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posted on 01 March 2016

Here Comes The Red Swan

by David Stockman

Appeared at Daily Reckoning 25 February 2016

The Red Chip casino took another one of its patented 6.5% belly flops last night. In fact, more than 1,300 stocks in Shanghai and Shenzhen fell by 10% - the maximum drop permitted by regulators in one day - - implying that the real decline was far deeper.

This renewed carnage was the worst since, well, the last 6% drop way back on January 29, and means that the cumulative meltdown from last June's high is pushing 45%. And all this red chip mayhem did not come at an especially timely moment for the regime, as the Wall Street Journal explained:

It comes at an awkward moment for the Chinese government, which is hosting the world's leading central bankers and finance ministers starting Friday. China has been expected to use the G-20 meeting to address global anxiety about its economy and financial markets. Worries about China's economic slowdown and the volatility of its markets have weighed on investment decisions around the world.

But if we are remarking on "awkward", here's awkward. The G-20 central bankers, finance ministers and IMF apparatchiks descending on Shanghai should take an unfiltered, eyes-wide-open view of the Red Ponzi fracturing all about them, and then make a petrified mad dash back to their own respective capitals. There is nothing more for G-20 to talk about with respect to China except how to get out of harms' way, fast.

China is a monumental doomsday machine that bears no more resemblance to anything that could be called stable, sustainable capitalism than did Lenin's New Economic Policy of the early 1920s. The latter was followed by Stalin's Gulag and it would be wise to learn the Chinese word for the same, and soon.

The regime is in a horrendous bind because it has played out the greatest credit spree in world history. This cycle of undisciplined, debt-fueled digging, building, spending and speculating took its collective balance sheet from $500 billion of debt in the mid-1990s to the $30 trillion tower of the same that now gyrates heavily over the land.

That's a 60X gain in debt over just two decades in an "economy" that has no honest financial markets; no legal system and tradition of bankruptcy and financial discipline; and a banking system that functions as an arm of the state, cascading credit down from the top in order to "print" an exact amount of GDP each month on the theory that anything that can be built, should be built in order to hit Beijing's targets.

If an economy and its ruling regime were an animate being you could call it a "fatal addiction" and be done with it. These folks are on the deadliest strain of financial heroin known to mankind and have no chance of surviving; its a dead economy walking.

Look no further than the hideous debt gains reported for the month of January. Total social financing rose by 3.42 trillion yuan or a round one half trillion USD.

That right. On top of it tottering $30 trillion tower China has just piled on new debt at a $6 trillion annual rate or 55% of GDP per year!

By now China's businesses - - especially the giant SOEs (state owned enterprises) - - are drowning in excess capacity and unpayable debt that amounts to upwards of 180% of GDP (compared to 70% in the US). But never mind. New loans to business in January were up by 73 percent over prior year.

Worse still, it is evident that a high share of January's lunatic rate of credit expansion was devoted to paying interest on the existing monumental debts of China's business and so-called local government financing vehicles (LGFVs). Even the authorities concede that more than 60% of new debt issuance in recent years has been used to pay interest. They are chasing their tail ever more furiously; they are strapped on to a debt whirligig they can't get off - - -until it finally explodes.

In truth, China's economy is no more efficient, productive, stable or prosperous than was Stalin's five-year plan GDP. The latter, by the way, grew at fulsome double digit rates the west envied for more than a decade.

The only difference is that the Red Suzerains of Beijing seem to have learned about the advantages of using a printing press and "bankers" to carry out their central planning schemes rather than tonnage quotas and commissars; and also that swapping quasi-slave labor in their export factories for IOU's from its customers in the US and Europe could temporarily relieve the misery and poverty that Mao had consigned to the hundreds of millions trapped in China's collectivist rice paddies.

Needless to say, having built a massive potemkin economy, China's rulers have no clue about how to contain the incendiary pressures which are now building to the ignition point. Indeed, since there are no possible economic mechanisms or even viable half-assed statist schemes to stabilize the $30 trillion mountain of debt that sits precariously on its fracturing hothouse economy, or to relieve it of its fatal debt addiction, Beijing will soon have no alterative but to rule by the brute force of paddy wagons, and even firing squads.

The days during which a giant daisy chain of ever inflating lending and spending was raising all boats is over and done. There is nothing ahead except a collapsing credit bubble which will be sinking the great Red Ponzi boat and its 1.3 billion passengers. And along with it, a worldwide economy and financial system afflicted with the plenary misrule being brought to Shanghai by the G-20.

As to the former, China's looming crash landing could not have been made more clear than by the telltale missive recently sent to the Beijing inner circle by a high official of their own central bank. According to the Wall Street Journal, China's money printers now realize continued reliance of easy credit could blow the system sky-high and turn the current trillion dollar capital flight into a uncontrollable torrent. So the central bankers are demanding that the fiscal arm of the state dramatically increase its own spending and borrowing:

In a recommendation to China's top policy makers reviewed by The Wall Street Journal, a senior official at the People's Bank of China wrote that the government should let the shortfall reach 4% or so, which could allow authorities to slash taxes on businesses to free up more of their funds for investments.

