China’s Bipolar Markets and Economy

The Chinese financial and economic sphere operates on a bipolar world or might I say "parallel universe".

Today, Chinese PMI data reveals of better than expected growth. Chart above from AAstocks.com From Bloomberg:

Chinese manufacturing growth beat analyst estimates in November, indicating the nation’s economic recovery is sustaining momentum amid government efforts to rein in credit growth.

The Purchasing Managers’ Index was 51.4, the National Bureau of Statistics and China Federation of Logistics and Purchasing said yesterday. That’s the same reading as October, which was an 18-month high, and exceeded 24 out of 26 estimates in a Bloomberg News survey. A number above 50 signals expansion

This comes even as the Chinese government has compelled for a reduction in sectors with glut in capacity...

China in July ordered more than 1,400 companies in 19 industries to cut excess production capacity and the Communist Party’s reform document said local officials will be evaluated on controlling overcapacity.

The Hebei provincial government said last month it demolished iron and steel furnaces and Xingtai Longhai Iron & Steel Group Co., a unit of China’s biggest producer, Hebei Iron & Steel Group Co., has halted production because of operational difficulties, according to Shenzhen stock exchange filings from customer Hangzhou Boiler Group Co.

It is important to point out that the Chinese political economy has largely been state driven. Many of what seems as private enterprises are really a spin off of local government units which has contributed to the ballooning of China's shadow banking industry. 

Yet Chinese industrial production growth varies from the PMI data. 

While the PMI has been surging, after a big upside move in July from the earlier stealth stimulus applied by the government, Chinese industrial production has been static from August to October. So confidence shown in the PMI data seems as having been overstated (so far).

Meanwhile sanguine expectations in the manufacturing sector seems incompatible with soaring costs of credit. Yields of Chinese 10 bonds has been spiraling higher. Yields have reached 4.71% until last Friday’s last minute decline.

Spiking interest rates are having real economic impact. From another Bloomberg article:

Chinese companies’ borrowing costs are climbing at a record pace relative to the government’s, increasing the risk of defaults and prompting state newspapers to warn of a limited debt crisis.

The extra yield investors demand to hold three-year AAA corporate bonds instead of government notes surged 35 basis points last week to 182 basis points, the biggest increase since data became available in September 2007, Chinabond indexes show. That exceeds the similar spread in India of 120 basis points. The benchmark seven-day repurchase rate has averaged 4.47 percent in November, the highest since a record cash crunch in June and up from 3.21 percent a year earlier.

Even the state run media recently warned of a potential crisis. From the same article

Borrowing ratios at some Chinese corporations are already relatively high, and rising interest rates may cause a “partial debt crisis to explode,” the China Securities Journal said in a front-page commentary yesterday. The central bank should take a “mild” approach to deleveraging as the economy is still delicately balanced, said the Economic Information Daily.

Hmmm. "Partial debt crisis to explode"

Curiously higher rates has partly altered borrowing patterns by Chinese enterprises, as more companies shift to foreign currency denominated debt.

From the Wall Street Journal:

Asia's market for foreign-currency loans is booming.

Banks across the region are lending record sums in the U.S. dollar, the yen and the euro—the so-called G3 currencies—even as economic growth slows and bad debts continue to rise in places like China and South Korea.

Loans in these currencies amounting to $133.4 billion have been issued this year in Asia, excluding Japan, 54% more than a year earlier and more than in all of 2011, the record year for such loans, according to Dealogic, a data provider.

Companies in Asia typically borrow in foreign currencies for capital expenditures, transactions linked to commodities or to fund cross-border acquisitions.

In short, despite deteriorating credit conditions Chinese credit markets continue to blossom. The recourse to foreign debt exposes the Chinese economy not only to credit risks but to currency risks as well.

So far Chinese financial markets have ignored signs of escalating credit risks. The Shanghai index has been rapidly recovering.

The Yuan is at record highs while default risks has plummeted back to the ‘normal’ levels.

Interesting because like almost everywhere the risks from the frenzy in credit accumulation has largely been ignored.

Charts: US Stocks and The Greater Fool Theory; No Weekend Stock Market Commentary

I’m taking this week off from my weekly stock market outlook.

