China's Minsky Moment Is Imminent

Crescat Capital's Q2 letter to investors shouold be retitled "everything you wanted to know about the looming bursting of the world's biggest credit bubble... but were afraid to ask..." Don't say we didn't warn you...

History has proven that credit bubbles always burst. China by far is the biggest credit bubble in the world today. We layout the proof herein. There are many indicators signaling that the bursting of the China credit bubble is imminent, which we also enumerate. The bursting of the China credit bubble poses tremendous risk of global contagion because it coincides with record valuations for equities, real estate, and risky credit around the world.

The Bank for International Settlements (BIS) has identified an important warning signal to identify credit bubbles that are poised to trigger a banking crisis across different countries: Unsustainable credit growth relative to gross domestic product (GDP) in the household and (non-financial) corporate sector. Three large (G-20) countries are flashing warning signals today for impending banking crises based on such imbalances: China, Canada, and Australia.

The three credit bubbles shown in the chart above are connected. Canada and Australia export raw materials to China and have been part of China’s excessive housing and infrastructure expansion over the last two decades. In turn, these countries have been significant recipients of capital inflows from Chinese real estate speculators that have contributed to Canadian and Australian housing bubbles. In all three countries, domestic credit-to-GDP expansion financed by banks has created asset bubbles in self-reinforcing but unsustainable fashion.

Post the 2008 global financial crisis, the world’s central bankers have kept interest rates low and delivered just the right amount of quantitative easing in aggregate to levitate global debt, equity, and real estate valuations to the highest they have ever been relative to income. Across all sectors of the world economy: household, corporate, government, and financial, the world’s aggregate debt relative to its collective GDP (gross world product) is the highest it has ever been. Central banks have pumped up the valuation of equities too. The S&P 500 has a cyclically adjusted P/E of almost 30 versus a median of 16, exceeded only in 1929 and the 2000 tech bubble.

The US markets are also in a valuation bubble because US-owned financial assets have never been more richly valued relative to income as we show below. The picture is equally frothy if we include real estate, also at record valuations to income. China’s capital outflow spillover from its credit bubble has driven up real estate valuations around the world.

The unique aspect of the current global credit bubble is that China has emerged at its epicenter. Since 2008, China has created the world’s largest M2 money supply, the world’s largest and most grossly mismarked banking assets, the largest global trade with the rest of the world, the second-largest GDP, and the world’s largest credit-to-GDP imbalances.

Based on our studies of past financial crises, forecasting credit bubbles that are ready to burst with a high probability requires a combination of two key macro indicators that have been proven out across different countries and across time:

1. A high absolute level of debt to GDP relative to history
2. A high recent debt-to-GDP growth relative to long-term trend, what the BIS refers to as the “credit-to-GDP gap”. The credit-to-GDP gap flashes a warning signal of a potential banking crisis when credit growth rises more than 10% above its long-term trend.

The chart below shows thirteen countries with significant credit imbalances based on one or both measures. Note that at least ten of the countries have significant trade and capital flow links with China.

The first panel in the chart above shows seven countries including China that have historically high household and corporate debt compared to GDP, our first indicator.

The second panel shows the top-ten countries today with the highest credit-to-GDP gaps according the BIS, our second indicator.

Note that six of the credit-to-GDP gap countries are in Asia.

They include China and five related “Asian tiger” economies. Hong Kong has both the highest outright debt-to-GDP and the highest credit-to-GDP gap of all countries tracked by the BIS today. Hong Kong is not even technically its own country. It is part of China under a “one country, two systems” concept. One is Chile, the world’s largest copper producer and copper exporter to China. Four countries overlap on both indicators: Hong Kong, China, Canada, and Singapore.

What the chart above emphasizes is that not only is China in a credit bubble that is poised to burst, it is linked to many other countries through trade and capital flows that also have large credit imbalances making the China bubble even more significant. The nexus of China with these other credit bubbles is just one of the reasons that we believe China is ground zero for a pending financial crisis that will have global repercussions.

Using the “credit-to-GDP gap” to flag likely credit busts is based on the work of economist Hyman Minsky, an academic whose career focused on studying the causes of financial crises. Minsky’s models were posthumously credited with predicting the global financial crisis and adopted by the BIS. Minsky’s “financial-instability hypothesis” essentially postulates that long stretches of prosperity sow the seeds of the next financial crisis. A long stretch of prosperity was certainly the case with China over the last 25 years as shown in the chart below. China’s share of global GDP grew from less than 2% in the early 1990s to almost 15% today. China even accelerated its growth rate in the wake of the global financial crisis in 2008. Since then, China has been the largest GDP growth economy in the world accounting for 54% of global GDP growth.

