I’ll start today’s Daily Reckoning by saying that the ongoing stock market crash in China will not derail the global economy or lead to a bout of contagion that will take down global markets.
But China’s economic tinkerers do have the capacity to make things much worse than they should be.
Before I explain how, let’s get some perspective. From the Economist:
‘Lost in all the drama about the stockmarket is that it still plays a surprisingly small role in China. The free-float value of Chinese markets—the amount available for trading—is just about a third of GDP, compared with more than 100% in developed economies. Less than 15% of household financial assets are invested in the stockmarket: which is why soaring shares did little to boost consumption and crashing prices will do little to hurt it. Many stocks were bought on debt, and the unwinding of these loans helps explain why the government has been unable to stop the rout. But this financing is not a systemic risk; it is just about 1.5% of total assets in the banking system.’
In a country as large as China, with disparate incomes and social classes, statistics like this can be misleading. But the point is, a stock market crash shouldn’t be the end of the world for China. Systemic financial crises happen when banks get involved en masse and asset values fall below debt levels, impairing their ability to create credit and restart economic growth. It’s something that Phil Anderson at Cycles, Trends and Forecasts writes about often.
And anyway, the booming stock market didn’t have much of an effect on the economy on the way up, so why should it do damage on the way down?
But this is China we’re talking about. Where everything is stage-managed and nothing left to the market to sort out. The Party knows best, because the Party wants to keep the plebs happy and stay in power.
Stocks bubbling higher? Good. Stock market crashing? Bad.
This is where the problems start to mount. China’s leaders panicked about the stock crash and its attempts to fix things have only made them worse.
You’re seeing the result of these bungled attempts now.
Yesterday, thanks to government actions, over 70% of Chinese listed stocks were suspended from trading. It was an attempt to restore stability to the market.
It was a disastrous decision. Panicked investors simply looked elsewhere for liquidity. When you need to raise funds to pay back margin calls (much of China’s stock boom is the result of buying on margin) you have to sell.
So the sellers just sold what they could. The Shanghai index still finished down nearly 6% yesterday. Sellers also turned to the Hong Kong stock market, down nearly 6% too.
You also saw the effects of this in the commodity markets. Much of the commentary around falling commodity prices involves reduced Chinese demand resulting from the stock market crash. But I don’t think this is the real story.
You may have heard of commodity stockpiles being used as collateral for cheap financing in China? Recently, traders have clearly used the funds raised to speculate on the stock market bubble.
Now the crash is upon us, and 70% of the Chinese market just froze up, commodity prices are under the pump in the search for liquidity.
The iron ore market is a perfect example. Overnight, the iron ore price crashed 10%. It’s now down to US$44.59 a tonne. The unwinding of collateral financing deals, along with horrendous demand and supply dynamics, means iron ore prices are in for special treatment.
A 10% overnight fall in anything is a major move. The crash represents a new low for the iron ore price and confirms the relentless downward trend is still in place. We’re heading into the US$30 a tonne region folks. And possibly going lower still.
Gina Rinehart’s Roy Hill mine is just about to start shipping ore. The majors are all in expansion mode, fooled by the false price signal delivered by China’s unsustainable credit boom.
You’ll soon see the juniors go into administration and stop producing. Atlas Iron’s crazy attempt to raise funds to restart production is dead and buried with this price collapse.
But the iron ore collapse means much more for Australia. The government’s budget deficit is in tatters again. A falling terms of trade means lower incomes and a lower standard of living.
But don’t worry. The Grocery Code of Conduct should pull us through the hard times. If you are concerned about the ability of our political leaders to steer us through these difficult times, rest assured, we’re in safe hands.
If you have your doubts, just read this article. It’s not a joke by the way.
While Tony Abbott thinks grocery conduct will trump China’s stock market woes, colour me sceptical. Australia’s day of reckoning is fast approaching and we have buffoons at the wheel.
The biggest risk China faces isn’t so much the bursting stock bubble, it’s the people’s reaction to it and their faith in their government to maintain control.
The Chinese people have an unwavering belief in the authorities to sort things out in times of turmoil. If this belief falters, you’ll see rising instability in China. I don’t see it as a big risk, but it bears watching.
The other thing to think about here is just how much cash can the Chinese blow chasing bubbles? First there was the Chinese property bubble. Then the money started flowing in to the Aussie property bubble and at the same time, the stock bubble began to inflate.
Will falling stock prices affect Aussie property values? Will Chinese buyers be able to come up with the other 90% of the property price on settlement day? We’ll find out in the next few months.
China has too much cash and not enough know-how. Culturally, it’s not aligned with the capitalist system of generating returns on capital to create wealth. For example, its largest overseas commercial real-estate project has just gone bust in the Bahamas. As the Wall Street Journal Reports:
‘The opening of Baha Mar, the $3.5 billion resort and casino project in the Bahamas, was supposed to be a showpiece that would help China’s largest construction company win lucrative resort business across the U.S.
‘Instead, a series of missed deadlines, a bankruptcy filing and bitter clashes with the developer over pay to imported Chinese workers are turning the flashy development for the global elite into a quagmire, one that could complicate China State Construction Engineering Corp.’s ability to win new business in the region and the U.S.’
China is misallocating capital around the globe on a massive scale. The source of the problems is the currency peg to the US dollar. This fixed currency price creates huge economic distortions and you’re seeing it everywhere. Chinese stocks, global real estate, iron ore prices…
The international monetary system with the US dollar as reserve currency is the core of the problem. Until it’s reformed, this volatility and constant ‘crises’ will not go away.
For Markets and Money, Australia