In gratitude to my readers, I will leave something for you to ponder on this weekend: Important charts depicting what seems as the greater fool theory in motion at the US stock markets. Remember, what happens to the US will most likely have a domino effect to the world.

Greater fool theory—buying assets in the hope that greater fools will buy the same assets at a much higher price—or as per Wikipedia.org—”a situation where the price of an object is not being driven by intrinsic values, but by expectations that irrational bidders for limited assets or commodities, will set the price”

Bullishness in investor sentiment has now reached extreme levels (Zero Hedge). The sustained upside movement has only strengthened the convictions of the bulls and the fools, luring more and more of them into a bidding spree.

Yet this appear to be signs of a ‘crowded trade’ where everybody’s "all in" and everyone's expecting higher prices from more fools buying at higher prices (endowment bias). 

Question is but what if there are lesser number of fools to sell to?

Who could be the fools?

Record US stocks have been driven mostly by retail/household punters (in billion of dollars).

Household buying of US stocks have also reached milestone highs, drifting slightly above the 2000 and 2007 levels (Yardeni.com).

The last 2 times US households furiously stampeded into the stock markets, bear markets followed (see pink rectangles). Remember the crash from the dot.com bubble bust and the US housing mortgage bubble bust? Again household buying has reached "peak" levels of 2000 and 2007.

Question is could the Bernanke-Yellen policies have transformed stocks into a “permanently high plateau” (to borrow from the late economist Irving Fisher)? 

Will this time be different?

What has financed such bidding frenzy from the bulls and the fools? The short answer is DEBT.

Record US stocks have now coincided with record margin debt.

Margin ‘real inflation-adjusted’ debt has currently surpassed the 2000 levels but has been slightly off the 2007 record highs.

Margin debt including free cash accounts and credit balances in margin accounts or Credit Balance as the sum of Free Credit Cash Accounts and Credit Balances in Margin Accounts minus Margin Debt  as per Doug Short, which are also at record levels, reveals how punters have increasingly used leveraged to push up stocks to record territory. 

It's more than just margin debt and investor credit. 

Systemic leverage in order to chase yields have been intensifying and broadening, from bond issuance to finance stock buybacks, near record consumer and industrial loans, stratospheric unprecedented levels for commercial real estate lending and more.

What have the bulls and the fools been buying?

Record stocks comes amidst declining EPS (Business Insider)…

…as well as record negative over positive eps announcements (Zero Hedge).

All these means that the fools have been chasing multiples rather than eps growth with escalating debt.

Will the current bonanza via a “don’t worry be happy” trade remain in favor of the stock market bulls and the fools?

Perhaps. Depending on how many more fools can be seduced into the frenzied pile up. Mania phases can have an extended period of euphoria. Manias signify the "peak" of the bubble cycles where convictions have been the strongest.

Nevertheless the farther the height of the serial increases, the bigger the accumulation of risk via more debt, the greater the fall.

Based on the “log periodic” pattern designed by economist Didier Sornette where bubbles reflect on “a widening gap between the increasingly extrapolative expectations of market participants and the prospective returns that can be estimated through present-value relationships linking prices and likely cash flows” current momentum indicates of an accelerating odds of a text-book stock market crash, according to fund manager John Hussman

Well such risks will be discarded and the ignored by the bulls and their fools because stock markets, for them, have been perceived as a one way street: "up, up, up and away!"—courtesy of the Greenspan-Bernanke-Yellen Put, which some believe have worked as an elixir.

At the end of the day, let us see who will be holding the proverbial bag.

Indonesia Crisis Watch: USD-Rupiah Pierces 12,000 level

The US-Indonesia rupiah pierced on the 12,000 psychological threshold today

Intraday, the US-IDR closed at the highest level

Indonesia’s LCY 10 year bonds also fell again at the last minute.

Indonesia’s officials dismissed concern over the rupiah’s unhinging noting that this would “help local manufacturers increase their exports”

Unfortunately Indonesia’s stock markets hardly seemed to agree as the JCI slipped, albeit modestly.

The falling rupiah which means higher CPI inflation also extrapolates to a significant distortion of economic calculation for commercial or business enterprises. For instance in response to popular clamor, the Indonesian government pushed up minimum wages significantly, although varying at local levels.

