Category Archives: Crash

We get some strong deflation signs in USA last 3 months

We get some strong deflation signs in USA last 3 months, economic numbers not too good only thing rising is debt and consumer confidence.

 

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  • 88
    Coal accounts for approximately 40 percent of all electrical generation on the entire planet.  When the price of coal starts to drop, that is a sign that economic activity is slowing down. Just prior to the last financial crisis in 2008, the price of coal shot up dramatically and then…
    Tags: crash, economic, economy
  • 86
    The price of iron ore has been crashing as well. It is down 35 percent in the last nine months, and David Stockman believes that this is because of a major deflationary crisis that is brewing in China… There is no better measure of the true contraction underway in China…
    Tags: months, crash, economy
  • 78
      Source : http://www.alhambrapartners.com/2015/08/14/the-dollar-run-hits-the-corporate-bubble/ The ‘Dollar’ Run Hits The Corporate Bubble by Jeffrey P. Snider in Bonds, Currencies, Economy, Federal Reserve/Monetary Policy, Markets Tags:asian flu, asset bubbles, china, convertibility, corporate bond bubble, dollar run, eurodollar standard,global recession, high yield, interbank, junk, leveraged loans, Repo, wholesale funding, yuan By the behavior of…
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  • 78
    Half of the 41 fracking companies drilling for shale oil and gas in the US will be dead or sold by year-end amid steep crude price declines, Bloomberg reports.  An executive with Weatherford International Plc said slashed spending by oil companies has put much of the US fracking industry at risk.…
    Tags: crash, economy
  • 78
    The fast food chain is targeting 700 poor performing restaurants for closing this year, according to a McDonald's news release in which it reported losses not only in the United States, but in Europe and Asian as well. First quarter comparable sales in the United States decreased 2.6 percent and…
    Tags: consumer, economy, crash

Halts Dividends as Miners Face Commodity Fall

Anglo American Plc dropped to a new record low after scrapping its dividend for the first time since 2009 and pledging deeper spending cuts to help the mining company withstand a collapse in commodities. The company will suspend its payouts for the second half of this year and for 2016, it said in a statement Tuesday. Anglo is abandoning its practice of steadily increasing the dividend in favor of a system that allows the payment to rise and fall with the company’s profits, known as a dividend payout ratio. Chief Executive Officer Mark Cutifani is seeking to turn around the company’s fortunes in the face of metalprices at the lowest in about six years and China’s sluggish economic growth.

By the time Anglo suspended its dividend in 1998, the S&P Metals & Mining Index was down 50% from its monthly closing high. In 2008, it was down 67%. Currently, it is down 69%…These dividend suspensions are exactly what potential shareholders should be looking for as a signal that sentiment is nearing a trough.”

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A Fireside Chat with Bill Gurley of Benchmark: The Future of Ecommerce — September 15, 2015

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Venture capitalists say startups are taking on too much risk, and a shakeout is inevitable. But they’re not saying who will be shaken out.

Venture capitalists say startups are taking on too much risk, and a shakeout is inevitable. But they’re not saying who will be shaken out.

It wasn’t long ago that startups refused to reveal their valuations. It makes sense—valuations are paper money, after all. They’re based on the company’s ability to hit future growth milestones, which is a big “if.” Announcing a high valuation to the world makes a startup look like a guaranteed success, even if the reality is far from that.

That’s all changed, though, in the age of the unicorns. More than 130 startups are now worth $1 billion or higher, according to Fortune’s latest Unicorn List, and fundraising announcements today lead with the valuations—sometimes going so far as to call it “unicorn status” in PR pitches. TheNew York Times even made a list of 50 future unicorns, startups it believes are likely to hit that once-elusive $1 billion mark.

But amid all the unicorns getting their horns, investors have warned of “dead unicorns.” In March, investor Bill Gurley made headlines with his pronouncement that “a complete absence of fear” would lead to dead unicorns this year. Venture capitalist Marc Andreessen warned in a tweetstorm that startups with high burn rates would “vaporize.” Last week Salesforce CEO Marc Benioff also predicted dead unicorns as startups seem to focus more on their valuations than their customers.

Investors are happy to predict failure, but they refuse to point any fingers. It’s understandable given the clubby, interconnected nature of Silicon Valley, and the fact that it’s bad form to be a “hater.” (Not to mention, they’d hate to admit having dead unicorns in their own portfolios.)

Whenever an investor does predict a major startup failure, it sends shock waves throughout the Twittersphere, as happened when Khosla Ventures’ Keith Rabois tweetedthat Foursquare, the local discovery service, would have to be bailed out with a “Hail Mary” acquisition. Rabois was quickly called a hater and compared to Donald Trump and Turtle, the freeloading character from Entourage.