The problem is that long stretches of prosperity tend to be delivered with increasingly speculative leverage and unproductive investment activity. The China growth story is not likely a miracle of communist government central planning; it’s a massive credit bubble, almost certainly the largest ever. China’s impressive growth has come overwhelmingly and almost exclusively from unsustainable credit expansion combined with extensive, largely unprofitable domestic infrastructure expansion. In the last two decades, China has seen the largest construction boom in any country ever. The construction boom can be seen in the chart below by looking at the portion of China’s GDP that has gone into fixed asset investment which has grown almost every year since 2000 from 23% of GDP to 87% of GDP in 2016.

We believe this has been a centrally planned misallocation of capital into white elephant, unproductive fixed-asset infrastructure projects that on balance will likely not ever generate sufficient return on investment to justify their cost. The penalty will come from China’s future economic growth.

A recent study by University of Oxford, Saïd Business School published in the Oxford Review of Economic Policy finds that China’s low-quality infrastructure investments pose significant risks to the Chinese and the global economy. The study headed by Atif Ansar analyzed 95 large Chinese road and rail transport projects in China. The evidence suggested that for over half of the infrastructure investments in China made in the last three decades, the costs were larger than the benefits they generated, which means the projects destroyed economic value.

Dr. Ansar and his colleagues concluded that investing in unproductive projects results in a boom only while construction is ongoing. The boom turns to bust when forecasted benefits fail to materialize and the projects become a drag on the economy. Because of the large build-up of debt associated with past projects, they warn that there is a strong probability that China is headed for an infrastructure-led national financial and economic crisis that will likely also be a crisis for the international economy.

A study of our own shows similar findings. In the left-hand panel of the chart below, we show the aggregate free cash flow profitability of all listed Chinese non-financial companies. It has been persistently and cumulatively negative since 2001 while aggregate debt has skyrocketed. The data clearly show that the debt and infrastructure expansion economic model for China has had more costs than benefits over the last 16 years for the whole of Chinese public non-financial companies. Look at the aggregate cumulative free cash flow of the more fundamentally sound non-financial companies of the S&P 500 over the same period in the right-hand panel. Note the stark contrast.

The Chinese local government sector has piled up a similar amount of debt compared to China’s listed corporates in supporting China’s poor returning infrastructure projects.

Michal Pettis a professor of finance at Guanghua School of Management at Peking University in Beijing explains the problem with China’s economic model:

“In a market economy, investment must create enough additional productive capacity to justify the expenditure. If it doesn't, it must be written down to its true economic value. This is why GDP is a reasonable proxy in a market economy for the value of goods and services produced. But in a command economy, investment can be driven by factors other than the need to increase productivity, such as boosting employment or local tax revenue. What's more, loss-making investments can be carried for decades before they're amortized, and insolvency can be ignored. This means that GDP growth can overstate value creation for decades.”

The insolvency problem has already been building up for decades in China. It can’t go on forever, because it has led to a massive credit bubble that is doomed to burst. When a country piles more and more credit onto a faulty underlying economic model, it becomes a Ponzi finance scheme that has no other possible outcome but to implode on itself.

According to Minsky, there are three possible credit regimes in an economy:

1. Hedge Financing. Households and firms rely on future cash flows to repay principal and interest on their borrowings.
2. Speculative Financing. Borrowers rely on cash flow but can afford to repay only interest.
3. Ponzi Financing. Cash flows neither cover principal nor interest. Debt can only be serviced with the addition of new borrowing.

In a Ponzi-financed economy, lenders lend more and borrowers borrow more based on the greater fool theory, the idea that asset prices will keep rising. It all works in upward spiraling, self-reinforcing fashion until it simply cannot go on any longer and then asset prices suddenly drop, to the surprise of the vast majority, and then there is a self-reinforcing unwinding of the bubble, a financial crisis. The onset of the crisis is marked by a grab for liquidity, freezing credit markets, and a collective rush for the exits. This is what has come to be known as the “Minsky moment”. The initial asset-price downturn is usually sharp, but it can also be protracted. The downward impact to future GDP growth can be especially prolonged after a credit bust as the experience of Japan’s lost two decades shows.

In our analysis, the Chinese economy today is a classic Ponzi finance regime as described by Minsky and has been so in an egregious way since 2008. At the center of China’s credit bubble is its massive and opaque financial sector. The China Banking Regulatory Commission reports that the Chinese banking system had USD 35 trillion in on-balance-sheet banking assets through the first quarter of 2017. This is an incredible more-than-fourfold bank-credit expansion since 2008 as we show in the chart below. As a result, based on the ratio of on-balance-sheet banking assets to GDP, China’s banking bubble today is more than three times larger than the US banking bubble prior to the global financial crisis!

