In the first week of the New Year, the freshly installed circuit breaker of China’s stock market went into effect four times in 2 days. Pretty efficient and just in time right? Not exactly.
As the stock market circuit breaker became the new hot word among Chinese netizens and individual investors, the newly minted system meant to protect the market was put in place quickly, and then withdraw quickly, as the government viewed [it] as something too risky and not “protective” enough.
While the circuit breaker is not exactly something in accordance with a pure market economy, and the system’s protective power and cooling effect was utilized in the United States successfully, its application turns out not that effective in the Chinese stock market, which is a question on everyone’s mind these days.
When Thomas Edison invented the circuit breaker 120 years ago, it served a needed purpose and therefore it is still in use today. Thirty years ago, when U.S. Treasury Secretary Nicholas Brady applied the concept to the stock market, it helped with cooling and calming down investors faced with drastic changes in stock market. The cooling off effect is temporary though, as no one knows if the stock will continue to tumble the next day.
That uncertainty makes the Chinese government decision makers uneasy though, they were probably thinking about a panacea that can safeguard the market no matter what condition it is in. Well, they underestimated the problem of the Chinese stock market and, when the Shanghai Stock Exchange had to halt the trades after only 29 minutes, a “miracle” was created in the 25 years of history of China’s stock market.
If the stock market fluctuation threshold is to be lifted, would the current Chinese regime have the confidence and tolerance for larger fluctuations?

Some analysts believe the threshold China set is too low to be practical (it’s set at a halt of 15 minutes if the fluctuation is more than 5 percent, and halt for the day if over 7 percent), compared with a U.S. threshold of 20 percent. The point is, if the threshold is to be lifted to 10 percent, 15 percent, or 20 percent, would the current regime have the confidence and tolerance for such huge fluctuations? Given the withdrawal of the mechanism after only a few days of implementing it, the bottom line of the government seems quite fragile, and there has got to be some deep down secrets of which the outsiders are not aware.
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It’s widely rumored that Xiao Gang, Chairman of Chinese Securities Regulatory Commission (SRC), was under tremendous pressure and his position became shaky. To be fair, no one should blame Xiao for the mishaps of the Chinese stock market. If the U.S. stock market crashes, Obama is in no authority nor power to summon U.S. SEC chairman for questioning and scapegoating. Instead, Obama would probably ask the SEC chief for advice and guidance under such circumstance.
The Chinese stock market is merely an extension of the political battlefield, and the chaos in the stock market is a reflection of the power face off at the highest level.

The conundrum stems from the fact that the Chinese stock market is merely an extension of the political battlefield, and the chaos in the stock market is a reflection of the power face off at the highest level. Chinese government accuse those who short Chinese stocks and RMB as “hostile,” well, would anyone find a voracious investor “benevolent” anywhere?
For those who are hostile to Xi Jinping’s reform efforts, especially those from the Jiang Zemin era, who have amassed a huge amount of wealth and are now facing retribution, they would indeed do anything to stir up and demolish the stock market as a way to protect themselves, and one can call [those] acts “hostile” for certain!
The introduction and trial of circuit breaker in China seems to be a complete failure at present. But this very action could one way or another make the Chinese market worse off.
MORE:Steve Keen: China’s Stock Market Is an ‘Unbelievable Bubble’For China’s Economy It’s Reform or Bust
With the breaker in place, the government may feel safe and comfortable, and will be less likely to remedy the current situation of systematic flaw in the system. But with the circuit breaker absent, that could be dangerous to China as well, just as a circuit without breaker could avoid the often disruption of power supply, but will foster greater calamity when the circuit can’t hold the current in really dangerous situation. This is exactly what could happen to the over-heated Chinese stock market today.
The government knows for certain that, with or without a circuit breaker, the eventual collapse of the market will all be inevitable, as everything is ultimately political in China, and not only the stock market is unsafe at the moment, the debt market and many sectors of Chinese economy and Chinese politics are all in need of a breaker and a change in its overall structure.
Frank Tian Xie, Ph.D., is a John M. Olin Palmetto professor in business and associate professor of marketing at the University of South Carolina Aiken.

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Of course, he did not say it exactly like that.
When Fed Vice Chairman Stanley Fisher spoke at the Council on Foreign Relations on Feb. 1 he said that “structural adjustments in China” were causing volatility in global assets markets.
“At this point, it is difficult to judge the likely implications of this volatility. If these developments lead to a persistent tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States.”
Fisher, speaking in central bank parlance, means to say that stock markets around the world crashed in January because investors are finally waking up to the fact that the slowdown in China is here to stay and that it has far reaching consequences for the world economy.
What Fisher likely means with persistent tightening of financial conditions is the relentless selling of foreign exchange reserves by China, which has the reverse effect of quantitative easing.