Behind the scenes, though, some venture firms are quietly keeping tallies of unicorn startups they expect to die. None that Fortune spoke with would admit as much, even off the record—no one wants to appear to get enjoyment from someone else’s failures. (When their own portfolio companies fail, they simply remove the startup’s logo from their homepage and quietly tiptoe away.) But those who operate in the orbit of those VCs—limited partners, portfolio company execs, angel investors—have shared multiple “dying unicorn list” email chains with Fortune.

Why would a venture capitalist want to track startups that are failing? Opportunity. Cash-strapped startups are chock full of valuable employees who may be ripe for recruitment, or outright acquisition, by a competing portfolio company.

So which companies are on the dying unicorn lists? None that would surprise anyone playing close attention. If anything, the ones Fortune saw were disappointing in their lack of creativity. They include Gilt Groupe, the luxury commerce company rumored to have raised a “down round” below its $1 billion valuation earlier this year; Jawbone, whose struggles with strategy and lawsuits have been widely documented (including this year in a Fortunefeature story); and Bloom Energy, a fourteen-year-old fuel cell startup that has raised more than $1 billion in funding in a category that has proven challenging.

A Bloom Energy spokesperson said in a statement that the company is experiencing strong demand from new and current customers, citing a new partnership with Exelon to support 61 megawatts of fuel cell deployments. Representatives from Gilt Groupe and Jawbone declined to comment.

The value of such a list isn’t lost on the companies selling the pick-axes in our era’s gold rush. CB Insights, a venture capital data provider, has created a list of early-stage companies it believes are likely running out of cash. To access it, you’ll need some cash of your own—it costs $6,895.

( Source : http://fortune.com/2015/09/08/dying-unicorn-lists/ )

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China runaway train ?

David Dredge of global hedge fund Fortress has built a career studying, predicting and protecting against the world’s major financial crises. The recent convulsions in global sharemarkets are “just the beginning” of a painful adjustment as money drains from the emerging market economies, he says.

“August 2015 will go down in the record books, much like July 2007 or July 1997, as the beginning of the coming contractionary cycle,” says Dredge who is the co-chief investment officer of Fortress Convex Asia Fund.

August 2015 will go down in the record books, much like July 2007 or July 1997, as the beginning of the coming contractionary cycle.

David Dredge, Fortress

He’s a believer that markets move in long cycles, which “despite all efforts to the contrary, central bankers have not by any means gotten anywhere close to eliminating”.

Hedge fund Fortress says all emerging economies are in the midst of a painful adjustment after a "burst of credit expansion".Hedge fund Fortress says all emerging economies are in the midst of a painful adjustment after a “burst of credit expansion”. Photo: AP

“Like weathermen have not eliminated seasons,” he says.

Singapore-based Dredge says the current volatility in financial markets is in the early stage as markets react to a correction of global imbalances that will last from18 months to three years.

The global economy is made up of nations with a deficit of capital – the West – and those with a surplus of capital – the East and emerging markets, he explains.

Policy determined by deficit

“The flaw is that those with the surplus have all tied their currency to the main protagonist on the deficit side – the US.

“So monetary policy is determined by the deficit of capital side and flows through the currency linkage, and you end up having some form or another of the same monetary policy on both sides, with economies that are 180 degrees diametric to each other.”

The financial links to easy-money policies in the US have unleashed a burst of credit expansion in emerging markets that has proved unsustainable and is now in the process of unwinding.

That is forcing a painful “market-induced tightening” that will affect  the growth of emerging markets as credit expansion is halted and reverses.

The “simplest measure of these imbalances” is foreign exchange reserves, which have swelled in the past few years but are now being liquidated, tightening financial conditions in emerging markets.

“When the hose is on and credit is pouring from the deficit to the surplus side, the FX [foreign exchange] reserves increase and are indicative of the growing size and the location as to where the imbalances exist – because that’s where the most money is going.”

China’s foreign currency reserves peaked at $US4 trillion ($5.7 trillion) in mid-2014 but have since run down to about $US3.6 trillion.

‘In the inverse of imbalance’

“Each crisis occurred at the peak of FX reserves. The emerging-market FX-reserves graph looks exactly like the US debt to GDP because they are just in the inverse of the imbalance.”

Dredge says that differentiating among emerging economies misses the point of what is occurring. Capital is draining from the emerging markets as conditions have tightened, and has been since the “taper tantrum” of May 2013.

“In December 1999 the point wasn’t whether you should invest in Apple or Microsoft. The point was they were both going down [as the tech bubble deflated]. And that’s where we are now.

“The [credit] contraction might be triggered in China with retail margin lending in the equity market, or in Malaysia with recognition of corruption.

