Wanted: Rubes

The headlines of the hour pertain to what journalists are calling The Great Fall of China.  Following the devaluation of the China’s currency, evidence of a slowdown and the flight of capital, global stock markets fell in what is now being called ‘Black Monday‘.

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The US Dow Jones index crashed more than 1000 points within minutes of opening before stabilising to trade around five per cent lower on Monday. It’s an unprecedented move for the Dow which has never lost more than 800 points in a single day.
Stockmarkets in the UK, Germany, France, Italy and Spain also plummeted after China’s Shanghai Composite Index lost 8.5 per cent on Monday – the largest margin in eight years.

The UK’s FTSE 100 index lost more than $85 billion in the first three hours of trading while markets in Japan, Hong Kong, Korea and Australia all closed more than more than 4 per cent down.

The massive sell off, dubbed the “Great Fall of China” is being stoked by fears China has lost control of the situation and doesn’t have the means to fix it.

The global sell-off made a mockery of Jack Lew’s assurance, made at a talk in the Brookings Institute, that China’s markets weren’t linked to the rest of the world.

Jack Lew, speaking at the Brookings Institution in July, confidently assured that Americans were immune from weakening markets in China.

“I will say that China’s markets still are pretty much separated from world markets,” the secretary of Treasury, said. “They’re, obviously, moving towards being more integrated, but right now they’re not.”

Chico Harlan, writing in the Washington Post, says Lew was actually right. Beijing’s stock exchanges are not linked to the world. The problem is that they’re not linked to reality either. However China’s economy is linked to the global engine. What actually happened is that China’s stock market began as a Potemkin project to assure the world of  Beijing’s strength.  Chinese investors knew the government would be propping up a mere facade; that the worse China’s economy got, the more the Communist Party would paint the facade. Harlan writes:

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Let’s take a moment to state clearly that the stock market and the “real economy,” particularly in China, don’t always dance together. Until 2013, China’s major indexes were among the poorest-performing — which made almost as little sense as what happened next.

Starting about a year ago (yes, amid the slowdown), equities boomed. The Shanghai Composite Index more than doubled, and much of China was in a stock-buying frenzy, most of them mom-and-pop investors rather than major money managers. Shares looked like one of the few good investments in the country, particularly with the real estate market cooling. In a sign of how weird it got, there was even an explosion in margin lending — where individuals borrowed money against the value of their portfolios. Chinese bought stocks with virtually no mind of how the companies were actually performing. On the Shenzhen stock market, the average company had a price-to-earnings ratio of nearly 70:1; in other words, companies were valued way way way beyond their (scant) earnings. (On the Dow, by comparison, that ratio is about 16:1).

What drove this frenzy, in part, was the assumption that a slumping economy would actually help stock prices — by prompting the government to unleash a massive stimulus.

“Whenever bad news came out from the Chinese economy, very frequently the Chinese stock market would rally,” said Patrick Chovanec, a chief strategist at Silvercrest Asset Management. “There was this perverse expectation — fiscal stimulus, lending stimulus. You know, good news equals bad news.

“People were telling themselves stories, just like in the dotcom bubble. ‘The government will put more money into the economy, especially as it is going down.’”

The China markets were to use the American term, “too big to fail” — and when  they collapsed the fall was a proxy indicator not of itself but of the underlying competence of China’s management.  The crisis shattered the illusion of the status quo, which was inconvenient for everybody.  Fergus Ryan, writing in the Guardian, quotes sources that regret that capitalism isn’t being more cooperative with government. “China’s leaders look powerless against destructive market forces. The longstanding perception created by Communist rulers that they are always ultimately in charge takes a battering from feral capitalism,” his article leads. It’s a phrase we often hear: feral capitalism.  What happens when it meets Feral Communism?  The score so far: markets 1: politburo 0.

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The authorities’ failure to step in to stop Monday’s market tumult seems to suggest the government has given up after throwing everything at the problem. There are signs now that the country’s transition to a “new normal” is coming up against some stubborn roadblocks.

Last week, state media ran an unexpectedly frank commentary describing the fierce resistance that Xi’s reforms were meeting within the Communist party. “The in-depth reform touches the basic issue of reconfiguring the lifeblood of this enormous economy, and making it healthier,” it said. “The scale of the resistance is beyond what could have been imagined.”

The Western parliamentary left appears shaken by events in China, which has undermined the belief that economies could be managed by the power of the State.  This belief was essential to Western social democrats who thought they had found a sustainable formula for milking the cows without necessarily thinning the herd.