Just as alarming as China’s on-balance-sheet banking assets are China’s shadow banking assets. The British newspaper, The Daily Telegraph, recently broke a story based on an apparent leak of the People’s Bank of China’s 2017 Annual Financial Stability Report completed in June. The PBOC report allegedly showed that off-balance sheet banking assets in China have risen to somewhere between USD 30 and 40 trillion recently. These figures have yet to be confirmed or denied because the actual PBOC report has apparently been concealed by the PBOC and the IMF. Including both on-balance sheet and shadow bank assets shown below, the Telegraph story claims that “Chinese banks have built up exposure to assets equal to 650% of GDP”. The amount of shadow banking assets in China had been more widely recognized before the PBOC report to be only USD 9 trillion. If the amount that China’s off-balance sheet banking assets have risen to even half as much as the Telegraph reported – see the chart below (about USD 37 trillion is what it shows) – China would have recently had a shadow-banking gap that is even more concerning than the credit-to-GDP gap flagged by the BIS.

The reason that China’s shadow bank asset growth is a concern is that these assets have long been regarded by credible analysts, bankers, and regulators as China’s least liquid and poorest quality loans. In many cases, these are non-performing loans once held on bank balance sheets that have been rolled over, taken off balance sheet, and newly funded through wealth management products (WMPs) and other shadow banking vehicles for the banks’ off-balance-sheet activities. WMPs are such big business that the Chinese tech juggernauts have gotten in on the game including Alibaba’s subsidiary, Ant Financial, Tencent, Bidu, and JD.com. In our analysis, these companies, wittingly or not, through their “fintech” businesses, have become a central part of China’s grand Ponzi financing scheme. They have built the platforms for Chinese depositors to easily buy WMPs on their smart phones and indeed Chinese depositors are doing just that. It makes sense that shadow credit is exploding. The problem is that the idea of funding China’s rapidly growing long-term, illiquid, and heavily non-performing assets with rapidly growing short-term, liquid liabilities, all facilitated by the banks and tech companies, and all kept off balance sheet, is a formula for a systemic banking crisis.

One of the reasons shadow banking assets have been exploding in the last several years is the moral hazard associated with them. There is an implicit assumption in China, but not an explicit guarantee, that the banks and ultimately the Chinese government will make good on shadow-bank deposits in the event of a financial crisis. The problem is that such a moral hazard is what will almost certainly guarantee the crisis.

Minsky said an extraordinary acceleration in credit would be needed just to maintain a constant growth rate during the late stages of a credit bubble, just before the bust. The idea of monitoring the credit-to-GDP gap, and why the Telegraph estimates for shadow banking growth would be a strong crisis warning signal even at half the amount, is that credit growth naturally accelerates as the “Minsky moment” is arriving in a Ponzi finance-style banking system. Therefore, if China really were on the last legs of its real GDP expansion, before the bust were to kick in, it would make perfect sense that it would need rapidly accelerating credit growth to eke out any sort of positive real GDP growth at all. In a Ponzi finance-styled economy, the scheme goes on until it goes bust because that is the model they have committed to. Only the bust can force a change.

Chinese leaders have likely been implicitly sanctioning the acceleration of credit growth this year in their shadow banking markets to keep growth going at all costs even while publicly admonishing it ahead of the 19th National Party Congress (NPC) in November. Over the past several weeks, we have been hearing over and over that the Chinese leaders will not let the bubble burst before the NPC in November. Such is the conventional wisdom on Wall Street today. The takeaway for us is that Wall Street is finally acknowledging that China is indeed in a massive credit bubble. Before, during, or after the NPC, the timing of the bursting of the Chinese currency and credit bubble is imminent in our view. We believe it is prudent to be positioned ahead of the NPC and ahead of everyone else who tries to scramble for the exits after it is too late. We want to be shepherds not sheep. Like in the Big Short, sure, there can be some short-term pain in being early, but it was the early players who stuck it out and had the foresight and strength of their conviction who ultimately reaped the big rewards for their investors. We believe being early is the way to reap the big rewards on the China bust. We believe the bust is coming soon.

The China credit bubble already started to burst in late 2015 and early 2016 and Crescat capitalized extremely well during this period as we showed in our last quarterly letter while markets and most other managers were down. We believe that is a foreshadowing what is still to come on a bigger scale. The China equity bubble already peaked in 2015 as can be seen in the four Chinese stock market indices in the chart below. The chart also shows based on the aggregate revenue fundamentals of all Chinese companies, which appear to be now in the third year of revenue recession, that China’s GDP has very likely has been overstated recently and that its economy is under much more stress than most global investors realize. In other words, the huge non-performing debt and loss-making company problem has likely only been getting worse as debt has been exploding recently.