“But the trigger is not what we are trying to compare. It’s the potential risk, which is the excess credit creation in the last cycle. In that sense Brazil, China and Malaysia are all the same.”

Dredge co-manages the Convex Asia fund, a “volatility fund”, which manages about $US200 million and seeks to deliver outsized gains in times of market stress.

Stay ahead of spreading fire

He says he’s attempting to stay ahead of the spreading fire and that means looking for cheap exposures to volatility. Interest rate volatility is low and, while foreign currency volatility may have risen, it is below many of the peaks reached over the past five years. Corporate credit spreads, too, are around post-financial crisis lows despite a fair-sized correction in corresponding equities.

“This is indicative that we’re just at the very beginning of this,” Dredge says.

Where does Australia fit in as the cycle turns dark for emerging markets? We’re special in the sense that we have not pegged our currency to the US.

“It is just about the only non-manipulated currency in the entire world, along with New Zealand. By allowing the currency to move and avoid being a hard linkage to the monetary policy whims of the global reserve currency, it takes a lot of the pressure off.”

But there has still been a build-up of risks as credit has grown virtually interrupted and our economic linkages to China make us vulnerable to, not immune from, any shocks.

“Australia came through many of the last several cycles better than most because most of the volatility was allowed to take place in the currency.

“This has allowed the asset volatility to be far less than it otherwise would have been. But that means credit has built up and imbalances, while far less than they would have been, have been allowed to persist.”

 

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  • 58
    Currency traders are having their worst start to a year since 2010 as a dearth of trends in major foreign-exchange markets crushes their investment strategies. Deutsche Bank AG’s Currency Returns Index has dropped 0.3 percent since Dec. 31, dragged down by momentum trading, where investors looks for consistent moves in…
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Bubbles oh Bubbles …

The risk that asset price bubbles pose for financial stability is still not clear. Drawing on 140 years of data, this column argues that leverage is the critical determinant of crisis damage. When fuelled by credit booms, asset price bubbles are associated with high financial crisis risk; upon collapse, they coincide with weaker growth and slower recoveries. Highly leveraged housing bubbles are the worst case of all.

Before the Global Crisis, the consensus among policymakers and economists alike was to largely ignore asset price bubbles. Justifications for this neglect differed. Some argued that asset price bubbles couldn’t be reliably detected. Others argued that nothing could or should be done about them since any intervention might be worse than the fallout from the bursting of the bubble. An implicit assumption was that central banks could, in any case, clean up the mess. The aftermath of the dotcom bubble lent support for this optimistic view of a central bank’s capabilities. Some even went so far as to decry the notion that asset bubbles exist.

After the Global Crisis, it has become harder for macroeconomists to treat asset price bubbles as rare exceptions that can be excluded from macroeconomic thinking on axiomatic grounds. In policy circles, Alan Greenspan, former Chairman of the Federal Reserve, very publicly stepped away from old beliefs; he admitted the ‘flaw’ in his worldview, and began to entertain the possibility that central banks might need to pay attention to bubbles.1 Yet, we still know little about the appropriate policy response to developing asset price bubbles. While a consensus is developing that ‘leaning against the wind’ with interest rates is not always a good idea, it remains to be seen if the high hopes that are pinned on macroprudential policy will turn out to be justified (Galí 2014, Svensson 2014).

Credit, asset prices, and economic outcomes: New evidence

To quantify these trade-offs, more empirical work is clearly needed. What risk do asset price bubbles pose to macroeconomic and financial stability? What does the evidence show? In our new research (Jordà et al. 2015), we study the nexus between credit, asset prices, and economic outcomes in advanced economies since 1870.

We rely on a combination and extension of two new long-run macro-finance datasets. In Jordà et al. (2014) we presented the latest version of our long-run credit and macroeconomic dataset in the form of an annual panel of 17 countries since 1870. To study asset price booms we have added equity price data. The second dataset from the study by Knoll et al. (2014) covers house prices since 1870 on an annual basis for the panel of 17 countries and extends coverage by about 50% compared hitherto available data.

Our main findings support the post-crisis consensus that leveraged bubbles must be taken seriously. Mishkin (2008, 2009) and other policymakers have argued that there are two categories of bubbles: unleveraged ‘irrational exuberance’ bubbles and ‘credit boom bubbles’. In the latter, a positive feedback develops that involves credit growth, asset prices, and increasing leverage. When asset markets switch into reverse gear, the balance sheet overhang creates a painful economic hangover.

  • Our study shows that leverage-fuelled asset price bubbles substantially raise the risk of a financial crisis and make recessions considerably more painful.
  • Unleveraged bubbles tend to blow over.

Yet, when credit boom bubbles go bust the macroeconomic consequences are severe.

  • Credit-fed housing bubbles are the most harmful combination of all.

Living in an age of leverage is not without its costs.