China liquidated $513 billion worth of reserves in 2015. This is almost the same as a negative QE 2 program, where the Fed bought $600 billion of Treasurys and mortgage bonds.
Like the market, Fisher thinks the value of the Chinese currency is key to understanding the country’s problems. It dropped more than 5 percent against the dollar in 2015 and continued its slide in January of 2016.
But Fisher has hopes the Chinese will get things under control: “I’m sure that after a while they will reach a mechanism that is understood both by them and by the public.”
The Fed doesn’t like falling stock markets and low inflation in the United States, but it will likely wait for more concrete signs of stress to act. Or maybe Fisher can give one of his colleagues at the People’s Bank of China a call to ask them to sort things out.
“The community of [central bank] governors is a rather remarkable institution and you can pick up the phone and call anybody in that community and have a serious conversation,” he said, but did not comment on whether he was going to take advantage of that option.   

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It’s the debt, stupid. This is what professor Steve Keen of London’s Kingston University has been saying all along: Private debt is responsible for financial crises. He’s also been saying that conventional economists are wrong, and even wrote a book about it: “Debunking Economics.”
Apart from his razorsharp logic and witty style, Keen was one of the few analysts who predicted the financial crisis in the West in 2008. Now he sees another crisis looming in the East.
Epoch Times spoke to Steve Keen about why private debt is again responsible for China’s economic problems and why the debt fueling China’s stock market is the most ridiculous thing ever.
A private person can’t direct the central bank to pay that debt.

Epoch Times: How did China avoid the financial crisis of 2008?
Steve Keen: The crisis in 2008 destroyed their export policies. There was a 45 percent fall in Chinese exports in one year.
The response at that time was to dramatically boost private lending, trying to cause a boom domestically, to take the place of exports which they have relied on. So you had an enormous increase in private debt in China.
Professor Steve Keen, an unconventional economist. (Steve Keen)
Epoch Times: Some people say that doesn’t matter because in China the debtors are mostly related to the government.
Prof. Keen: It’s state-owned banks and state-directed banks that lent to private institutions. The liabilities are private. State-owned banks have loaned to private companies. Almost all of the increase in debt is to private organizations, and almost all of that has gone to Chinese property developments.
It’s not like the debt in the West where private banks lend to private organizations. What matters is: Who owes the money. It’s still owed by private individuals and companies. If they can’t pay, they are bankrupt and they want to run away and get out of their liabilities. This is going to cause the usual downturn in the economy, even though the debt is owned by state-owned banks.
It comes down to who the liabilities are owed by. If the federal government has a debt, it can direct the central bank to pay that debt. A private person can’t direct the central bank to pay that debt.
Total demand will fall, and that’s the situation we find in China now.

Epoch Times: Give us some numbers please.
Prof. Keen: Seven years ago private debt was about 120 percent of GDP, according to the Bank of International Settlements (BIS). Now it’s 201 percent. The American level peaked at 170 percent before the financial crisis.
The level of demand coming into the economy is relying on continually increasing that debt ratio. But once you reach a peak level of debt, people will not be borrowing beyond that point. The change in debt goes from 20 percent growth to zero. As a result, 20 percent of GDP disappears.
(Macquarie)
Epoch Times: Please explain how that works.
Prof. Keen: Total demand in the economy is demand generated from existing money plus the change in debt. Let’s say GDP is running at a trillion and debt increases 20 percent then total demand is $1.2 trillion dollars in year one.
So GDP is growing at let’s say 10 percent. So next year’s GDP is $1.1 trillion, but if the change in debt goes to zero, total demand will fall from $1.2 trillion to $1.1 trillion. So even if GDP keeps growing at the same rate—which won’t happen—total demand will fall, and that’s the situation we find in China now. That affects all asset markets.
This is an unbelievable bubble.

Epoch Times: What about debt and the Chinese stock market?
Prof. Keen: I have never seen anything quite as ridiculous as margin debt in China. The level of leverage per asset market is crazy. The Shanghai Composite Index had a bubble and a crash in 2008, but there was no margin debt after that crash.
It continued down until June 2014, then it took off and hit a peak of about 5100. What had happened in the meantime, they had deregulated and allowed margin debt to be brought in 2010.
The level of margin debt began in march 2010 at 0.00014 percent of China’s GDP. You fast-forward to 2014, it was 0.3 percent of GDP. In July of 2014, it was 0.5 percent of GDP, by 2015 it was 1 percent of GDP, by July 2015 it was 2.16 percent of GDP. It has since fallen to .84 percent of GDP. This is an unbelievable bubble.
It’s the most volatile level of margin debt anywhere in the world—ever. So you have got this insane level of debt finance and speculation at the same time.
Epoch Times: What can the Chinese do?
Prof. Keen: The property market was the original way to boost demand in the Chinese economy. That has come to an end; the share market has come to an end. So you have this enormous hole in demand.
The 20 percent in debt growth per year was all financing the building boom, suddenly that’s over. All those workers are losing their jobs, and they are going back to the countryside.
There is not going to be demand for new housing in China for 10 years. For example: China is still a major buyer of Australian concrete. A huge part they are buying they can’t use it anymore. So it has been used by China as foreign aid in Africa.
A big part of the political shifts we are seeing are reactions to the slowdown and they are desperately trying to soften the slowdown and that’s where all the crazy policy choices are coming from out of the Politburo.
Most of the infrastructure projects, they can’t keep on doing. The only thing that’s needed is to replace coal with solar. They have huge excess capacity, there is no new export market to go into anymore, and they can’t boost domestically.