Larry Summers, the former US Treasury Secretary under Bill Clinton, said today’s crash could be ‘the early stage of a very serious situation’.

Billionaire US presidential hopeful Donald Trump, meanwhile, warned the crisis could get ‘very messy’ and warned of a looming depression.

Former Treasury aide under Gordon Brown, Damian McBride went even further – claiming the crisis would prove to be ’20 times worse’ than in 2008.

Now the herd is bolting in all directions. The failure of China’s monetary policy has caused Paul Mason in the Guardian to question whether Labour stalwart Jeremy Corbyn’s plan to do the same thing isn’t misguided.  In the process Mason touches upon an obvious but ignored fact.  Once everybody starts playing the Hope and Change Game,  the Third Way Tax, Spend and Print routine, and similar variations of ‘gentle socialism’ then the mathematical outcome is everybody loses.

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Since China slashed the value of the yuan against the dollar, the financial world has been forced into a guessing game …

It’s a question not just with global ramifications but parochial ones. When Yvette Cooper slammed Jeremy Corbyn’s call for “people’s quantitative easing” – printing money and spending it on infrastructure instead of debt – she was, in her own way, plunging Labour into the same debate as the wider one triggered by China …

When interest rates approach zero – as they did in the slump that followed 2008 – you have to print money. This, too, all things being equal, will collapse the value of your currency some more and you get an even nicer accident: you steal some growth from anywhere that is not printing money. America and Britain did it first, in early 2009; Japan waded in massively in 2012 and the eurozone finally did it, in the teeth of German resistance, in January this year.

Economists have always feared that, once everybody starts printing money, reducing the effectiveness of the growth-stealing game, one player would break ranks and turn the “nice accident” of lower exchange rates into an overt policy. If that player is massive – like China – and has massive overcapacity of goods, services and labour, the impact would be to export stagnation to the rest of the world.

Once everybody subsists at the expense of Other People, one soon runs out of Other People. If China, with lotsa people, couldn’t do it, even after soaking America, then who could?

To make things work, Mason points out,  only Some People can be allowed to live at the expense of Other People.  Once everyone starts acting like China the whole shebang topples over. Dishonesty is only lucrative for as long as honesty remains in vogue somewhere.  Once everybody is a crook it’s trouble. There has to be a steady supply of civilians for robbers to stick up otherwise the perps will have to resort to waylaying each other, which is no good.

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An all-perp civilization is mathematically impossible and that is, at least in part, at the root of the current global crisis. Money has for too long become regarded as something to redistribute to buy votes. The Greeks do it, the Euros do it, Obama does it and China until recently played the game of “beggar thy neighbor”. For a long time they seemed able to do this without harm. But as with a recursive algorithm, the money-spinning eventually has to return actual goods and services for the function call to work.

Once the recursive algorithm keeps calling itself without ever terminating and returning something other than another function pointer the routine fails. The problem is that too many virtual claims are now being posted against too few actual goods and services. The world financial system is trying and failing to satisfy the immediate claims on global goods and services without revealing it’s aggregate assets are actually unable to cover all its commitments. It is only locally solvent but globally bankrupt.

The crisis will end in either one of two ways. Either the world’s economic managers will print so much money that claimants will be convinced the system is globally solvent (thereby stopping the run) or the claims will be written down so that the claims match the available assets.

What “feral capitalism” does is send investors to the barber for a haircut. It will hold up a mirror to the bankrupt and show him his actual state of affairs. This will cause no end of trouble to politicians who’ve promised entitlements to all and sundry because it will make clear to the electorates of Venezuela, Greece, much of Europe, China and the US that all that free government money their leaders have promised them is a lie.  Nothing but Three Card Monte, a shell game.

There is still money but the pea under the shell is actually your own pea, not a prize sourced externally from the system. That is the hard reality under the illusion. Most of the other stuff you are counting on obtaining, because it’s been promised by a guy with creased pants, is really fairy mist, lovely to behold at a distance, but smoke and mirrors at close range.

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The collapse of currencies, markets, accounts, is really like the fall of dreamscape cities in movies when you are about to wake up. But something of it is real. The periodic upheavals the world undergoes has the purpose of momentarily putting the worst grifters out of business so that in the interval the sheep can recover their depleted numbers.

It’s the Circle of Life, the Wheel of Fortune, Hakuna Matata.

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