Empirical identification of asset price bubbles

The term ‘bubble’ traditionally refers to a situation in which asset prices increasingly deviate away from their fundamental value. Bubbles often end with a crash in asset prices. Determining the fundamental value is not easy since it is not directly observable. Moreover, there is no universally accepted standard definition of bubble phenomena. Studies such as Borio and Lowe (2002), Bordo and Jeanne (2002), Detken and Smets (2004), and Goodhart and Hofmann (2008) have all used either large deviations of price levels from some reference level and/or large rates (or amplitudes) of increase/decrease as indicative of the rise and fall of bubble episodes. We apply a two-pronged approach. We require a spell of sizeable asset price run-up (defined as a price deviation from log HP trend by 1 standard deviation or more) and a collapse in prices of 15% or more during the spell. Figure 1 displays examples of bubbles identified with this procedure.

Figure 1. Examples of bubble identification

Notes: The figures show, for each 10-year window, the log real asset price (rebased to the start year), a band of ±1 standard deviation (for that country’s detrended log real asset price), and the years for which the Bubble Signal is turned on using our algorithm.

Bubbles, credit booms, and financial crises

It is well known that rapid expansions of credit – credit booms – are associated with a higher likelihood of financial crisis (e.g., Schularick and Taylor 2012, Jordà et al. 2013, Drehmann and Juselius 2014). Here, we investigate how the interaction of asset price bubbles and credit booms affects financial stability. As the logit crisis prediction models in Table 1 show, our new research clarifies the results from our previous research. The association of credit and asset price booms is particularly dangerous relative to expansions of credit alone. Housing bubbles more so than equity bubbles.

Table 1. Predicting financial crisis recessions

Notes: Standard errors in parentheses. * p < 0.10, ** p < 0.05, *** p < 0.01. The dependent variable based on peaks of business cycles identified using Bry and Boschan (1971) algorithm. The dependent variable is one if the recession is associated with a financial crisis within a 2-year window of the peak, 0 otherwise. Bubble episodes are associated with recessions by considering the expansion over which the bubble takes place and using the subsequent peak. See text.

The economic costs of bubbles

The core theme of our new paper is about the connection between asset price bubbles, credit, and the consequences for the real economy. Can asset price bubbles be safely ignored? Does credit make any difference to how we think about the aftermath of bubbles? Are equity bubbles as dangerous as housing price bubbles? Using historical data, we characterise the typical paths of economies through the business cycle when an asset price bubble is involved and where we stratify by the expansion of credit. We apply local-projection methods (Jordà 2005) to calculate the dynamic responses of economies to leveraged and unleveraged bubbles in equity and housing markets.

The key results are presented in Figure 2 for the full sample (N=140 recessions). The left-hand panel shows the average path of real GDP per capita of economies through recessions and recoveries. In normal recessions, the economy shrinks in year 1 and recovers the previous peak level of output in year 2. The other lines show the average path when there is an equity bubble and below/above average credit growth, and the right-hand panel shows a similar chart using the housing bubble indicator instead. Each panel displays the baseline normal recession path with a 90% confidence region.

The basic lessons are as follows:

  • Equity bubbles are damaging.

They are associated with a slightly worse recession and a slower recovery in the full sample. However, we do find that after WWII the damage from equity bubbles does diminish. And even if equity bubbles have a relatively small effect overall, they are clearly associated with more damage when accompanied by above average growth in credit, regardless of the sample studied.

  • The right-hand panel shows that bubbles in housing prices are associated with noticeably worse recession and recovery paths.

Moreover, these effects grow much stronger when credit expands above the historical mean during the preceding expansion. On average, after a credit-fuelled house price bubble, advanced economies have taken more than five years to return to their previous peak level of output.

Figure 2. Economic costs of bubbles (full sample with controls)

Conclusions: Bubble trouble

In this column, we turned to economic history for the first comprehensive assessment of the economic risks of asset price bubbles. We provide evidence about which types of bubbles matter and how their economic costs differ. Our historical analysis shows that not all bubbles are created equal. When credit growth fuels asset price bubbles, the dangers for the financial sector and the real economy are much more substantial. The damage done to the economy by the bursting of credit boom bubbles is significant and long lasting.

In the past decades, central banks typically have taken a hands-off approach to asset price bubbles and credit booms. This way of thinking has been criticised by some institutions, such as the BIS, that took a less rosy view of the self-equilibrating tendencies of financial markets and warned of the potentially grave consequences of leveraged asset price bubbles. The findings presented here can inform ongoing efforts to devise better macro-financial theory and real-world applications at a time when policymakers are still searching for new approaches in the aftermath of the Great Recession.