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Even before the work week starts properly on Monday morning on the East coast, the bad news from China are already flowing in Sunday evening because of the time difference.
This time, the Shanghai Composite is down another 5 percent to 3017 on Jan. 11, minus 15 percent for the year. On the upside, the yuan is only down 0.1 percent against the dollar and its little brother, the offshore yuan (mostly traded in Hong Kong) is up 1.2 percent to 6.60 per U.S. dollar.
Of course, it wouldn’t be China if the regime hadn’t intervened heavily in both markets. For the stock market, all it could do was to prevent it from dropping more by buying stocks without caring for the losses.
And the losses for the regime are substantial. Goldman Sachs estimates the regime bought stocks worth 1.8 trillion yuan ($270 billion) from June to November of 2015 to prop up the stock market after the July crash.
(Goldman Sachs)
The so called “national team” spent the money in vain, as prices approach the August bottom of 2927 for the Shanghai Composite.
As for the currency, and especially the offshore yuan (down 2.3 percent for the year already), the Chinese central bank made it go up on Monday, but it also paid a heavy price for it.
Overnight interbank lending rates in Hong Kong went up a ridiculous 9.39 percentage points to 13.4 annualized on Monday, a sign that the interventions on the currency market are draining liquidity from the interbank market. This is the highest rate on record.
The movement in the currency and the interbank lending rates is a perfect example of how putting out one fire stirs up another, a problem the regime finds impossible to manage since the shock devaluation of last August.
The offshore yuan (the ticker is CNH and there are about $230 billion of them) sit around as deposits on the balance sheet of private banks, mostly in Hong Kong.
When the Chinese central bank buys up these deposits and hands out dollars in exchange, these deposits are no longer available for private use not even for private banks. They are now locked up on the central bank’s balance sheet.
So if a bank now needs offshore yuan, there are now fewer of them sloshing around in the market. Because there are so few of them to begin with ($230 billion is really nothing compared to the size of the euro or the Japanese yen foreign exchange markets) the market is very sensitive to changes in liquidity and banks have to pay a high interest rate to get the offshore yuan funding they need.
The same is true for the domestic stock market. When the People’s Bank of China sells dollars and buys yuan in the market, those yuan aren’t available for private use anymore, like for investing in the stock market. As a result of the intervention, the stock market—and everything else for that matter—goes down.
The only solution to the problem of the impossible trinity: Let the currency go free.

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If you want to have a functioning market, you have to stick with it in good times and bad. China never really let the market rule in good times, but at least it could pretend it had invented its own brand of state-controlled capitalism.
Now that things are going from bad to worse, China still doesn’t want a 100 percent market. The problem is, it has liberalized the stock market and the exchange rate enough for Mr. Market to get a foot in the door.
While the New Year started badly with a 7 percent stock crash on Jan. 4 and a currency meltdown on Jan. 6, Mr. Market burst through the central planning door on Jan. 7.
Stocks Crash Again
Thursday, Jan. 7, will go down as the shortest trading session in Chinese history—it lasted less than 30 minutes with the Shanghai Composite Index down more than 7 percent at 3,125 at the end of trading. Why so short? Did traders want to take the rest of the day off in preparation for Chinese New Year?
No, they were scared that so-called circuit breakers would halt trading before they could complete all of their sell orders. Ironically, this fear caused a flood of sell orders, which pushed prices so low that the circuits broke and trading shut down for the day.
The circuit breaker kicks in when there’s a 5 percent rise or fall on the main share index and automatically halts trading for 15 minutes; a shift of 7 percent triggers trading to stop for the day.
“If today you have this break, tomorrow everybody will want to run away as soon as possible,” said Yao Yang, professor at the China Center for Economic Research, at a panel discussion in New York on Thursday.
The Chinese stock exchange only installed this system in December after the lessons of the summer of 2015 stock market crash. It thought it would make investors more rational and prevent excessive sell-offs. It did the opposite.
Or in the words of Macquarie research analysts: “Efforts to control the market and enforce an arbitrary pricing floor have had less-than-ideal consequences.” An understatement if there ever was one.
If there is anybody due for an early holiday, it’s David Cui and his analysts at Bank of America. They predicted the Shanghai Composite to drop 27 percent over the year—it’s already halfway there in just the first week of January.
 
