumed rather than stored. That is positive.
On the other hand, the fact that silver is mainly an industrial metal, rather than a monetary metal, is a big negative in this environment. Still, as a speculation, silver has more upside just because it's a much smaller market. If a billion dollars panics into silver and a billion dollars panics into gold, silver is going to move much more rapidly and much higher.
TMR: Are you are saying that because silver is more volatile generally, that is good news when the trend is to the upside?
DC: That's exactly correct. All the volatility from this point is going to be on the upside. It's not the giveaway it was back in 2001. In real terms, silver is trading at about the same levels that it was in the mid-1960s. So it's an excellent value again.
TMR: In another recent interview, you called shorting Japanese bonds a sure thing for speculators and said most of the mining companies on the Toronto Stock Exchange (TSX) weren't worth the paper their stocks were written on, but that some have been priced so low, they could increase 100 times. What are some examples of some sure things in the mining sector?
DC: Of the roughly 1,500 so-called mining stocks traded in Vancouver, most of them don't have any economic mineral deposits. Many that do don't have any money in the bank with which to extract them. The companies that I think are worth buying now are well-funded, underpriced—some selling for just the cash they have in the bank—and sitting on economic deposits with proven management teams. There aren't many of them; I would guess perhaps 50 worth buying. In the next year, many of them are likely to move radically.
TMR: Are there some specific geographic areas that you like to focus on?
DC: The problem is that the whole world has become harder to do business in. Governments around the world are bankrupt so they are looking for a bigger carried interest, bigger royalties and more taxes. At the same time, they have more regulations and more requirements. So the costs of mining have risen hugely. Political risks have risen hugely. There really is no ideal location to mine in the world today. It's not like 100 years ago when almost every place was quick, easy and profitable. Now, every project is a decade long maneuver. Mining has never been an easy business, but now it's a horrible business, worse than it's ever been. It's all a question of risk/reward and what you pay for the stocks. That said, right now, they're very cheap.
TMR: Let's talk about the U.S. Are we in better or worse shape as a country politically and economically than we were last year? At the Casey Research Summit last year, I interviewed you the morning after former Congressman Ron Paul's keynote, and you said that you hoped that the IRS would be shut down instead of the national parks. There's no such shutdown going on today, so does that mean the country is more functional than it was a year ago?
DC: It's in worse shape now. The direction the country is going in is more decisively negative. Perhaps what's happening in Ferguson, Missouri, with the militarized police is a shade of things to come. So, no, things are not better. They've actually deteriorated. We're that much closer to a really millennial crisis.
TMR: Your conferences are always thought provoking. I always enjoy meeting the other attendees—it's always great to talk to people from all over the world who are interested in these topics. But you also bring in interesting speakers. In addition to your Casey Research team, the speakers at the conference this year include radio personality Alex Jones and author and self-described conservative paleo-libertarian Justin Raimondo. What do you hope attendees will take away from the conference?
DC: This is a chance for me and the attendees to sit down and have a drink with people like Justin Raimondo and author Paul Rosenberg. I'm looking forward to it because it is always an education.
Another highlight is that instead of staging hundreds of booths of desperate companies that ought to be put out of their misery, we limit the presenting mining companies in the map room to the best in the business with the most upside potential. That makes this a rare opportunity to talk to these selected companies about their projects.
TMR: We recently interviewed Marin Katusa, who was also excited about the companies that are going to be at the conference. He was bullish on European oil and gas and U.S. uranium. What's your favorite way to play energy right now?
DC: Uranium is about as cheap now in real terms as it was back in 2000, when a huge boom started in uranium and billions of speculative dollars were made. So, once again, cyclically, the clock on the wall says buy uranium with both hands. I think you can make the same argument for coal at this point.
TMR: You recently released a series of videos called the "Upturn Millionaires." It featured you, Rick Rule, Frank Giustra and others talking about how you're playing the turning tides of a precious metals market. What are some common moves you are all making right now?
DC: All of us are moving into precious metals stocks and precious metals themselves because in the years to come, gold and silver are money in its most basic form and the only financial assets that aren't simultaneously somebody else's liability.
TMR: Thanks for your time and insights.
You can see Doug LIVE September 19-21 in San Antonio, TX during the Casey Research Summit, Thriving in a Crisis Economy. He'll be joined on stage by Jim Rickards, Grant Williams, Charles Biderman, Stephen Moore, Mark Yusko, Justin Raimondo, and many, many more of the world's brightest minds and smartest investors. To RSVP and get all the details, click here.
The article How is Doug Casey Preparing for a Crisis Worse than 2008? was originally published at Casey Research
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Tuesday, September 2, 2014
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