References

Bordo, M D, and O Jeanne (2002), “Monetary Policy And Asset Prices: Does ‘Benign Neglect’ Make Sense?”, International Finance 5(2): 139–164.

Borio, C, and P Lowe (2002), “Asset prices, financial and monetary stability: exploring the nexus”, BIS Working Paper 114.

Detken, C, and F Smets (2004), “Asset price booms and monetary policy”, in Siebert, H (ed.), Macroeconomic Policies in the World Economy, Berlin: Springer, pp. 189–227.

Drehmann, M, and M Juselius (2014), “Evaluating early warning indicators of banking crises: Satisfying policy requirements”, International Journal of Forecasting 30(3): 759–80.

Galì, J (2014), “Monetary Policy and Rational Asset Price Bubbles”, The American Economic Review 104(3): 721–52.

Goodhart, C, and B Hofmann (2008), “House prices, money, credit, and the macroeconomy”,Oxford Review of Economic Policy 24(1): 180–205.

Jordà, Ò (2005), “Estimation and Inference of Impulse Responses by Local Projections”, The American Economic Review 95(1): 161–82.

Jordà, Ò, M Schularick, and A M Taylor (2013), “When Credit Bites Back”, Journal of Money, Credit and Banking 45(s2): 3–28.

Jordà, Ò, M Schularick, and A M Taylor (2014), “The Great Mortgaging: Housing Finance, Crises, and Business Cycles”, NBER Working Papers 20501.

Jordà, Ò, M Schularick, and A M Taylor (2015), “Leveraged Bubbles”, NBER Working Papers 21486.

Knoll, K, M Schularick, and T Steger (2014), “No Price Like Home: Global House Prices, 1870–2012”, CEPR Working Paper 10166.

Mishkin, F S (2008), “How Should We Respond to Asset Price Bubbles?”, Financial Stability Review, Banque de France, vol. 12 (October), pp. 65–74.

Mishkin, F S (2009), “Not all bubbles present a risk to the economy”, Financial Times, November 9, 2009.

Schularick, M, and A M Taylor (2012), “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870–2008”, The American Economic Review 102(2): 1029–61.

Svensson, L E O (2014), “Inflation Targeting and “Leaning against the Wind”, International Journal of Central Banking 10(2): 103–14.

Footnote

1 See, for example, “An interview with Alan Greenspan,” FT Magazine, 25 October, 2013.

( Source : http://www.voxeu.org/article/leveraged-bubbles )

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This is a cyclical downturn this is a cyclical downturn

( Source : http://www.bloombergview.com/articles/2015-08-31/maybe-this-global-slowdown-is-different )

The global economy is slowing down. A couple of the big emerging-market economies that drove much of the growth during the past 15 years have hit a wall, and the question of the moment is whether the biggest of them, China, is in real trouble too. Commodity prices are tanking. Trade volumes are down. The Baltic Dry Index of shipping costs, which rebounded from a record low earlier this year, is falling again.

These are all characteristic of a cyclical downturn. And this is a cyclical downturn — oil prices will rise again someday. So will emerging-market stock and bond prices.

But there could also be something else afoot. We could be seeing early signs of longer-term changes in the global economy — changes that could be enormously positive, but also have the potential to upend a lot about how the world works today.

At this point these are just inklings, but I did what I always do when I have an inkling: I made some charts. First, here’s the picture on global trade:

global trade

After a spectacular rise in the 2000s, trade volumes plummeted after the 2008 financial crisis. They then recovered, but declined again in 2013. More up-to-date figures for just the G7 and BRIICS countriesshow that the decline may be accelerating.

trade slowdown new

Again, these things do go in waves. But there’s good reason to think that the trade gains of the 1990s and 2000s probably won’t be replicated anytime soon. As Michael Francis and Louis Morel of the Bank of Canada summed up in a recent report:

[T]rade reforms and technological innovations that lowered trade costs during the 1990s had a substantial effect on global trade by encouraging emerging markets to integrate into the global economy and by making global value chains economically viable. As a result, global trade rose relative to GDP. However, since this process is largely complete, the underlying incentives to expand trade are likely weaker now than they were in previous decades, leaving the world in a state where trade is neither rising nor falling relative to GDP.

A related argument is the one that’s been made by Harold Sirkin of the Boston Consulting Group for several years: Building global supply chains became so fashionable for Western manufacturers that they built them even when it made sense to keep production closer to customers; now they’re retrenching and revising their approach.

Still, I can’t help but thinking (perhaps wishfully thinking) that what we’re seeing might also be the beginnings of a plateauing in the world’s demand for things — and, even more, the resources needed to make those things. After all, the latest United Nations population projections, released in July, do indicate that we may be nearing a plateauing of the number of people on the planet.

population

Still, in the median forecast, the plateauing won’t happen till the end of the century. It’s possible that it won’t happen at all. Also, there are still billions of people around the world hoping to emerge from poverty and consume more things and resources. We’d have to see already-affluent people buying fewer things and consuming fewer resources to get the kind of shift I’m talking about. Are we seeing that?