Chinese equities still have much further down to go down in our strong opinion based on still-excessive valuations as we show further below. The banking crisis has not even happened yet in terms of losses being recognized through earnings charges and book value write-downs. Bad debt has been building up behind the scenes for two decades since the last banking recapitalization. Bank earnings are vastly overstated. By rolling over non-performing loans facilitated by new short-term credit, such as WMPs, banks have continued to report strong earnings and appear cheap. This is not much different than how US banks looked in 2007 before all hell broke loose. The difference is that Chinese banks are much bigger and likely much more insolvent.

If one wants to understand how big China’s overall financial sector bubble is today, relative to the overall China equity market, just look at the financial sector weight in the major Chinese and Hong Kong Indices: 36% of the Shanghai Composite; 43% of the CSI 300; 44% of the Hang Seng Index. Financials only make up 25% of the China MSCI Index because 28% of that one is crowded out by two tech stocks, Tencent and Alibaba, each priced at a frothy 11x EV/Sales. The indices in our table below that appear cheap on P/E are heavily overweighed in the highly leveraged financial sector. The E in the P/E of Chinese banks and other financials is simply not credible. Neither is the book value. Many global investors today are being fooled by this huge value trap. China’s technology–laden indices, Shenzhen and ChiNext, are also overvalued. Our table shows them with negative median free cash flow and massive P/Es. Chinese equities are overvalued across the board and offer excellent short opportunities today.

The Chinese currency is also highly overvalued and headed for a crisis as we explain further below. By shorting overvalued Chinese equities through US ETFs and ADRs, one also gets the bonus of the yuan currency short imbedded in the trade. By shorting ultra-frothy Chinese fintech stocks, including through US ADRs, one also gets exposure to China’s coming shadow banking meltdown.

The China currency and credit bubble has only gotten bigger since early 2016. The big credit bust is still ahead of us, in our strong opinion. The bust in some form will be triggered by bank runs from the masses of Chinese depositors when they learn that they are the ones holding the bag with respect to China’s insolvent banking system. We believe this is why the Chinese currency has already been under so much pressure already from capital outflows. It is pressure from the Chinese trying to get their money out of the banking system. The capital outflows to date have likely been less from the masses and more from wealthy Chinese elites who have seen the writing on the wall for some time already. Like money that fled the Soviet Union and Russia prior to and during its two big currency crises in the 1990s, that money is probably never coming back. The masses within China are the ones buying WMPs on their smartphones.

When the outflow pressure shifts from the elites to the masses of domestic bank and shadow-bank depositors, there is high risk of bank runs and social unrest. When this threat becomes all too real and begins to transpire, in our analysis, that is when Chinese authorities will be left with no other viable option than to resort to massive quantitative easing to bail-out and recapitalize their banks and re-stimulate their economy. That is when the insolvency problem in the Chinese banking system will have to be addressed, one way or another, and if China has true ambitions to transition from an emerging market to a developed economy, it will have to come clean on its NPLs. QE is therefore the only implicit guarantee that Chinese depositors should be relying on, but QE does not prevent a crisis; it will likely only coincide with the crisis.

So how much money will China have to print to recapitalize its banking system? Let’s be conservative and say that China’s non-performing loans are only half as bad as they were when it recapitalized its banks in the early 2000s. China ultimately confessed that 40% of its banking assets were non-performing loans that had built up in the wake of the 1997 Asian Financial Crisis. Let’s say it is only 20% today. It is probably more. Let’s also assume the most conservative estimates for shadow bank assets of USD 9 trillion. Along with USD 35 trillion of on-balance sheet assets (the Telegraph article says it is now $38 million), our conservative estimate equates to USD 8.8 trillion of loans in the Chinese banking system today that will effectively never be repaid and will need to be written off. Such an amount is equal to 84% of China’s GDP, more than enough to wipe out all the equity in its Chinese banking system twice over. If the banks were to write that debt down and recapitalize the banks with money printing, it would equate to 37% of its M2 money supply, all else equal a 37% currency devaluation. This is our best-case scenario for the inevitable devaluation of the China currency. It will likely be worse.