(Bloomberg)
China Sells Record Amount of Reserves in December
According to official figures released Jan.7, China had to sell a record $108 billion in foreign exchange reserves (FER) in December, bringing the total for the year to $513 billion. China now has $3.3 trillion left.
But why sell in the first place? According to professor Lu Feng of Peking University, “China is at the trough of its cyclical adjustment” and will keep growing at around 7 percent. He seems to be one of the few people left to believe this.
Chinese people are voting with their money, and they are voting the current system out of office. According to Epoch Times estimates, as much as $1.2 trillion of capital left China in 2015. Throughout the year, China sold U.S. dollars to prevent the currency from crashing.
After the IMF admitted China to its international reserve currency basket in November, the People’s Bank of China let the yuan drop slowly throughout December. Observers, including this publication, then thought China made the smart choice of letting the currency drop and at least keep its stash of reserves.
(Macquarie)
The fact that China had to sell a record amount of FER and depreciate the currency, means that the PBOC is losing control. According to Macquarie, the yuan will drop at least another 5 percent against the dollar and this gradual devaluation will cost the PBOC at least $400 billion in 2016.
“Further devaluation is not good for the United States and is not in the interest of China. China wants to maintain a reasonably strong currency,” says Yao Yang. But maybe Mr. Market has a different idea.
Biggest Devaluation Since August
Mr. Market forced the PBOC to set the fixing for the currency 0.5 percent lower on Jan. 7, the biggest drop since the shock-devaluation of August 2015.
The yuan is down 1.85 percent against the dollar during 30 days of record intervention. If this trend continues for 2016, we are looking at a 20 percent devaluation, not 5 percent.
The dollar rose almost 2 percent against the yuan over the past month. (Google Finance)
Because after all, the currency works like the stock market, only without a circuit breaker. The market knows the central bank is going to let the currency drift lower, and traders are following the classic rule of “who sells first, sells best,” leading to precisely the panic selling that the PBOC wants to avoid.
At which price will traders decide to turn around and buy again? This, only Mr. Market knows.

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The Chinese regime still has considerable power over the markets. After a 7 percent crash of the Shanghai Composite on Jan. 4, it managed to reverse another 3 percent drop on Jan. 5.
So in the very short term, all is well. In the long term and even in 2016, Bank of America sees big problems ahead for the Chinese economy.
According to their analysts the regime has to fight multiple battles at once and will ultimately lose to market forces.   
“We judge that China’s debt situation has probably passed the point of no-return and it will be difficult to grow out of the problem,” states a report by Bank of America’s chief strategist David Cui.
(Google Finance)
The report points out that a spike in private sector debt almost inevitably leads to a financial crisis.  China’s private debt to GDP ratio went up 75 percent between 2009 and 2014, bringing total debt to GDP to about 300 percent. Too much to sustain.
Western analysts often point out that China can handle it and that Beijing has found its own brand of state sponsored capitalism which can prevent a crisis from happening.
Cui shows this assumption is wrong from the start. China already went through all forms of debt crises (currency devaluation, hyper-inflation, and bank recapitalization) since the reform and opening up policies started in 1978.
(Bank of America)
“Banking sector NPL reached some 40 percent in the late 1990s and early 2000s and the government had to strip off some 20 percent of GDP equivalent of bad debt from the banking system between 1999 and 2005,” Cui writes.
(Bank of America)
He also writes that investors assumptions about how the Chinese regime runs the economy will face another severe test  in 2016. The assumptions were as follows:

GDP will keep growing fast
The yuan will appreciate against the dollar
The regime will support the stock market
No major company will default on its debt
The regime will prop up the real estate market

As of 2016, most of these assumptions are no longer true. In addition, market participants and the regime have made the debt problem worse by adhering to them.
This is “a classic case of short term stability breeding long term instability. It’s our assessment that the longer this practice drags on, the higher the risk of financial system instability, and the more painful the ultimate fall-out will be,” Cui writes.
For the coming crisis, Cui believes China will probably have to devalue its currency, write off bad debts, recapitalize the banks, and reduce the debt burden with high inflation.
And even if the regime wants to continue to deliver on the five assumptions, it won’t be able to, as they sometimes contradict themselves. For example, it is impossible to keep growth from crashing by printing money without further downward pressure on the currency.
So after the events of last August and after the International Monetary Fund finally included China in its reserve currency basket, the regime completely abandoned the stable currency objective and let the yuan drift lower.
Another key point Cui doesn’t mention but is important is reform. The regime promises reform and even follows through in some cases. But if push comes to shove, it resorts back to central planning to mold the market according to its needs, with less and less success.  
“It seems to us that the government’s policy options are rapidly narrowing—one only needs to look at how difficult it has been for the government to hold up GDP growth since mid-2014. A slow-down in economic growth is typically a prelude to financial sector instability,” writes Cui and predicts the Shanghai Composite to drop by 27 percent in 2016.
 

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Western commentators complain that China’s 7 percent stock crash on Jan.4 is a  dreadful start to the new year.
Well, technically speaking, the Chinese still can hope their new year is going to be better than the old one, as it only starts on February 8.
Until then, it looks like it’s going to be downhill for the economy, stocks, and the yuan.
The Shanghai composite slipped 6.9 percent to 3296 on Jan. 4, triggering circuit breakers. The onshore yuan dropped 0.37 percent against the dollar.
(Google Finance)
 
Official GDP numbers come out on Jan. 19 but whatever the official number, it real growth won’t be good judging from data on the ground.  
Market commentators blame recent weak manufacturing data and new IPOs but analysts knew all of this beforehand.
In fact, if you look at any data coming out of China, whether it’s official or unofficial, all of it is pointing south. 
Research Firm Capital Economics compiled a chart book of important indicators for the Chinese economy based on official data, showing firmly established downtrends.
The currency will devalue further against the dollar because it has actually gotten stronger in trade weighted terms  in 2015 and that’s what China cares about.
This is the only reason why China launched a trade weighted index for the yuan, so it has a justification to devalue further against the dollar. 
(Capital Economics)
Official GDP growth slowed to 6.9 percent in the third quarter of 2015, but Capital Economic’s own activity proxy indicates growth of only 4 percent.
Electricity consumption, one of the best economic indicators is not growing at all. 
(Capital Economics)
Retail sales are still growing at 10 percent, but retail is not a large share of the economy and growth fell from a peak of almost 20 percent right after the financial crisis.
(Capital Economics)
Trade has collapsed, firmly trending down.
(Capital Economics)
Producer and commodity prices are deep in deflationary territory. Capital Economics is optimistic this will change soon though.
(Capital Economics)
Credit is still growing, but also trending down. Also, the ratio of output per unit of credit decreased dramatically over the years.
(Capital Economics)
Knowing all this, how can traders be surprised by weak manufacturing data? Hope dies last. 
 