Higher minimum wages means an increase in input costs which erodes on any advantage from a weaker currency.

This hasn’t just been an Indonesian story.

Thailand surprisingly cut interest rates yesterday which spiked up local stocks yesterday.

Unfortunately the zero bound rates policy appears to have only an overnight magical impact as the Thai SET fell by 1% today.

The good news is that the IDR plunge has not triggered a panic. Yet it remains to be seen how ASEAN financial markets will react if the rupiah and or if Thai’s stocks continue to substantially decline. 

Risks remains very high.

Senkaku Islands Dispute: The Risks from Political Brinkmanship

The US, Japan and China appears to be playing a dangerous geopolitical brinkmanship game.

From today’s headlines at the Inquirer.net

Days after China asserted greater military control over a swath of the East China Sea to bolster claims to a cluster of disputed islands, the US defied the move Tuesday as it flew two B-52 bombers through the area.

China, however, insisted Wednesday it has the capacity to enforce its controversial newly declared air zone over islands disputed with Japan, despite Beijing’s reluctance to intervene after American B-52 bombers flouted its rules.

The US said what it described as a training mission was not flown to respond to China’s latest military maneuver, yet the dramatic flights made clear that the US will not recognize the new territorial claims that Beijing laid out over the weekend.

There are several angles I see here

One these nations have been attempting to promote “nationalism” in order to justify government spending in their respective military industry, to “pump prime” their fragile economies.

If this is true then, then all these has been a smokescreen in favor of pushing the interests of the military industrial complex. (charts above from the Economist)

Second, since China’s central bank recently signaled that they may be scaling back on purchases of US treasuries (euphemism for financing of the US government which includes the military) because these “does not benefit any more from increases in its foreign-currency holdings”, the US taunting of China’s government at the disputed Senkaku islands could have been implicit threat on the Chinese to sustain such such financing arrangement or else…

As one would note, both Japan and China has been providing support to the US government by cushioning the impact of the bond vigilantes through record UST accumulations.

Based on the US Treasury’s TIC September data, Japan holdings of USTs has spiked to record levels while China’s drifts at record levels

So while we see these countries posture and debate on media, behind the scenes Japan and China appear as coordinating their support to the US government via the bond markets against the bond vigilantes.

So we have a strange case of Dr. Jekyll and Mr. Hyde.

Third, the three crisis prone governments have earnestly been trying to divert the public’s attention from the real issue.

As shown above (via the Zero Hedge) despite the so-called 7+% economic growth in China, the PBoC has been rapidly expanding her balance sheet faster than the US.

And with unfulfilled expectations for real economic growth, despite the huge ballooning of central bank assets, governments need schemes to distract the public. And geopolitical brinkmanship with major political economies looks like a convenient way to achieve this.

Of course, it could all be a combination of the above

And we understand that all wars have been financed by inflationism.  

The problem is when games transform into reality.

Philippine statistical ‘bubble’ economy grows as expected

In discussing the convergence trade, here is what I wrote two weeks back (bold original)

The surge in banking loans was equally reflected on domestic liquidity or M3 which grew by 31% year on year.

So the BSP will achieve a $32k per capita income by continually inflating of bubbles via a massive build-up of debt or by borrowing tomorrow’s spending today.

This also means that statistical economic growth for the third quarter will likely remain at 7% or above.

Let us see where the latest (3rd Quarter) statistical growth has been attributed to… [note I will not depend on the NSCB's narration but rather on the data they presented.]

From the NSCB’s breakdown of the statistical economy based on expenditure type (at constant prices), durable goods powered growth…

In the durable equipment sector, transportation equipment has been instrumental in the attainment of this quarter’s 'strong' statistical economic growth.

The Transportation sector accounts for 57.8% of the gross capital formation category based on 3rd quarter output. Air Transports reported a stunning 23.9x (times) growth. Meanwhile railway transports posted a 25.2% growth rate and road vehicles grew by a modest 12.9%. Although the above numbers appear to be different here and here

Since the NSCB’s sources of data for transportation and communications are from National Statistics Office (NSO), Land Transportation Office (LTO), Philippine National Railways (PNR), Light Rail Transit Authority (LRTA), Philippine Postal Office (PPO), Philippine Air Lines (PAL), Philippine Ports Authority (PPA) and Department of Transportation and Communication (DOTC), my guess is that airline companies may have added new planes or that the government has acquired non-military planes that has contributed to gist of the growth in the “fixed capital formation”.

