An economy on the verge of an implosion is like watching a bear in full flight. You are equal parts astounded and terrified that something so massive can move so quickly and so destructively. And when it’s coming right at you, it’s even worse.
Of course bears don’t fly. But you take my point. When you see something powerful and fearsome headed your way at top speed, you have to decide what you’re going to do. Fight? Flight? Faint?
The decision you end up making is part rational and part neurological. Part of your brain already knows what to do when you’re in danger. You don’t have to consciously think about it. Your little amygdala does all your thinking for you and tells your muscles, your heart, and your lungs just what to do.
It’s when your rational brain—the pre-frontal cortex—gets involved that bad decisions become possible. You think, therefore you’re more likely to get eaten by the bear.
But why am I talking about bears in flight and economies in implosion? Because capital flight in China is directly related to the implosion of its economy. The Shanghai Composite fell 6.2% overnight. Now, after a 20-month run up over 150%, a little correction now and then shouldn’t bother anyone. Chinese stocks are still up a respectable 91.56% in less than two years. So why are Chinese authorities fighting market forces so hard?
(Source: Stockcharts.com)
Here’s what Jim Rickard’s had to say about it last week in Strategic Intelligence: “To put it simply, the Chinese economy is undergoing implosion. Its exports and imports collapsed. In June, the system of shadow banking (a significant part of the credit market in China) is completely dry. The net rate of new loans was zero. This kind of slowdown is not only an economic problem in China: it is also a political problem. If the Communist Party cannot create jobs, civil unrest and riots will ensue. The Party gave priority to its survival rather than good relations with the United States. Recommendation is to shift portfolio to defensive.”
As you can see, Jim’s taking developments in Chinese capital markets very seriously. He’s also connecting the dots between what happens in the economy and what happens politically. That brings up a point which is the very basis for having a publication called Capital and Conflict: the economic is always political.
The economic becomes even more political when savings are destroyed and stock values decline. This is why the giant monetary experiment we live in is so dangerous. The distortion of monetary values leads to the distortion of personal and political values, too. Extreme behaviour in private life and in public politics becomes routine when monetary simulations go wrong.
Keep your eye on the credit markets. I’ve been having a discussion with our own Tim Price on whether some price signals still work. Yes, it’s true that interest rates distort stock values and price signals. But there are underground or intermarket price signals that survive and still communicate useful information to the attentive investor.
For example, you may have noticed the nearly 10% rise in rates short-term lenders charge each other for overnight loans in the Chinese money market. The rise has come all in the last week, since China devalued its currency. And to be sure, rates are still low. They were 1.57%. They’re now 1.72%, according to the Wall Street Journal.
But even that is enough to spook Chinese monetary authorities. They engineered the largest one-day cash injection in markets in 19 months yesterday. That’s a liquidity move. The 120 billion yuan seven-day reverse repurchase agreements from the People’s Bank of China gets money into the market quickly. That money is intended to smooth things over and keep the herd from stampeding for the exits (capital flight).
Bears are tricky, though. Most of the time, if you avoid them, they’ll avoid you. I learned this on a recent holiday in the mountains in Colorado, where I grew up. The cabin I stayed in had two large picture windows on the north and south side. One fine afternoon, as I went to the kitchen to grab a bite, I noticed a mother and her cub on the north side of the cabin and a big daddy-looking bear on the south side.
You don’t want to come between a mama bear and her cub. But I didn’t panic. And I didn’t break out my smartphone to tweet a photo. I hustled my brother’s dog (a brave but foolish Chihuahua named Bandit) into a room with no windows, where he couldn’t see the bear and freak out. I then watched the bears majestically and methodically pass through the meadow and into the woods. They were only black bears. But they were big enough.
That’s the best and safest way to encounter a bear, with a wall between you and it. But if you don’t have that wall, then you’d better have a plan. Which brings me back, briefly, to banks. Whether you’re a shareholder or a depositor, be on guard.
“Global banks are facing billions of pounds worth of civil claims in London and Asia over the rigging of currency markets”, according to today’s Financial Times. The fines in London could be in the “tens of billions of pounds” according to barrister David McIlroy. The global forex market is huge, with over $5.3trn changing hands each day. London is the centre of that market, with over 40% of forex trade taking place here.
Goldman Sachs, HSBC, Barclay’s and the Royal Bank of Scotland reportedly settled with thousands of investors in New York for about $2bn in response to FX rigging. The FT reports that class action lawsuits are easier in the UK than they used to be. Foreign investors are more likely to join a suit in London as well, since this is where so much trading is done. Thus, the possibility of much larger settlements.
But what’s really at stake here? Is a large settlement of several billion pounds/euros/dollars going to make a material difference to a bank? It might affect profits and the stock price for a quarter or two. But even the fines associated with the rate-rigging Libor scandal didn’t seem to damage the banks in any meaningful way.
Stories like this remind you of how broken our financial system still is, seven years on from the onset of the great credit crisis. The suit in New York found that banks routinely manipulated the values of the seven-largest traded currency pairs. It wasn’t Enron-style fraud, where liabilities were hidden off the balance sheet to conceal them and inflate earnings.
But the distortion of values by the banks is now part of the story of our time. It appears routine. Cheap credit makes it possible. And the compensation structure of the financial industry virtually guarantees it. You’d be forgiven if you had the feeling that large financial companies exist to make their executives rich by taking risks with shareholder capital and borrowed money for short-term, compensation-linked gains.
In other words, none of modern banking has much to do with allocating scarce capital to productive enterprise. It’s not about storing your personal savings and then making wise lending decisions based on prudent risk management. It’s about cheating people here and there for as much as you can get, as quickly as you can get it.
To be sure, not everyone in the banking industry is a fraud. It would be slanderous and libelous to say so. But you can see that the incentives in the system reward those who take the most risk, including the risk of getting caught breaking the law to rig prices for personal gain.
Is that the kind of system you want to trust your life savings to? Is it any safer than having dinner with a bear?
Category: Market updates