The Chinese Swamp America’s QE

Rowing upstream sucks. But if you can hear a waterfall, it’s probably a good idea to give it a go.

Economists disagree. It’s all about speed to them. And paddling towards a waterfall is a great way to add speed. At some point, a lot of speed.

Questioning economists about the direction you’re heading will get you blank stares. Who cares? Economic growth is economic growth, no matter what it looks like.

But that attitude leads to all sorts of bizarre outcomes. In the Soviet Union, industry produced useless products like giant nails to try and meet production targets expressed in tonnes. In the US, Spain and Ireland a vast supply of houses was built to take advantage of low interest rates.

Despite the blindingly obvious, economists have come up with proof that their obsession with growth has no bad consequences. Their favourite tool for generating growth these days is debt. Interest rates are like a throttle lever to them. If economic growth is too low, generate some debt growth by lowering rates.

Researchers at the IMF used statistical analysis of historical data to show that there is ‘no evidence of any particular debt threshold above which medium-term growth prospects are dramatically compromised. Furthermore, we find the debt trajectory can be as important as the debt level in understanding future growth prospects…

So it’s not just enough to borrow a lot of money to generate growth. You have to keep borrowing it. But don’t worry, this isn’t a dead end. You can borrow as much as you like. In fact, to maintain growth, you’ve got to keep borrowing once you start.

The reason economists focus on debt as the lever to control the economy is that they’ve given up on many of the other tools. Economist Milton Friedman and his mates proved that price controls, rent controls, subsidies, tariffs, anti-discrimination laws, and the rest of their harebrained policies create more problems than solutions. Central planning inevitably fails and if you have a specific policy, its failure is obvious.

But for some reason, Milton abandoned his own logic when it comes to money and debt. He reckoned manipulating the price of debt – the interest rate – is a good idea. It isn’t subject to all the same flaws as other price controls.

But, as the Austrian school of economics shows, you get exactly the same problems, just on an economy-wide scale. Surpluses of debt show up in the form of a boom, and then shortages of debt in the form of a bust. By trying to deal with the shortage of debt, policy makers trigger the next debt binge, which ends in, you guessed it, another bust.

For some reason, the IMF research says otherwise. It doesn’t see debt binges as ending in debt busts. We smell a rat in terms of their dates and method, but never mind that. They’ve proven that debt doesn’t matter. Borrow and binge away. Nothing will go wrong.

China certainly took a leaf out of that book. It is creating hundreds of billions of loans, which includes loans from all sorts of financial institutions, not just the banks.

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The interesting thing is that the Chinese central bank stepped up its rhetoric of leaving the financial sector to its fate should it lend irresponsibly. They don’t seem to be walking the walk though.

They’re bailing out their own shadow banking sector with monetary policy, injecting hundreds of billions of RMB into the market. But it’s not enough. Authorities were ‘forced’ to save Jilin Trust and CEG1 Trust with more direct aid. Maybe policy makers in China learned the Lehman Brothers’ lesson.

The Chinese are determined to go one step further than the Americans in every way. Not content with bailing out the financial system, they helped out coal company Shanxi Liansheng. It might seem weird to bail out a coal company, but when it owes enough money to cause a problem in the banking system (30 billion RMB), it makes perfect sense. And then there’s the signal such a bailout sends to the market. Keep lending and we’ll back you up.

The problem right now is that the Chinese financial system is on increasingly expensive borrowed time. Finance companies are forced to borrow to pay out on their maturing debt. But the market rate has surged because of the defaults so far. At some point, funding yourself with expensive debt kills your profit margin and you default. Or you pass on the cost of funding to your customers – the companies buying all that copper and iron ore from Australia.

For now, those companies are still enjoying China’s epic credit boom. BHP doubled profits to $9 billion for the first half of the financial year.

Not that we need a China crisis to cause a problem. Dan Denning’s latest theory is that prohibitive electricity prices are going to trigger all sorts of issues for Australian industry.

The proof is in the pudding. In addition to all the dismal news about the car manufacturers and their satellite suppliers, Alcoa announced the closure of its Port Henry aluminium smelter this morning.

According to today’s Financial Review, ‘This is not a case where workers’ conditions were the principal culprit… But the biggest single cost in aluminium production — otherwise known as “congealed electricity” — is energy. Australia has for years had a high cost energy strategy.

Oh well. It’s just another 950 jobs leaving the south-eastern part of Australia. In our opinion, they’d all be better off in Queensland anyway.

Dan is unusually optimistic about all this. He’s found a way to profit by looking at the alternative energy to standard electricity. On the other hand, The Money for Life Letter readers learned about how companies are setting up their own power supply using unique solutions. There may be a fundamental change coming for Australia’s energy infrastructure. And Dan has his readers positioned to profit.

It wasn’t only economic news that captured our interest this morning. The Swiss defence force has always been popular amongst libertarians. All eligible men must keep a rifle and report to a designated location should Switzerland be invaded. And around three thousand crucial infrastructure points are rigged to blow at short notice.

Unfortunately, the Swiss air force didn’t get the memo when it comes to a constant state of readiness. ‘You have a budget and you have to prioritize,’ said Swiss Air Force spokesman Juerg Nussbaum. He was trying to explain that the air force is only ready to scramble jets during its office hours, starting at 8 am.

Overnight, a co-pilot hijacked an Ethiopian Airlines flight, landed in Geneva and tried to claim asylum in Switzerland. The Swiss were happy to let French and Italian fighter jets fly an escort while their own pilots were safely tucked up in bed. Luckily, the Swiss do monitor their airspace 24/7, so nobody panicked when foreign fighter jets flew over Geneva.


Nick Hubble+
for Markets and Money

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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