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China ends 2015 with an economic win: The U.S. Congress approved a reform package to boost China’s voting rights at the International Monetary Fund (IMF) from 3.8 percent to 6 percent.
This win, however, is largely symbolic, similar to the inclusion of the Chinese renminbi in the IMF’s reserve currency basket (SDR), which happened in November this year.
In 2015, China gained prestige on the international stage while the economy at home had its worst year since reforms started in earnest in 1992.
International Prestige
In spite of being symbolic and far removed from the day-to-day action of global finance, the IMF’s endorsement of China as a whole is a big win Beijing pursued for years. The inclusion of the yuan into the Special Drawing Rights Basket (SDR) means the IMF thinks the currency, and by extension the whole Chinese political economy, is on par with the dollar, euro, yen, and pound sterling.
Why symbolic? Until China’s plan to replace the dollar with the SDR as the global reserve currency becomes reality, there are too few of the SDRs in circulation ($285 billion) to change the demand for the yuan as a reserve asset. Its use is also limited to member countries, who use it mostly for transactions with the IMF.
Also, the increase in voting rights doesn’t change the power structure at the IMF, since the United States retains veto power with 16.5 percent of total votes. However, it recognizes China’s efforts to build up an alternative power structure to the Bretton Woods financial system set up after World War II. China successfully launched its Asian Infrastructure and Investment Bank this year, convincing even staunch U.S. allies like Australia and the U. K. to participate.
The regime plans more reforms of the exchange rate, interest rates, as well as housing registration next year.

China also refined its efforts to compete in global gold trading and started several initiatives to gain control over global trade, like the Silk Road initiative, which plans to bring another U.S. ally, Pakistan, closer to China economically, as it opens up trade with central Asia and eventually Europe. China launched new clearing centers for the yuan worldwide, now the fourth most used currency in the world.
As part of the reforms to convince the IMF to give it more voting rights and include it in the SDR, China has for the first time since 2009 updated its official gold reserves, which increased more than 60 percent to 1,743 metric tonnes (1,921 short tons). It also lifted the cap on interest rates banks pay out to depositors to shift income to consumers, who are supposed to become the growth engine of the economy. It has somewhat liberalized its exchange rate compared to the dollar, although it is still closely managed. The regime plans more reforms of the exchange rate, interest rates, as well as housing registration next year.

Problems at Home
All these reforms move the economy away from a closed-off, centrally planned system to a real market economy fully integrated in the global financial system.
Alas, it may be too little too late and China is now chasing reforms it should have undertaken while the economy was still growing fast. Officially, China will grow at 7 percent in 2015, the lowest rate since 1990. Unofficially, growth has crashed to around 2 percent, with a marked deceleration in the fourth quarter.
In 2015, even the most optimistic analysts realized China’s investment driven growth model is over. Even more so than official data on investment, the plunge in commodity prices as well as producer prices in China suggest a severe slowdown, maybe even outright recession. This unexpected change in demand has left commodity exporters like Russia, Canada, Brazil, and Australia reeling and has wreaked havoc among international mining and commodity giants. They spent hundreds of billions building up their infrastructure to satisfy supposedly never-ending Chinese demand.
We will remember 2015 as a historic turning point for China—and the world.

The only debate still raging among investors and academics is whether the consumer or service sector can take over from manufacturing, investment, and exports. Although there are some signs of resilience in all of these sectors, a real rebalancing will take decades and will be painful, according to Peking University professor Michael Pettis. The consumer just doesn’t have enough income to make up for all the wasteful investment spending.
Wasteful investment spending has created economy-wide debt close to 300 percent of GDP: Debt that needs servicing. This year, reports about defaults and the inability of companies to service their debt have become more frequent, despite the efforts of the regime to provide monetary easing through lower interest rates and different accounting gimmicks, like the local government debt swap program.
Financial Markets
Too much debt and too little growth are the main reasons for the stock market boom and bust, as well as the shock currency devaluation in mid-August. Because many firms cannot service their debt loan anymore, the regime engineered a stock market boom, giving companies access to capital, which doesn’t carry interest and doesn’t have to be repaid.
This worked for a while, but because banks created the stock bubble with margin debt, it had to crash sooner or later, and eventually did in July. With the stock market bust, all asset classes in China were impaired and became uninvestable.
The real estate bubble had already burst in 2014. The fact the second half of 2015 was relatively better doesn’t make a big difference. The stock market had crashed and local government bonds or corporate bonds as of the beginning of the year carried the risk of default, something quite unknown to investors in Chinese companies.
A board shows the stock movements inside the Shanghai Stock Exchange in the Lujiazui Financial District of Shanghai on Sept. 22, 2015. (Johannes Eisele/AFP/Getty Images)
These factors worsened a trend, which probably started in mid-2014: capital outflows. Ever since China joined the World Trade Organization in 2001, it has accumulated trillions of dollars’ worth of foreign currency reserves, by running massive trade surpluses and attracting foreign capital. The country still has a trade surplus,