The 1997 Asian Currency Crisis provides several mid-case scenarios for what we should expect from the coming Chinese yuan devaluation. In the second half of 1997, four Asian Tigers came off extensive credit bubbles that had been building over a prolonged period including Thailand, South Korea, Malaysia, and Indonesia. In the bust, their currencies all declined between 47% and 85% within six months. Another mid-case comparable would be post-Soviet Russia where in Russian financial crisis of August of 1998, the ruble crashed 70% in one month. For the worst case scenario, the comparable is China’s former communist neighbor, the Soviet Union. The Soviet ruble was essentially a 100% wipeout, a zero though hyperinflation after the Soviet Union breakup the early 1990s.

One key signal that the China’s credit bubble is about to burst is housing prices in China’s Tier 1 and Tier 2 cities. Home prices in Tier 1 and Tier 2 cities reflect one of the biggest asset bubbles in China to go along with its massive credit expansion. Real estate prices have been soaring for many years led by Tier 1 cities such as Beijing and Shanghai. Rent yields in Beijing recently hit a new low of about 1.25% an insanely high price-to-rent multiple of 80 times. As part of China’s massive infrastructure buildout, there is an oversupply in housing. As shown in the chart below, price appreciation in Tier 1 cities has been decelerating for over a year. Prices may have turned negative in July in Beijing and Shanghai according to local sources. If true, this is just one of many sings that we have laid out herein that China’s Minsky moment is imminent.

Another new catalyst that is heating up right now is the possibility of President Trump imposing trade sanctions on China for “unfair trade practices” to punish them for not taking a tougher stance on North Korea also perhaps to fulfill a campaign promise.

Demographic trends are another key catalyst that point to clear bursting of the China bubble soon.

The idea here as shown in the chart above is that China’s working age population will peak next year.

The idea behind Minsky’s work is that it is the unsustainability of the credit bubble itself that is the catalyst for its implosion, but there are also many specific catalysts that have identified to justify our conviction that China bubble is going to burst soon. We have discussed many of them herein particularly related to China’s “credit gap”. In our last quarterly letter, we showed why Federal Reserve tightening credit late in the business/economic cycle is a significant catalyst to accelerate the bursting of the China bubble.

Here we enumerate the catalysts for the imminent bursting of the Chinese currency and credit bubble discussed herein and in our other work:

1. Fed credit tightening puts pressure on Chinese currency

2. China and Hong Kong is now flashing a banking crisis warning signal in BIS “credit-to-GDP gap” model

3. China’s connections to other countries also flashing warning signals of credit bubbles about to burst

4. Pressure from Chinese capital outflows

5. Threat of bank runs from Chinese masses

6. Housing prices on precipice of drop in China Tier 1 and Tier 2 cities from record price-to-rent levels and supply/demand imbalance

7. Ongoing poor and deteriorating fundamentals of China’s non-financial listed companies linked to unsustainable infrastructure investment binge

8. Dwindling, encumbered, and likely overstated foreign reserves

9. Imminent threat of US trade sanctions on China

10. Looming cresting of China’s workforce population

11. China credit bust already started to unfold in 2015, an early warning signal, but just a taste of what is to come, because the credit imbalances have only become more extreme

12. Widespread Wall Street complacency ahead of China NPC political elections in November

Fonte: qui

China Dumps Treasuries: Foreign Central Banks Liquidate A Record $403 Billion In US Paper

One month ago, when we last looked at the Fed's update of Treasuries held in custody, we noted something troubling: the number had continued to drop sharply, declining by another $14 billion in one week, and pushing the total amount of custodial paper to $2.788 trillion, the lowest since 2012. One month later, we refresh this chart and find that in last week's update, there is finally some good news: foreign central banks finally bought some US paper held in the Fed's custody account, which following months of liquidation, rose over the past two weeks by $23 billion, the biggest two-week advance since November of 2016, pushing the total amount of custodial paper to $2.816 trillion, the highest since early October.

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That was the good news, and we use the term loosely in as much as the custody account can be used as a proxy of foreign buying, which according to most rates watchers, it can.

The bad news came out with the release of latest monthly Treasury International Capital data for the month of October, which showed that the troubling trend presented one month ago, has accelerated to an unprecedented degree.

Recall that in mid-November, we reported that in the latest 12 months we observed a record $375 billion in Treasury selling by foreign central banks in the period August 2015-September 2016, something unprecedented in size.

Fast forward to today when in the latest monthly update for the month of October, we find that what until a month ago was "merely" a record $375 billion in offshore central bank sales in the LTM period ending  September 30 has, one month later, risen to a new all time high $403 billion in Treasuries sold in the past 12 months.

As the chart below shows, there has never been such an aggressive selling of US Treasuries over a 12 month period in history.