Well, sort of. Here’s one remarkable shift the U.S. economy has made during the past 65 years:

goods services

The U.S. economy has grown so much during that period that people now are still buying more physical stuff than they did in 1950. Still, there are signs of a plateau. Consider what was long the iconic good produced by the U.S. economy, the automobile.

peak auto

The big growth years definitely seem to be over, even though U.S. population has kept growing. Still, this chart doesn’t exactly offer conclusive evidence. The trajectory on energy use is a little clearer.

energy

Americans use substantially less energy per capita now than they did in the 1990s. In Europe the trajectory is muddled by the entry of Eastern European countries into the global economy in the 1990s, which brought increased affluence and with it higher energy use — but the low level is an indication that the U.S. likely still has a lot of room to cut. The rapid growth in energy use in China was of course one of the factors behind the global natural resources boom that recently went bust.

The decline in Chinese demand for natural resources during the past year has been one of the main things prompting observers to wonder if the country is undergoing a much-sharper economic slowdown than the official numbers indicate. It may well be. But this also could be evidence of the Chinese economy’s shift away from resource-intensive manufacturing and infrastructure-building and toward providing services for Chinese consumers. In general, developing countries are making the switch from goods to services much earlier in their development than the U.S. and Europe did. This may not be all good news; economist Dani Rodrik worries that it might make it harder for them to catch up with wealthy countries. But it does mean less demand for things, and for the resources to make those things.

Finally, consider the things that people do want to spend their money on. The defining consumer product of our age is the smartphone. A smartphone is a good, and it takes resources to make and transport it. Still, it takes a lot less resources than, say, a car. Most of its value is in the software that is loaded onto it and the people, information and entertainment you can connect to with it. That’s a different sort of value creation than 20th-century resource-based value creation. If that’s the direction the global economy is headed in, the connections between growth, trade and resource consumption aren’t going to be the same as they have been. That is probably a good thing.

  1. G7: Canada, France, Germany, Italy, Japan, United Kingdom, United States. BRIICS: Brazil, the Russian Federation, India, Indonesia, China, South Africa.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Justin Fox at justinfox@bloomberg.net

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Why did the market Crash ?

When stock markets are free-falling 10+% in a matter of days, it’s natural to seek some answers to the question “why now?”

Some are saying it was all the result of high-frequency trading (HFT), while others point to China’s modest devaluation of its currency the renminbi (a.k.a. yuan) as the trigger.

Trying to finger the proximate cause of the mini-crash is an interesting parlor game, but does it really help us identify the trends that will shape markets going forward?

We might do better to look for trends that will eventually drag markets up or down, regardless of HFT, currency revaluations, etc.

Five Interconnected Trends

At the risk of stating the obvious, let’s list the major trends that are already visible.

The China Story is Over

And I don’t mean the high growth forever fantasy tale, I mean the entire China narrative is over:

  1. That export-dependent China can seamlessly transition to a self-supporting consumer economy.
  2. That China can become a value story now that the growth story is done.
  3. That central planning will ably guide the Chinese economy through every rough patch.
  4. That corruption is being excised from the system.
  5. That the asset bubbles inflated by a quadrupling of debt from $7 trillion in 2007 to $28 trillion can all be deflated without harming the wealth effect or future debt expansion.
  6. That development-dependent local governments will effortlessly find new funding sources when land development slows.
  7. That workers displaced by declining exports and automation will quickly find high-paying employment elsewhere in the economy.

I could go on, but you get the point: the entire Story is over.  (I explained why in a previous essay, Is China’s “Black Box” Economy About to Come Apart? )

This is entirely predictable. Every fast-growing economy starting with near-zero debt and huge untapped reserves of cheap labor experiences an explosive rise as the low-hanging fruit is plucked and the same abrupt stall and stagnation when the low-hanging fruit has all been harvested, leaving only the unavoidable results of debt-fueled speculation: an enormous overhang of bad debt, malinvestment (a.k.a. bridges to nowhere and ghost cities) and policies that seemed brilliant in the good old days that are now yielding negative returns.

The Emerging Market Story Is Also Done

Emerging currencies and markets have soared on the back of the China Story, as China’s insatiable demand for oil, iron ore, copper, soy beans, etc. drove global demand to unparalleled heights.

This demand pushed prices higher, which then pushed production (supply) higher, as the low cost of capital globally enabled marginal resources to be put into production with borrowed money.