"Fiscal policy hasn't been proactive enough," said Sheng Songcheng, head of the survey and statics department at the central bank and the lead author of the recommendation, in an interview Thursday. "The concern over increasing the fiscal deficit is that it could lead to a fiscal crisis. But our research shows otherwise....."

.A combination of factors would work in Beijing's favor if it were to sharply expand the fiscal scope. The debt held by the central government as a percentage of GDP has been declining in the past few years, from 19.4% in 2007 to 15.1% in 2014, according to Mr. Sheng's report....."China has room to expand its fiscal deficit to 4% or even 4.5% even if the GDP growth rate drops to 5%," Mr. Sheng said in the interview.

Now isn't that pettifoggery perfectly ridiculous. As a purely statistical matter, China's true central government fiscal debt is not even close to 15% of GDP or just under $2 trillion. It's actually nearly $11 trillion or 100% of GDP, and that's on the phony, bloated GDP total published by Beijing on the last say of each quarter - -never to be revised again, world without end.


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Here's why. There is no difference whatsoever between the state and the economy in the Red Ponzi. China's hideously bloated $30 trillion banking system - including trillion of off-balance sheet loans through wealth management products, entrusted loans, receivables financing and many more crooked devices - -would not last a week without state backing. That means that even if the embedded loan loss rate in the system is just 15%, there is already another $4.5 trillion claim on China's central government balance sheet. Sooner or later Beijing will be forced to bailout the banks.

Likewise, the entirety of the $3.5 trillion of acknowledged LGFV debt - -and probably far higher in actuality - - would blow up in an instant were it not for Beijing implicit backing. On top of that there is the need for trillions more to be reserved for the cost of massively downsizing and restructure China's vastly overbuilt industrial plant, beginning with the steel industry and all its upstream and downstream supply chain partners.

The Red Suzerains have built themselves 1.2 billion tons of steel capacity, or more than that of the rest of the planet combined. Yet they have supportable demand for only 500 million tons per year, and that's only if they can manage to prevent total economic anarchy and entropy. By their own recent announcement they plan to take out 150 million tons - or well more than the steel industry of Europe - and to make massive adjustment payments to the millions or workers, families and communities which will be dislocate.

But even that won't cut it. Once the world goes Full Donald against the current 100 million ton flood of dumped Chinese steel exports, the central government will have to spend tens of billions more to support payrolls in several hundred million tons of additional steel plants which will have no customers.

At the end of the say, however, it does not matter under which pea China shuffles its gargantuan debt. The Red Ponzi is a unitary house of economic cards, meaning that the discussion which will occur between the Jack Lew's and Christine Legarde's of the G-20 and their Chinese interlocutors this weekend is utterly pointless.

Even the Chinese rulers know the truth about the state's immense shadow debt as summarized above. They will therefore be exceedingly reluctant to expand the official deficit much beyond 3% of GDP, but prodded by today's timely leak from the People Printing Press (e.g. central bank) you can be sure that the G-20 visiting squad of clueless Keynesian apparatchiks will demand 4% to help the world avoid the China slowdown bullet. Much time will be spent dickering on the decimal points in between.

Talk about playing tiddlywinks on the deck of the Titanic. The G-20 will come and go without even engaging on the enormity of the ticking time bomb which will surround them.

And they will also, thankfully, probably never even get around to an even stupider grand scheme now resident in Legarde's purse, which was also conveniently leaked to the WSJ, as follows:

The problem is figuring out how to revive demand in a world where central banks are running out of gas and most of the world's biggest growth engines are downshifting, idling or struggling to get out of first gear. The solution, many G-20 officials have indicated in recent days, is a stronger effort to restructure stagnating economies and increase investment in infrastructure.

As central banks vie to gain traction, some investors are calling for the G-20 to orchestrate a coordinated exchange-rate adjustment. Under one idea, world powers would agree to allow China to devalue the yuan to spur growth in the world's No. 2 economy, Europe would encourage public spending and the U.S. would help stabilize emerging markets by providing short-term emergency credit lines.

Well, no, not at all. The Chinese would not touch this with the world's longest bamboo pole because they know it would be a signal for massive capital flight. Likewise, can socialist, sclerotic Europe - - already buried in public debt at well more than 100% of eurozone GDP if you take Germany out of the equation, which would never agree anyway - -borrow the global economy back to prosperity?

And good luck with lame duck Obama getting a GOP congress to make bridge loans to the likes of Brazil and Indonesian.

Yes, take cover. There is a Red Swan rising and its soon going to be circling the economic globe.

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