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This year, the Chinese economy hit a rough patch. Whether it is official data, bank research data, foreign exchange markets, or commodity prices, they all paint the same picture.
Many economists predicted this slowdown, but there was one researcher who knew it first. Leland Miller of the China Beige Book operates the most comprehensive system of real-time business surveys in China and claims to have the most reliable and timely data.
Each quarter, his researchers contact thousands of businesses across the country and interview high-level executives to find out what the economy looks like from the ground.
Modeled after the Federal Reserve Beige Book, Miller and his team replicated this approach in China—with stunning results. 
Epoch Times spoke to Mr. Miller after CBB published a particularly worrisome report for the fourth quarter. 
They are realizing there is going to be pain.

Epoch Times: Your fourth quarter, on the ground report on the Chinese economy was pretty bad. Why did this surprise you?
Leland Miller: It has been a long term slowdown. It was something that read out very clearly in the data across quarters and years.
But before this quarter, over the summer, the markets went from optimistic to becoming bearish in a short time. It was the mismanagement of the stock market and people were wondering whether this meant the incompetence in running the stock market would spill over: If these are the same people running the economy, why won’t we see similar problems elsewhere?
The second thing was the currency devaluation, which was justified considering what was going on with other currencies. But it wasn’t communicated very well and investors were left wondering whether this was part of a bigger thing—maybe the start of currency wars, or clandestine stimulus policy through other means. Investors didn’t understand what was happening.
The third strike was the weak manufacturing data—low manufacturing indicators, very low official data for manufacturing. China Beige Book manufacturing data was very weak as well.
Chinese workers prepare stuffed toys at a factory on September 17, 2015 in Zhejiang, China. The China Beige Book surveys thousands of small and large businesses in China.  (Kevin Frayer/Getty Images)
The combination of these three things got people nervous and caused a market sell off based on the mistaken notion that China had become fragile over night and was about to blow up.
So we have been saying, there are problems, let’s track them, but the system is not crashing now. 
In the third quarter, we had the modest slow down continue, but it was not a crisis and the data looked similar to the type we had been seeing for two years. No question there was a slowdown, but the third quarter wasn’t markedly different from what we had been seeing before.
The new data shows significant deterioration that wasn’t there over the summer when everybody got scared. We saw significant weakness in revenues and profits, which had been relatively strong for the last couple of years despite the economy’s deceleration. What made this drop in profits more concerning was that the two hidden sources of strength looked shaky in Q4 as well.
Epoch Times: You are talking about the price level and the labor market?
Mr. Miller: The inflation picture—it looks like for the first time it could have been harmful deflation. We have not been tracking deflation broadly, but this time it starts to look like disinflation has become deflation for some firms.
If you don’t have firms interested in borrowing and spending, you will have a hard time enacting a stimulus program.

And the labor market, we have been talking about the surprising stability of the labor market despite the economy slowing down. Analysts mistakenly assume the economy is slowing down, so the labor market has been weakening. That wasn’t the case. But in Q4, it’s worrisome, a lot of metrics went down, from job growth to labor supply. Wage growth also slowed.
Now, this is one quarter, it’s not yet a trend. But the data are interesting and different enough to raise at least a yellow flag right now.
We thought the slowdown would change China dramatically over time, but it’s one that investors and the regime can manage. But the type of slowdown we saw this quarter—if it continues in the future—then this will be something very different and much more difficult to manage.
Epoch Times: What about China’s currency policy, monetary policy, fiscal policy?
Mr. Miller: We think the Chinese are not very likely to devalue the currency dramatically. Especially with the strong dollar, there will be some depreciation against the dollar. We think there is going to be depreciation, but they are not trying to do a one-off devaluation
For a long time, the people assumed the Chinese have monetary stimulus on the one hand and fiscal stimulus on the other hand. Rates have been falling for a number of quarters and yet the share of firms borrowing has been dropping despite that. Capital expenditure was falling.
You have to understand that the promises of 7 percent growth forever are part of a political narrative that don’t reflect reality.

If you don’t have firms interested in borrowing and spending, you will have a hard time enacting a stimulus program.
All the talk is about fiscal policy. But if you look at some of the sectors that are most relevant to the government trying to boost up stimulus, it’s transport and transport construction. Both of those sectors have had a dismal fourth quarter.
If this fiscal stimulus is happening, why aren’t those sectors improving. If you have the ammunition, were is the evidence it is actually working? We have shown for years monetary stimulus no longer works.
If this becomes a new normal, if the labor market is weakening, if sectors keep showing those downticks, will the Chinese decide to double down on stimulus even though they know it has limited use.
Epoch Times: Is the regime panicking?
Mr. Miller: I don’t think they are panicking. Trying to stage manage a slow down for years, the dynamics are changing and certain things scare them a bit, like what happened over the summer. They are trying to do it as painlessly

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China’s stock market has been rising steadily since its August 26 low. Until Black Friday of November 27, 2015, when we got a reminder that China’s market is at the whim of the authorities.
The Shanghai Composite dropped 5.5 percent to 3,436 on Nov. 27, paring its gains since August to 17 percent.
(Google Finance)
Why the sudden drop? There are at least four main reasons:
One: Chinese authorities continue to prosecute individuals and companies in the securities industry. Citic Securities Co., Guosen Securities Co., and Haitong Securities Co. all said the securities regulator started an investigation, but none of them said why.
Guotai Junan International Holdings Ltd. this week said it had been looking for its Hong Kong branch chief executive Yim Fung since Nov. 18, who could not be reached by phone and has not showed up again until this day.
“After the stock market bubble burst they just continue to clamp down on markets, pull away rights to trade, create an environment where people are afraid to trade even though they have done nothing wrong,” said China expert and “Red Capitalism” author Fraser Howie.
Two: For good measure, China’s securities regulator also banned brokers from using derivative contracts to finance stock purchases.
None of this reflects a properly functioning market, let alone a rising one. “They attach these market concepts and names to something that is not a market,” says Diana Choyleva, Chief Economist at Lombard Street Research.
Three: Against this backdrop, the 4.6 percent decline in industrial profits almost becomes mute, but also doesn’t help.
Four: Last, but not least, another two Chinese companies announced they will probably default on the payment of debts next week.
Jiangsu Lvling Runfa Chemical Co., is calling on its debt insurance to make a 53.1 million yuan ($8.3 million) payment in bond principal and interest due Dec. 4, according to Chinamoney.
Sichuan Shengda Group Ltd., said it may not be able to make good on a promise to take some notes back on Dec. 5, it stated on Chinamoney.
The two defaults follow at least six others in 2015, compared to only one in 2014.
This at least could be the only good news of the day, albeit for the long-term
“I want more defaults, another sign we are moving toward a more open a more market driven economy,” says Fraser Howie.
 

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Wilbur L. Ross Jr., Chairman and Chief Strategy Officer at WL Ross & Co., in Chelsea, Manhattan, on Sept. 2, 2015. (Samira Bouaou/Epoch Times)Wilbur L. Ross Jr., Chairman and Chief Strategy Officer at WL Ross & Co., in Chelsea, Manhattan, on Sept. 2, 2015. (Samira Bouaou/Epoch Times)

NEW YORK—Wilbur Ross Jr. is not like the other Wall Street high rollers like Donald Trump and Carl Icahn. He is a soft-spoken, well-mannered, and impeccably dressed gentleman, and has succeeded on Wall Street, becoming a billionaire in the process.

Ross, worth $2.9 billion according to Forbes, has made his names in distressed assets investments and rose to fame turning around Bethlehem Steel as well as Burlington Industries. 

Unlike the classic private equity raiders, Ross has managed to save jobs during these turnarounds, working closely with the unions. “In our work, which is mainly dealing with distressed situations, we’re able to do good and do well for ourselves at the same time,” Ross claims.

Epoch Times spoke with Ross about the people factor in investing, the current market valuation, China, and his troubled investments in Greece.

READ: Wilbur Ross on the People Factor in Investing
READ: Wilbur Ross on His Greek Bank Investments

EPOCH TIMES: When you look at American manufacturing today, have some of your predictions about Chinese competition from 2003 come true?

WILBUR ROSS: What we argued against then, was dumping; namely selling products for less in a foreign market than their true price in your domestic market.

China is so much about jobs as opposed to profits.

That’s the kind of activity that we think should be protected against. We are generally free market people but what was happening back in the early 2000s with steel and what is starting to happen again, is that product was actually being sold in this country for less than the total cost of manufacturing it.

That’s not legitimate competition. If someone can make things more inexpensively in their country and sell it here that’s fine with me. But it shouldn’t be that they have one price in their country and a lower price outside.

EPOCH TIMES: Why do you think China did this?

MR. ROSS: I think they had a period of overcapacity and because China is so much about jobs as opposed to profits, it was very important for the government to maintain jobs. So to maintain jobs they had to maintain production, even though there was not enough demand for it. The way they tried to solve the problem was by dumping it outside.

EPOCH TIMES: The United States is probably the most innovative country in the world, something that cannot be said about China.

MR. ROSS: China is coming along in terms of innovation. They now have the world biggest and fastest computer. That would have been unimaginable a decade ago. They’ve launched spaceships into outer space. They have not yet gotten to be as innovative as the United States is, nobody has been as innovative. Year after year the United States gets more patents than any other country by a wide margin. Interestingly, it’s Japan that comes in second.

They have not yet gotten to be as innovative as the United States is, nobody has been as innovative.

EPOCH TIMES: Why is there this difference, especially between the United States and China which has mostly been copying and stealing technology? Now they have something, as you said, but they lack innovation versus the United States which has always created things?