The biggest seller, and keep in mind that TIC data is on a market-price adjusted basis, was once again was China, which in October "sold" a record $41 billion in US paper (the actual underlying number while different, as this particular series is adjusted for Mark to Market variations, will be similar), and a massive $125 billion in the last 4 months, bringing its total Treasury holdings to just $1.116 trillion, the lowest amount of US paper held by Beijing since 2010. In the process, China has now been overtaken by Japan for the top US creditor position in terms of total holdings with $1.132 trillion, for just the second time.

It wasn't just China: Belgium, which has long been rumored to be the venue where China's keeps its "secret" offshore Treasury holdings couretsy of Euroclear, also dumped its TSY holdings, and in October its stated holdings (which again have to be adjusted for MTM), tumbled from $143Bn to $117Bn, the lowest since the summer of 2015.

Furthermore, as we have shown previously, when superimposing China and Belgium's holdings together, these tend to allign almost perfectly with the monthly change in Chinese reserves, which as reported before, have been declining sharply in recent months as a result of China's aggressive attempts to prevent a sharp devaluation of the Yuan. This can be seen on the chart below, and confirms that at least when it comes to China, the reason for the selling of Treasurys has been due to reserve liquidation.

As we pointed out one month ago, what has become increasingly obvious is that both foreign central banks, sovereign wealth funds, reserve managers, and virtually every other official institution in possession of US paper, is liquidating their holdings at a disturbing pace, something which in light of the recent surge in yields to over 2 year highs, appears to have been a prudent move.

In some cases, like China, this is to offset devaluation pressure; in others such as Saudi Arabia and other petroleum exporting nations, it is to provide the funds needed to offset the drop in the petrodollar, and to backstop the country's soaring budget deficit. In all cases, it may suggest concerns about a spike in future debt issuance by the US, especially now under the pro-fiscal stimulus Trump administration.

So who are they selling to? The answer, at least until August, was private demand, in other words just like in the stock market the retail investor is the final bagholder, so when it comes to US Treasuries, "private investors" both foreign and domestic are soaking up hundreds of billions in central bank holdings. As we said two months ago when we observed this great rotation in Treasuries out of official holders into private hands, "we wonder if they would [keep buying] knowing who is selling to them." Well, last month this changed, and after private investors had been happily snapping up bonds for 4 straight months, in September "other foreign investors" sold a whopping $31 billion, bringing the total outflow between public and private foreign holdings to $76.6 billion, the second highest number on record. In October, while foreign official entities sold another $45 billion, at least the pace of selling by private entities moderated somewhat, to "only" $18.3 billion.

Meanwhile, while just four months ago yields had tumbled to near all time lows, suddenly the picture is inverted, and long-yields are surging on concerns that not only will the ECB and the BOJ soon taper their purchases of the long end, but that Donald Trump is about to unleash a $1 trillion debt tsunami at a time when the Fed will not be available to monetize it, now that the Fed is again hiking rates.

While it is unclear under what conditions foreign buyers may come back - after all TSY rates have already jumped high enough to where US paper should be more than attractive to foreign official institutions - one thing is clear: as of this moment the selling strike not only continues but is accelerating, and should the foreign liquidation of Treasuries fail to slow, Yellen will soon have to plan how to not only abort the current rate experiment which continues to pressure yields higher around the globe, but to start thinking how to launch QE4 instead.

Fonte: qui

P.S.: potete usare la funzione TRANSLATE di Google(sulla colonna di destra), selezionando prima un qualsiasi linguaggio e poi successivamente, l'italiano, per avere la traduzione automatica.

Is India The Next Venezuela?

Submitted by Jayant Bhandari via Acting-Man.com,

India’s Currency Ban, Part VII

This article continues right where Part VI left off (for earlier updates on the demonetization saga see Part-I, Part-II, Part-III, Part-IV, and Part-V).

There is still huge support for Modi even among the poor.  A big carrot is dangled before them, which makes many stay numb to their current suffering.  During his election campaign in 2014, Modi promised to deposit more than Rs 1.5 million (~$22,000) in each poor person’s account once the government had seized all black money.

Massive problems have been reported with the new bills. Some have been printed on defective paper and are simply falling apart. The inferior quality of the print job is generally often on the appalling side of deplorable. The new notes are counterfeited with great abandon, quite likely to a much greater extent than they ever were in the past. So much for Modi’s plan to stop counterfeiting.

Photo credit: The Hindu

How he arrived at this fantastic figure is anyone’s guess. But given India’s GDP of $1,718 per capita, Modi has promised to deposit 1,300% of annual GDP in individual bank accounts. The total amount would be larger than the entire GDP of the US. Evidently, this does not even remotely add up.

