Why The Chinese Credit Market Might be the Biggest Gambling Ring in the World

Japanese economy

It’s still winter here in Melbourne. Saturday’s Cox Plate was apparently the coldest in history…and it was first run in 1922! Perhaps a record was fitting, because Winx’s win was the most dominant in history, too. Unbelievable.

Markets are still frosty, too. The Dow fell 0.22% on Friday, while the S&P 500 dipped 0.11%. The major indices are pretty much frozen in a tight range…waiting for the election, for interest rates to rise…or for some better than expected news from the US economy.

Who knows what’s behind the lack of movement…but it’s getting a little boring.

Looking at a chart of the Dow Jones Industrials, this boredom won’t last for long. As you can see, prices are trading within a narrowing range. These patterns usually resolve themselves by moving sharply out of the range.

The line in the sand for the Dow is 18,000 points. A decisive break below there will signal a shift in momentum. That is, it will increase the odds that the upward momentum that has been in place since the start of the year is giving way to a new downtrend.

On the other hand, a break above the downward sloping trend line will indicate a continuation of the upward trend. The odds favour the trend continuing, but I wouldn’t be betting on either outcome at this stage. Let the market make the decision for you.

Source: Optuma
[Click to enlarge]

The biggest risk to stocks right now is a Trump victory in the upcoming US election, which is now just two weeks away.

While the polls suggest Clinton will win, you just never know.

The parallels with the Brexit vote are obvious. That is, the mainstream media and ‘educated elite’ favour Clinton unanimously. But Trump has tapped into a growing disaffection among the masses, which may or may not show up in a surprise outcome on Tuesday, 8 November.

Although, Trump seems to have successfully alienated women, blacks, Asians and Mexicans, so he really does have his work cut out. But no one thought the UK would vote to leave Europe; and while no one thinks the US will vote in Trump, there’s a higher probability of that happening than the media would have you believe.

A major theme in the markets over the past few months has been the persistent strength of the US dollar. That’s thanks to expectations of an interest rate rise coming in December.

Surprisingly, the Aussie dollar has held up nicely during this bout of US dollar strength. As you can see in the chart below, since bottoming in January, during the last global growth scare (and concern over China’s growth path) it has trended higher.

Source: Optuma
[Click to enlarge]

That’s much to the disappointment of the RBA, which tried to weaken the Aussie dollar with rate cuts in May and August. Clearly, these attempts had no effect.

When you’ve got creditor nations like Japan and Europe monetising billions every month, attempts by Australia to weaken their currency with little interest rate cuts are useless.

When I say creditor nations, I mean both Europe and Japan run current account surpluses. They produce more than they consume, and so have excess savings to export and invest elsewhere.

With quantitative easing programs ongoing in both Europe and Japan, this flow of capital is only enhanced.

Throw China into the mix, with a record credit expansion underway, and you have a lot of capital flowing into Australia purely because it seems like a decent place to invest, in a world where growth is holding up.

That’s why the Aussie dollar tanks when there is a global growth scare. Foreign capital inflows dry up.

The Aussie exchange rate reflects these capital movements. When more capital flows in than out, the ‘price’ of the currency goes up. And it goes down when capital flows out.

The combined monetary policies of Europe, Japan and China are bullish for the Aussie. The fact that the Aussie hasn’t really weakened in response to the prospect of higher rates in the US tells you that a US rate rise is not (yet) seen as detrimental to global growth.

The biggest influence on the Aussie, in my view anyway, is the ongoing credit boom in China. China has a problem in that the more credit it creates, the bigger the problem it has with capital outflows.

That is, in order to maintain economic growth at the targeted rate, China must create huge amounts of credit growth. But because much of this is by government mandate, when the private sector gets its hands on the credit as it flows through the economy, it wants to get the funds out of China.

That’s why you saw the crackdown on Crown Casino last week. China’s authorities see gaming as just another conduit for illegal capital flows. Why Crown in particular was targeted is a mystery. Whatever the reason, the Chief Executive of rival casino company The Star Entertainment Company [ASX:SGR] saw the need to cancel his trip to Macau this week…where gambling is actually legal.

He obviously doesn’t want to risk a potential visit to a Chinese detention centre. And who could blame him?

The irony of all this is that Chinese authorities are running the biggest casino in the world — the Chinese credit market. But they want to keep the money in-house…and, as the saying goes, the house always wins.


Greg Canavan,
For Markets and Money

Greg Canavan

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing.

He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’.

Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors.

Greg Canavan

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