MR. ROSS: The United States is basically a free market economy and their entrepreneurship has been highly prized here for centuries and centuries so there’s a real tradition of risk-taking. Innovation involves a lot of risk-taking.

A state-owned enterprise is much less likely to be a big risk-taker then private capital. Since China had been so dominated by the state-owned enterprises it’s hard in a big bureaucratic system to be innovative. Look at the U.S. government itself, what interesting innovations have they come up with?

When that government shows panic it makes people more frightened, not less frightened.

So it shouldn’t surprise one that a very state-dominated economy has some trouble. In recent years China has made big strides in some areas. They’re also are putting much more emphasis on engineering and technical education in their university system. Something like 42 percent of Chinese graduates this coming year will be in math, engineering, science, or technology. That’s about 3 times the percentage in the United States.

EPOCH TIMES: You are talking about quantity.

MR. ROSS: Yes.

EPOCH TIMES: China is always big on quantity, but sometimes the quality is not as good.

MR. ROSS: If you have more engineers and more scientists, just on a probability basis, the probability of them discovering something becomes higher.

Billionaire investor Wilbur L. Ross Jr., Chairman and Chief Strategy Officer at WL Ross & Co., in Manhattan, on Sept. 2, 2015. (Samira Bouaou/Epoch Times)

Billionaire investor Wilbur L. Ross Jr., Chairman and Chief Strategy Officer at WL Ross & Co., in Manhattan, on Sept. 2, 2015. (Samira Bouaou/Epoch Times)

EPOCH TIMES: What about the current problems in China, like the stock market?

MR. ROSS: We think that China has two separate problems right now. One is the market itself, the equity market, and that got completely out of control. In the June period, many more new brokerage accounts were opened by retail investors than had been in the whole prior year. And most, two-thirds of those who opened accounts, did not have a high school degree.

So it was very unsophisticated people who had been lured in by the huge appreciation in the Chinese market. Still, only 8 percent of Chinese families own securities. You also had the phenomenon of margin trading. Fifteen percent of the entire Chinese market was on margin at the time of the peak of the bubble, 15 percent of the freely tradeable shares. That’s a huge percentage. So you had all those factors compounding each other, then the bubble burst.

I think what they’re trying to do is several things all at once and that makes it very challenging.

I think what then happened, the government seemed to have panicked and made lots and lots of very panicky moves. They first raised the margin requirement then they lowered it. They threw hundreds of billions of dollars into the market. Now they’re prosecuting people who spread negative stories about the market.

I think the difficulty with all that is, when a government shows signs of panic, particularly a government that historically has been able to control what happens pretty well, when that government shows panic it makes people more frightened, not less frightened.

EPOCH TIMES: What do you think about the official growth numbers?

MR. ROSS: The Chinese economy clearly is not growing at anything like 7 percent. We have felt for a couple of years that those figures were very, very generous. If you look at physical indicators—electricity consumption, natural gas consumption, oil consumption, cement consumption, steel consumption, telecom consumption, retails sales—if you look at all those indicators, none of them were growing at a rate that was equal to 7 percent and neither were the exports.

So we have felt for some time that the real growth is something less than 5 percent, probably nowadays something less than 4 percent. Many people in the outside world believed the 7 percent growth and now that it’s become pretty clear that it’s gone there’s been a readjustment of people’s thinking. Since that came as a shock to a lot of people, although it shouldn’t have, it produced spillover effects into our markets as well.

EPOCH TIMES: Do you believe in economic reform in China?

MR. ROSS: I think what they’re trying to do is several things all at once and that makes it very challenging.

They’re trying to become more of a consumer-driven economy, but the reality is that their largest driver is capital investment. It’s hard to make that transition because capital investment is still about 44 percent of the economy.

They’re trying to make the transition, but meanwhile they’re doing the very-much-needed anti-corruption drive and that in a strange way has hurt consumer spending. People are afraid to show they’re spending a lot of money, even middle-class people and even people who have nothing to do with corruption.

You are trying to get rid of some of the huge amount of corruption in the country and yet it’s hurting the transition to a consumer-based economy.

I think they’ll get there, just that the transition is a hard one. Meanwhile there is super-imposed upon it, the economic issues in the rest of the world. Combined with China’s rising labor costs and the very strong currency, make it very difficult to be an exporter.

EPOCH TIMES: What can the regime do?

MR. ROSS: They need to continue lowering the cost of borrowing there. It still is very high relative to developed markets. The bank reserve requirements, well they’ve cut them too, they’re very high relative to those elsewhere in the world.

They need that stimulation for the economy. The other thing that they need to do, and I believe they will in the 13th 5-year plan which will come out in October.

I think this time there will be much more focus on social safety network, on education, on healthcare, on some of the parts of the economy that have not kept pace with the overall economic development of the country. I think they need to do that and I believe you will find that they do it with the October announcements.

This interview has been edited for brevity and clarity.

Wilbur Ross Jr. is the chairman and chief strategy officer of WL Ross & Co., an investment management company which is part of Invesco. Before founding WL Ross & Co. in 2000, Ross worked for Rothschild Investments as a bankruptcy adviser and private equity manager. Ross holds a B.A. from Yale College and an M.B.A. from Harvard Business School. 

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