On growth based on industry type, the services sector has again delivered the substance of this quarter’s statistical growth. 

The services sector has largely been fueled by Financial Intermediation and Real Estate Renting & Business Activities

Remember this chart where we saw a vibrant revival of banking loans to the same industries during August-September?

Meanwhile the agricultural sector has taken the second spot mainly led by fishing.

But what of the industry sector which trailed services and agriculture?  (note all of the above are based on constant 2000 prices)

The growth in the construction sector eased while manufacturing took leadership.

Now go back to the chart above from the BSP. One would note of a two month spike in manufacturing loans while construction loans 'dived' over the same period. Trends in the loan growth dynamic have been manifested on statistical growth.

I’d also like to point out that despite the so-called moderation in the growth rate of construction activities in the 3rd quarter, based on 1st up to 3rd quarter for the past 3 years, slope of growth in the construction activities has been ascending in a near vertical fashion.

The table above which represents the NSCB’s breakdown on the quarter on quarter growth in construction sector reveals the numbers.

How about household consumption? Well again, household consumption (via the HFCE), which represents the final demand, has grown less than the overall statistical growth.

In other words, supply-side growth continues significantly outpace demand. The continuing dynamic essentially leads to a widening of the chasm between supply side and demand side growth which extrapolates to an accumulation of more imbalances, brought about by a credit boom from zero bound rates. 

No bubble?

The Phisix (chart from technistock) appears to be celebrating what seems much of an expected outcome.

As I said last weekend:

Well the oversold markets will surely experience bounce. Mr Pacquiao’s victory or the coming announcement on Philippine GDP which I expect to be in line with the mainstream’s expectations given the late spurt of credit growth will have little do with it.

Again I’d rather watch what is happening to our neighbors.

The Inflation of Airline Frequent Flyer Miles

In response to the Fed policies, Airline companies in the US have been giving away less services by inflating frequent flyer miles. Or simply put; indirect price increases.

Simon Black of the Sovereign Man explains

Today, millions of passengers in the Land of the Free will take off their shoes and assume the “I surrender” pose inside a radiation machine that provides negligible benefit and maximal cost to taxpayers.

Our modern security theater is a stark contrast to the past. But there’s been something else happening over the last several decades that is even more insidious… and far less obvious.

In 1979, Texas International Airlines (the precursor to Continental) introduced the first modern frequent flier program. American Airlines soon followed, launching their AAdvantage frequent flier program in 1981.

When the program launched, you could upgrade to a first class seat on the Concorde for 20,000 miles (something that you couldn’t even do today). Today, an upgrade to first class between the US and Europe would set you back 50,000 miles, plus $900 in fees.

In fact, just about every mileage award category has been getting more ‘expensive’, particularly among the major US carriers. The majority of the increases have taken place in the last several years.

United Airlines, for example, is raising the number of miles required for most of its awards starting February 1st. The steepest is an 87% increase for first class award seats on United’s partner airlines flights to the Middle East.

A United economy class ticket to Hawaii will increase by ‘only’ 12%. And business class to Europe and Japan will increase 20%.

Just like central bankers with paper currencies, airlines are devaluing their miles.

They have created trillions of miles in the system, many of these through special gimmick promotional giveaways. We’ve probably all seen the ‘sign up for the new credit card and receive 25,000 bonus miles’.

But just like the real economy, rapidly increasing the money supply (airline miles) devalues the currency and creates inflation.

That’s exactly what’s happening here. Airline miles are worth less and less.

Read the rest here

Thanksgiving Treat: The Turkey Inflation

In the US and elsewhere, media and their ivory tower experts allege that statistical CPI inflation has been “low”.

But not for the Turkey which will grace the dinner tables of Americans in celebration of Thanksgiving day…

Notes the Zero Hedge: (bold original)

While shoppers will perceive the discounts on Black Friday as 'saving' them fortunes, the cost of the 2013 Thanksgiving Day dinner may be the most expensive ever. As the gorging commences, despite an entirely benign inflation in the eyes of the Federal Reserve, the prices of everything from chocolate chip cookies to ice cream are on the rise. But it is the centerpiece of the meal that is weighing on pocket-books. As Bloomberg's Michael McDonough notes, Americans are paying the most for whole frozen turkeys since the Bureau of Labor Statistics began publishing data on the series in 1980.

Happy Thanksgiving.

Guest Post: Per Bylund on Sweden’s Great Depression

Many myths beholds Sweden’s success story. Some say devaluation has saved Sweden from the crisis in the 1990s, others say it has been the welfare state. Much of the popular misimpressions have left out the most important ingredient: the Sweden’s largely ignored free markets.

Mr. Per Bylund, research professor in the Department of Management & Entrepreneurship in Baylor University‘s Hankamer School of Business and the John F. Baugh Center for Entrepreneurship & Free Enterprise and Associated Scholar with the Ludwig von Mises Institute and senior fellow at the Ludwig von Mises-institutet i Sverige published an indepth insight of Sweden’s real economic profile at this month’s Free Market edition of the Mises Journal. (with Mr. Bylund’s permission) [bold mine]

During the recent financial crisis, Sweden has emerged as one of very few financially sound economies. The country’s strong position, setting it apart from Western nations, makes it an interesting example of what could—or should—have been done. Indeed, Paul Krugman, the economist and Nobel Prize laureate, has repeatedly pointed approvingly at how the Swedes handled their depression in the early 1990s as the reason for their recent success. Specifically, he notes the nationalization of some banks at the time of the crisis. While he misses the point by focusing exclusively on a narrow selection of short-term measures rather than longer-term changes, as is the hallmark of a Keynesian, Krugman is right that Sweden has done some things right.

In September of 1992 the Riksbank, Sweden’s central bank, raised the interest rate to five hundred (500) percent in a vain attempt to save the fixed exchange rate of the Swedish krona (Sweden’s currency). This drastic measure was taken in conjunction with large spending cuts and tax increases to address the free-fall of the nation’s economy.

The economic meltdown was the culmination of two full decades of decline, and it fundamentally changed the political situation in Sweden.

Since that time, Sweden has, across the board, seen consistent government cutbacks while increasing restrictions on welfare policies, deregulating markets, and privatizing former government monopolies. The country has instituted an overall new incentive structure in society making it more favorable to work. The national debt tumbled from almost 80 percent of GDP in 1995 to only 35 percent in 2010.

In other words, the country successfully rolled back its unsustainable but world renowned welfare state. Despite Krugman’s wishful thinking, this is the real reason for Sweden’s success in riding out the present financial crisis.

The Rise and Fall of the Welfare State

Sweden experienced a century of high economic growth from approximately 1870 to 1970, which literally made one of Europe’s poorest countries into the world’s fourth richest. The first half of this period of growth was marked by extensive free-market reform, and the latter half is notable for Sweden’s staying out of both world wars and thus benefiting from intact industrial infrastructure when the rest of Europe lay in ruins. While a welfare state was established and expanded during the post-war period, it was generally built around capitalist institutions and therefore had limited impact on economic growth.

But the political situation changed. The 1970s and 1980s saw a welfare state run amok with a greatly expanded scope with new government benefits, the introduction of very rigid labor market regulations, active propping up of stagnating sectors of the economy, and drastic increases in tax rates with some marginal rates in excess of 100 percent. In an attempt to fully nationalize the economy, löntagarfonder (“employees’ funds”) instituted in 1983 to “reinvest” private companies’ profits in stock ownership and to be administered by the national labor unions.

During this period government deficits abounded and the national debt increased almost ten-fold from 1975 to 1985. Sweden also saw high price inflation, a situation aggravated by repeated devaluations of the currency’s exchange rate to boost exports: in 1976 by 3 percent; in 1977 by 6 percent at first, and then an additional 10 percent; in 1981 by 10 percent; and in 1982 by 16 percent.

Overall, the rapid expansion of the welfare state can be illustrated by the ratio between tax-financed and private sector employment, which rose from 0.386 in 1970 to 1.51 in 1990. Sweden was heading for disaster.

Explaining Sweden’s Great Depression

A popular explanation of the meltdown in the 1990s blames deregulation of the financial markets that occurred during November 1985. But as our research (still in progress) suggests, deregulation was an attempt to solve increasing problems to finance the Swedish government’s already weak and deteriorating financial situation. In the fiscal year 1984–85 alone, the interest payments on Sweden’s national debt amounted to 29 percent of tax revenue—equal to the government’s total spending on social security. The country’s unsustainable financial situation made deregulation necessary.

The increased access to financial markets made a desperate situation somewhat more tenable. But Sweden then experienced an immense increase in credit. Our numbers show that the volume of bank loans to non-financial businesses increased from 180 billion in late 1985 to 392 billion in late 1989, an increase of 117 percent total or 21 percent annually Where did all this money come from? Some of it can be explained by deregulation and the inflow of funds that followed. But it was also made possible by monetary inflation.

Several factors were at work during the 1986–1990 credit-infused boom that ended in the depression of 1990–1994. Some factors had no inflationary effect or even a deflationary effect, but other factors, especially those that relate to government policy, or are driven by government policy, were strongly inflationary and quite substantial

These include increases in the Riksbank’s advances to banks (a 975-percent increase from 1985 to 1989) and purchases of government debt and securities (a 47-percent increase from 1985 to 1987, followed by a 7-percent decrease from 1987 to 1989).

Sweden is an interesting case to study. We do indeed, as Krugman repeatedly tells us, have much to learn from it: from the long-lasting era of economic growth thanks to free markets to the rise and fall of the welfare state. The country’s recently (re)gained financial strength and its ability to resist a global recession are due, not to a strong welfare state as Krugman claims, but to the long-term rolling back of the expansive welfare that Keynesians so often praise

Indonesia Crisis Watch: Rupiah Falls to New Lows, JCI drops 2.3%

The 11,730 USD-rupiah resistance level didn’t hold for long.

Today the US dollar-rupiah closed to a fresh 5 year high at 11,765 after hitting 11,798 intraday.

The yield of the Indonesia’s sovereign 10 year bonds was marginally up (one basis point) though.

But activities in the domestic bond market barely explained of the weakness of the rupiah.

Early today, Indonesia’s government reportedly failed to raise a targeted $450 million in dollar bond sales. The government settled with only $190 million. This comes even when coupon yields had been priced higher or “at a weighted average yield of 3.51671%, about half a percentage point higher than a bond with a similar maturity that Indonesia had earlier sold overseas” according to the Wall Street Journal. 

This meant that the markets expected much higher yields than what the Indonesian government had been willing to offer. So the failed expectations by Indonesia's bond market may have been vented on the rupiah (via outflows).

Meanwhile the weak rupiah seems to have been transmitted to Indonesia’s stocks where the benchmark JCI got bludgeoned by 2.3%. And as shown above, the gist of the losses by the JCI occurred at the session’s close.

ASEAN stocks has been largely mixed today amidst the rupiah's weakness.

The Phisix ended its 6 day losing streak with a last minute rally. 

After spending most of the day on the red, the Phisix closed .35% higher. Curiously, opposite to the JCI, gains in the Phisix had been due to a last minute spike (technistock.net)

Given the lopsided advance (51) decline (111) spread (-60) and the mixed sectoral performance (PSE), today’s rebound appears to have been ‘centered’ on a few heavyweights. This may have been due to entities desperate to see a higher Phisix. 

Incidentally the Philippine bellwether closed 1.32% Monday a day after Manny Pacquiao’s victory.

A win by the legendary Pacquiao supposedly would have lifted the market’s sentiments. Yet despite the statistical data used to “prove” such postulations where Pacquiao’s triumph should have meant higher stocks since stocks rose by 73% of the time (frequency) backed by .5% gains (scale), apparently Pacquiao’s win became a black swan or an outlier event.

This validates my view of the tendency by so-called experts to use the current events--via the availability heuristic, resorting to pattern seeking methods and appealing to emotions--to justify personal biases and to satisfy public demand for simplistic explanations.

Yet such events turn about to be largely irrelevant or diversionary noises.

Video: Mark Thornton on Real Economic Growth versus Statistical Economic Growth

"Don't be fooled by GDP (3:17)...you've got to be leery of statistics (4:14)"