So what is really motivating the anti-corruption feelings of so many Indians — including the salaried middle class —  simply seems to be a mixture of greed and envy. There have also been hints that India’s income tax might be repealed. This is very appealing to the salaried middle class.

Banned bank notes must be deposited by 31st December 2016.  Modi supporters widely expect that the windfall he has promised them will be announced soon thereafter. Not only isn’t there going to be any  free stuff, but bank accounts are likely to stay frozen, because the Indian government is incapable of printing all the cash needed to re-liquefy the economy.

On January 1st 2017,  when members of the salaried middle class start waking up to the reality that they have been scammed, Modi’s support should begin to crumble.  Anecdotal evidence indicates that not only the opposition, but even members of Modi’s own party are unhappy with the demonetization scheme. These politicians have been left holding bags of banned currency, on which they have had to take a cut of 20% to pay for the services of the mafia.

They cannot oppose Modi openly, as that entails the risk that they might be seen as corrupt and unpatriotic. It seems likely that Modi will eventually lose his political support. But by then he may well have established himself independent of his party. He could easily be an autocrat in the making.

Vegetable prices have declined by 25% to 50%. Electronic transactions fail even in big cities, as connections are often bad. How is this supposed to ever work in rural places, where electricity and internet connections might not even exist? One needs to be mindful of the fact that prices are not going down due to excess supply, but because poor people cannot buy anything. Are they going hungry?

Photo via indianexpress.com

Is India the Next Venezuela?

India, the world’s largest democracy, is surrounded by banana republics as the accepted narrative has it: Pakistan, Bangladesh, Nepal, Sri Lanka, Myanmar, Thailand, and Afghanistan. The situation in the Middle East and in Africa is considered yet worse.

There seems to be a lot to celebrate about India. Its democracy has been sustained over the 70 years following independence. The army has remained  fully under civilian control. Today India is also seen as an information technology juggernaut. It is claimed to be the fastest growing large economy. India is the next China, so the story goes.

The reality is very different from the perception of those who only see India through the lens of the international media.  India has a population of 1.34 billion people with a GDP of $1,718 per capita. Almost 50% of India’s citizens have no access to toilets, electricity or running water.  48% of children under the age of five are stunted, a percentage greater than in any other major country in the world.

Contrary to the perceptions created by the international media, if Africa were a country, it would actually look better than India with respect to these metrics. India has lower GDP per capita and a proportionately greater number of Indian children are exhibiting stunted growth.

As a second step in trying to understand India, it makes sense to split the population in two parts: the 25% that have benefited — directly or indirectly — from the internet and cheap telephony over the past three decades, and the remaining 75%, whose lifestyle is comparable to a medieval existence, almost animal-like.

For all intents and purposes, India is a banana republic, a wretched place of poverty and disease. The only difference between India and other well-recognized banana republics is that India has so far avoided overly negative headlines in the international media;  Indian lobbies in the US and the UK work very hard to make India look good. As noted above, this mainly serves to prop up the self-esteem of NRIs.

It has become fashionable to compare India to China. This comparison seems extremely far-fetched. Chinese GDP per capita is more than five times higher, and is growing more than four-times faster than India’s in absolute terms. If India keeps growing at the recent high rate of 7.5% and China at a mere 6.3%,  it will take India more than 135 years to catch up with China’s economic output in absolute terms.

People who have been concerned about the demonetization policy have repeatedly asked me if India is the next Venezuela. My response was “I wish it were.” On per capita basis, Venezuela’s GDP is more than seven times that of India. Venezuelans fight when they go hungry. Indians are too weak to even leave their homes. Indians should be fighting, particularly the poor, who have always got a very bad deal.

When India becomes the next Venezuela, which hopefully won’t take longer than three decades, one would actually have cause to celebrate.

Almost half of Indians have no choice but to defecate in the open. What looks like a simple problem has proved impossible for India’s government to solve. The government nevertheless wants to send probes to Mars and make India the first cashless economy. In due course, Modi will get swept away by India’s realities. The problem is that whoever succeeds him, will very likely be worse. A military general perhaps?

Photo credit: Keystone / AP

Millennia of human progress in terms of economic transactions have been wiped out  overnight. People have been forced to go back to barter.

Demonetization Continues

More than 90% of the banned banknotes have reportedly already been deposited in banks. This is widely hailed as a victory of the government. As Mumbai-based economist Mithun B. Dutta explained in a note, the reality is the exact opposite. He argues that demonetization would only have made sense if a large part of the banned currency had never made it into bank deposits.

Up until recently,  the banned currency was selling for a 20% discount to its face value. Not only has this discount disappeared in recent days, but the remaining banned bills are now trading at premiums of up to 10%.

The poorest people lack the connections to deposit their cash and get it back out. The queues outside bank branch offices have continued and the mood is increasingly desperate. Businesses are closing, with many too damaged financially to be able to ever restart again. Poor people are losing their jobs.

Food prices are down by 25% to 50%, leaving farmers without the funds needed to support the next crop planting cycle. Shops remain empty, as discretionary spending is put on hold. Many businesses have suffered sharp declines in sales. Wheat sowing is said to be down sharply as well.

Who cares when one has problems of one’s own? This half-dead old woman serves as an example for more than 75% of India’s population. She cannot even write her own name, but is expected to learn to use plastic cards. For Modi she does not count if she isn’t paying taxes and isn’t part of the formal economy; but it is Modi who will eventually be thrown out.

Desperate poor people, whose pain is not reflected in any news or statistics.

Photo credit: Praveen Kumar/HT

Members of the salaried middle class, Modi’s biggest supporters, are slowly starting to face the pinch as well. When they went to their banks on  December 1, 2016 to collect part of their salaries, they had to rub shoulders with the poorest of the country, for whom they have deep-rooted disgust. And then they had to go back home empty-handed or with only part of the cash they had wanted to withdraw.

They are still hoping that their bank accounts will be unfrozen after the demonetization deadline on December 31 passes. They will soon realize that  their accounts will stay frozen, as simple math shows there is no other possibility. Modi will have to make a new announcement on December 31 to keep his social engineering project on track with yet another patch-up job, and to keep people’s hopes up.

There has been a significant surge in spontaneous outbreaks of violence across the country. Indian police are not sufficiently trained and lack the competence to keep a material increase in social unrest under control.

Conclusion

No one has explained yet how the currency demonetization policy will lead to less corruption. Most of the outstanding cash has already made it into bank accounts, but despite that, the queues at bank branch offices seem to be never-ending. It is the unbanked, the poorest people, who are most likely to have failed to deposit their currency and get their cash back out.

The government clearly has the intention of keeping bank accounts frozen after the official deadline of 31st December 2016. The economy will remain stalled at an enormous human cost. Modi is losing his control over his own party. He has isolated himself in a cocoon, surrounded by yes-men; but the middle class, which has so far considered itself to occupy the moral high ground, is starting to experience cash-related problems as well now.

At the same time, the political opposition is fragmented and weak. Modi probably cannot even imagine losing power, believing himself to be indispensable. If he sees his support dwindling, India could easily end up being pushed toward outright autocratic rule.

To properly understand all the undercurrents, it is best to consider first principles. India is an extraordinarily irrational, tribal and superstitious place. Despite the country’s long association with Britain, which by now has lasted over 300 years, it has failed to adopt the concept of reason. India and its institutions as they exist today were constructed by the British. It was inevitable that they would crumble, as India lacks the will and human capabilities needed to maintain them.

A society lacking in rationality cannot be expected to be able to differentiate between right and wrong. It cannot have respect for the individual, or develop moral instincts. Its people will be lacking in empathy and compassion, as demonstrated by the indifference of members of the middle class to the suffering of their desperately poor fellow citizens.

When such people are given western education, it merely sits in their minds as yet another belief system. Evidently, they don’t even understand that an ethical society cannot possibly be compatible with a government reneging on the contract that is printed on its currency.

Even poor people suffer in silence, or even worse, are fighting among themselves. They too lack the necessary understanding of moral principles to feel revulsion when they are mistreated. Instead of directing their anger at those responsible for their plight, they take out their frustrations on the nearest persons weaker than themselves.

With the passage of time, Indian institutions are necessarily mutating to accommodate India’s irrational culture. Culture cannot be changed through education alone, and changing it takes a very long time. India is likely to disintegrate at some point, fragmenting into tribal units or several smaller countries. Institutional decay has been underway for the past 70 years, but with Modi as a catalyst, its pace is picking up. The story of many countries in South Asia, the Middle East, Africa and large parts of South America is quite similar.

What should investors do? Ultimately India is likely to turn out to be a terrible investment destination. Indian savers should consider moving their wealth abroad. Indians are still permitted to transfer $250,000 per year, but eventually capital controls are bound to be instituted. Keeping in mind that Indian savers are already paying premiums of 30% or more to purchase US dollars or British pounds, there seems hardly a good reason for foreigners to send money to India.

Fonte: qui

P.S.: potete usare la funzione TRANSLATE di Google(sulla colonna di destra), selezionando prima un qualsiasi linguaggio e poi successivamente, l'italiano, per avere la traduzione automatica.