Now that China’s demand has fallen off—by some accounts, China’s GDP is actually in negative territory, despite official claims that it’s still growing at 7% annually—commodity prices have crashed, taking the emerging markets’ stock and currency markets down. (Source)

Here is a chart of Doctor Copper, a bellwether for industrial and construction demand:

Here is Brazil’s stock market, which has declined 54% in the past 12 months:

These are catastrophic declines, and with China’s growth story over, there is absolutely nothing on the global horizon to push demand back up.

Diminishing Returns on Additional Debt

The simple truth is that expanding debt has fueled global growth. Though people identify China as the driver of global demand for commodities, China’s growth is debt-driven. As noted above, China quadrupled its officially tracked debt from $7 trillion in 2007 to $28 trillion as of mid-2014—an astonishing 282 percent of gross domestic product (GDP).  If we add the estimated $5 trillion of shadow-banking system debt and another year’s expansion of borrowing, China’s total debt of $35+ trillion is in excess of 300% of GDP—levels associated with doomed to default states such as Greece and Spain.

While China has moved to open the debt spigot in recent days by lowering interest rates and reserve requirements, this doesn’t make over-indebted borrowers good credit risks or more empty high-rises productive investments.

Borrowed money that poured into ramping up production in emerging nations is now stranded as prices have plummeted, rendering marginal production intensely unprofitable.

In sum: greatly expanding debt boosted growth virtually everywhere after the Global Financial Meltdown of 2008-2009. That fix is a one-off: not even China can quadruple its $35+ trillion debt to $140 trillion to reignite growth.

Here is a sobering chart of global debt growth:

Limits on Deficit-Spending (Borrowed) Fiscal Stimulus

When the global economy rolled over into recession in 2008, governments borrowed money by selling sovereign bonds to fund increased state spending.  In the U.S., federal borrowing soared to over $1 trillion per year as the government sought to replace declining private spending with public spending.

Governments around the world have continued to run large deficits, piling up immense debts since 2008.  The global move to near-zero yields has enabled governments to support these monumental debt loads, but even at near-zero yields, the interest payments are non-trivial. These enormous sovereign debts place some limits on how much governments can borrow in the next global recession—a slowdown many think has already started.

Here is a chart of U.S. sovereign debt, which has almost doubled since 2008:

As noted on the chart: what structural inadequacies or problems did governments fix by borrowing gargantuan sums to fund state spending?  The basic answer is: none. All the same structural problems facing governments in 2008 remain untouched in 2015. These include: over-indebtedness, bad debts that haven’t been written down, insolvent banks, soaring social spending as the worker-retiree ratio slips below 2-to-1, externalized environmental damage that has yet to be remediated, and so on.

Central Bank Stimulus (Quantitative Easing) as Social Policy Has Been Discredited

In the wake of the Global Financial Meltdown of 2008-2009, central banks launched monetary stimulus programs aimed at pumping money into the economy via bank lending. The stated goals of these stimulus programs were 1) boost employment (i.e. lower unemployment) and 2) generate enough inflation to stave off deflation, which is generally viewed as the cause of financial depressions.

While it can be argued that these unprecedented monetary stimulus programs achieved modest successes in terms of lowering unemployment and pushing inflation above the zero line, they also widened wealth and income inequality.

Even as these programs made modest dents in unemployment and deflation, they pushed asset valuations to the moon—assets largely owned by the few at the top of the wealth pyramid.

Here is a chart of selected developed economies’ income/wealth skew:

The widespread recognition that the benefits of central bank stimulus mostly flowed to the top of the pyramid places political limits on future central bank stimulus programs.

The 2008-09 Fixes Are No Longer Available

In summary, the fixes for the 2008-09 recession are no longer available in the same scale or effectiveness.  Expanding debt to push up demand and investment, rising state deficit spending, massive monetary stimulus programs—all of these now face limitations. This means the central banks and states have very limited tools to reignite growth as global recession trims borrowing, investment, hiring, sales and profits.

 

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Everything you’ve heard about China’s stock market crash is wrong

(Source : http://qz.com/486476/everything-youve-heard-about-chinas-stock-market-crash-is-wrong/ )

This week’s Chinese stock market implosion has been widely viewed as a reaction to the Chinese government’s devaluing the yuan on Aug. 11—a move many presume was a frenzied bid to lower export prices and strengthen the economy.

This interpretation doesn’t stand up to scrutiny. First, Chinese investors haven’t been investing based on how the economy is doing, but rather, based on what they think the government will do to prop up the market. The crash, termed “Black Monday,” was more likely a reaction to the central bank’s failure over the weekend to announce a widely expected cut to the bank reserve requirement since previous cuts in February and April had boosted stock prices. The government eventually caved andannounced a cut on Tuesday (Aug. 25).

Second, the crash happened nearly two weeks after the devaluation, and the government only let the yuan depreciate by about 3% before swooping in and propping up its value again—which hardly helps exporters since the currency’s value effectively rose some 14% in the last year.

The devaluation probably had more to do with breaking the yuan’s tightly managed peg to the US dollar, an obligation that has been draining the economy of scarce liquidity as capital outflows swell.

Both moves—the government pulling back from its market bailout and the currency devaluation—stem from the same ominous problem: China’s leaders are scrambling to find the money to keep its economy running. To understand the broader forces that led to this predicament, here’s a chart-based explainer tracing its origins:

China used its exchange rate to stoke growth

China has long pegged its currency to the US dollar at an artificially cheap rate. Keeping the yuan cheaper than it should be, even as export revenues and foreign investment gushed in, allowed China to amass huge foreign exchange reserves, as we explain in more detail here:

A cheap currency has also powered China’s investment-driven growth model (more on this here). By paying more yuan than the market would demand for each dollar, the People’s Bank of China (PBoC) created extra money out of thin air, sending it sloshing around in the economy. (Meanwhile, the PBoC prevented from driving up inflation by setting its bank reserve requirements unusually high, as we explain here.)

Easy money, easy lending, easy growth. This was especially true after the global financial crisis hit, when China pumped 4 trillion yuan ($586 billion in 2008 US dollars) into its economy to protect it from the fallout. The resulting double-digit growth attracted foreign investment and hot money inflows, raising demand for yuan. To buoy its faltering export industry, the PBoC had to buy even more dollars to prevent surging yuan demand from driving up the local currency’s value.

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The government pumped the stock market

But growth is now slowing, making the $28 trillion in debt China racked up in the process even harder to pay off.

About a year ago, the government turned to pumping up the stock market. The thinking behind this move, says Derek Scissors, economist at the American Enterprise Institute, was, “Hey, why not address our huge problems by replacing debt with equity?” In other words, a bull market would help indebted companies raise new capital and pay off overdue loans. But eventually the market tanked.

So starting in early July, the government launched a sweeping stock market bailout, vowing to prop up the Shanghai Composite Index until it hit 4,500. The problem is, every time it has neared that target level, investors start selling in anticipation that the government will pull back its support. As a result, the Chinese government has now spent as much as $1 trillion to prop up stocks.

Hot money fled the country

While some investors were betting on stocks, others had seen the writing on the wall and were getting out—swapping their yuan for other currencies. Starting in late 2014, the influx of hot money reversed course, and speculative investment flooded out of China. One measure of that is the drop in (mostly) short-term trade finance from foreign banks, which started in Q4 2014:

Another is the fall in foreign exchange that Chinese banks are holding:

Once people started selling the yuan, others began fearing that their yuan holdings would lose value—so they sold too. Lower demand for the yuan should have lowered the currency’s value relative to the dollar. But the PBoC had to keep the yuan’s value stable. Not only had it promised to do so as a requirement of joining the IMF’s basket of central bank reserve currencies; the yuan’s stability and gradual appreciation has long attracted foreign capital into China, says Carlo Reiter, an analyst at J Capital Research. To continue propping up the yuan’s value, the PBoC started selling dollars from its precious reserves in exchange for yuan:

Buying back yuan lowered liquidity, however, which raised borrowing costs, putting a damper on borrowing and investment and threatening deflation:

Higher borrowing costs exacerbated the country’s $28 trillion in debt, much of which has been borrowed at variable interest rates.

The rising stock market crimped bank lending

As investors shifted money from their banking deposits into brokerage accounts to buy stocks, liquidity tightened, leaving banks with less money to lend, says Christopher Balding, finance professor at Peking University. To keep the economy growing, the government continued to pressure banks to lend.

To help keep credit flowing, the Chinese government launched a bailout in early July (which, as we mentioned earlier, cost the government more than $1 trillion.) To fund this bailout, interbank lending by state-backed entities has surged, says Carlo Reiter, analyst at J Capital Research. In July, government institutions lent 9.3 trillion yuan to banks, mostly to boost the stock market, he says.

However, the flood of interbank capital eventually caught up with the PBoC. Adding even more money into the financial system put downward pressure on the yuan.

This brings us to the Aug. 11 currency devaluation, which likely occurred because the yuan became too “expensive to defend,” says Reiter. Nevertheless, the exchange rate has leveled off over the last few trading days—a sign that capital outflow is so great that the central bank has once again resorted to selling dollars for yuan.

Already, this “battle to stabilize the currency has had a significant tightening effect on domestic liquidity conditions,” wrote Wei Yao, economist at Societe Generale, in an Aug. 25 note. In other words, the government’s grand plans to reduce its debt woes while preventing capital from flowing out may have the perverse effect of causing more of both.

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Are we heading into a bigger storm ?

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