MorningWord 3/7/16: More Can Kicking

by Dan March 7, 2016 9:41 am • Commentary

Reminder: I’ll be a panelist on the latest Ticker District webinar this evening, at 8pm If you  haven’t already register here:

Webinar Preview: As we head into a potentially volatile period with three major central banks set to announce policy March, Guy, Tim, Dan and BK will each provide their best ideas for the next few weeks and months. Topics will include, domestic equities, option strategies, emerging markets, commodities and bonds.



The U.S economy is off life-support with better than average job growth and just enough inflation to put the recession talk on the bank burner for a few months. But elsewhere things are a bit more complicated. When the ECB meets later this week they are widely expected to push sovereign yields further below zero in an effort to fight off deflation. And as my friend from the TickerDistrict Brian Kelly highlighted this morning, China’s 5 year growth pan announced over the weekend seems to be Going the Wrong Way in their aim to find a growth rate that is sustainable:

The plan is to foster a level of slower growth through more debt. This, my friends, is going the wrong way. As growth slows and debt grows bad things happen.

The experience of the last 800 years of economic history suggests that when debt to GDP breaches the 130% level an economic crisis always follows. With this new plan, China’s debt to GDP will approach 260%. The world (including BK) may be screaming that China is moving in the wrong direction, but China appears to believe that BK (and the world) is drunk.

The common refrain goes something like this: “those who compare the Chinese command economy to other economies misunderstand the culture.” To this BK responds that there has been 800 years of economic history from multiple cultures and economic systems…and when debt grows while growth slows, a crash is a near certainty.

So today, iron ore is up 16% in anticipation of massive building in China that will revive demand. However, given the debt dynamics BK finds it hard to believe that any stimulus plans will be sustainable.

I just don’t get how this is going to work. I hit the topic in this space last week:

Much smarter peeps then myself say central banks have little choice but to continue on their path of easy monetary policy in their efforts to stimulate growth, but what’s really needed is the sort of fiscal stimulus instituted by the Chinese to the tune of a half a trillion dollars that got the global economy off of the mat in 2009.  In hindsight that very fiscal policy caused a massive super cycle in commodities that ultimately led to massive excess overcapacity that has resulted in a massive implosion in industrial commodities and related industries which will be ground zero for the next credit crisis.  Kind of a chicken or an egg sort of thing.  Investors in risk assets have reason to be cautious about increased fiscal spending in China, as we know how this will end, at a time where they desperately need to take out industrial capacity as the company attempts to transform their economy to consumer led as opposed to industrial.  There was a great read in the FT from Monday on the challenges of this transition (China’s state-owned zombie economy).

Last week, prices of industrial commodities ripped on news that China was focused on cutting excess capacity in the coal and steel industry, to the tune of 1.8 million jobs.  But after the recent bounce in iron ore, it is merely back to pre financial crisis levels, prior to the point where Chinese fiscal policy included building cities that no one would live in, and bridges to nowhere:

From Bloomberg
From Bloomberg

I read a lot over the weekend on markets and politics. I am not sure which I more depressed about.  There are plenty of reasons to be hopeful that the U.S. economy can muddle along as the ECB finally succeeds in their previously stated mission to do whatever it takes, but with the recent push from unconventional monetary policy to the sheer lunacy of negative rates leads me to believe that they are far closer to another crisis then the re-emergence of sound economic growth. It’s my view that fiscal stimulus is what’s needed across the region, but given the state of the refugee crisis this is just the first inning of what could be a very dark period for Europe from a geopolitical standpoint and a massive challenge for economic growth.

As for China, again, I just don’t get it. If you subscribe to the belief (that I do) that what’s going on globally is merely a rolling credit crisis that started here in the U.S. nearly a decade ago, the only way to come out the other end in one piece (like the U.S. economy… kinda) is through de-leveraging.

It happened on the corporate level here, not as much on the consumer level, and let’s not even talk about the $4.5 trillion that the U.S. Federal Reserve has added to their balance sheet since 2008. Yes it’s all a bit of a joke, but until we see Chinese corporations and consumers take the medicine we are just delaying the inevitable. And that is the bursting of a massive credit bubble in China that will infect emerging markets and will be impossible for Europe and the U.S. to de-couple from. Chinese officials are talking out of both sides of their mouths on cutting capacity. And adding debt fueled fiscal stimulus is completely mental.

On that note, below are three articles from Bloomberg that struck me in my weekend reading: