Elephant, Meet China—Or Why The Global Bubble Is Fracturing

Oh man, I wanted to keep this short, what I wanted to say looked so straight-forward. But then, in this convoluted world of pretense, is anything ever anymore?

Please allow me to start off with something I wrote yesterday in Oil, Gold And Now Stocks? concerning the nonsense spouted by New York Fed President Bill Dudley, who claimed that money not spent by Americans on gas would actually boost the economy if -and that’s still an if – they spent it on anything else. I said they’d still have the same amount of money to spend, so how can it be a boost? Sure, you can say that a lot of the oil is imported, which would transfer profits abroad, but then so are most of the trinkets people can may buy at WalMart with their gas savings. .

Today Zero Hedge’s Tyler Durden turns that theme into not one, but two different posts. First this morning, ‘Central Bankers’ Say The Darndest Things – Bill Dudley Edition, and then just now the second take on the topic, with a very good explanation of what it is Dudley, perhaps the second-most important man in the American financial world – if he’s not numero uno-, gets so wrong, intentionally or not.

Fed Fischer’s Complete & Bizarre Nonsense: Oil Price Collapse “Making Everybody Better Off”

“I’m not very worried,” explains Fed Vice Chairman Stan Fischer in a very Bernanke-”contained”-like nonchalance about the total collapse of oil prices (and US oil producer stocks). Sharply lower oil prices will boost spending and aid U.S. growth, Fischer stated in a mind-blowingly naive speech for the 2nd-most-important-monetary-policy-maker-in-the-world, adding that lower oil prices were “a phenomenon that’s making everybody better off.” We don’t understand his ignorance: as Raul Ilargi Meijer noted earlier, Fischer is talking about money that would otherwise also have been spent, only on gas. There is no additional money, so where’s the boost? This is just complete and bizarre nonsense. As Bloomberg reports:

Fed Vice Chairman Stanley Fischer and New York Fed President William C. Dudley, speaking at separate events yesterday in New York, both stressed the positive economic impact from the steepest decline in oil prices for five years. “I’m not very worried,” Fischer told an audience at the Council on Foreign Relations. “The lower inflation that we’ll get from the lower price of oil is going to be temporary.” He also said lower oil prices were “a phenomenon that’s making everybody better off.”

Perhaps Mr. Fischer should ask the owners of oil producer and servicer stocks, the workers in Texas and North Dakota, as well permits collapse..

Here’s some 1st grade math…
• Money people have to spend (the number that is US CONSUMPTION) = X
• Money people have to spend on Gas = GAS
• Money people have to spend on everything else = EVERYTHINGELSE

Now if Gas becomes cheaper by 30%… the savings are merely spent on more of everything else OR ‘saved’ – there is not boost in US consumption… How does it make X any bigger? How does that make anyone better off? Just don’t tell Fischer, Dudley, or anyone on CNBC this!!!

Will Dudley, or the press that covers him, learn anything from this? Does he really not understand why what he says in gibberish, or does he do it on purpose? Do the press too? Will we ever know? All we can do is point it out, and hope people understand it with us.

But I was thinking about another topic today, and it happened to come up in a comment on my article on both The Automatic Earth and Zero Hedge, by an old friend and commenter I hadn’t seen in a while. I started off yesterday saying:

“Is the Plunge Protection Team really buying oil now? That would be so funny. Out of the blue, up almost 5%? Or was it the Chinese doing some heavy lifting stockpiling for their fading industrial base?”

And got this comment:

The Chinese have a “fading” industrial base?! The most spectacular industrial development story of all time, over decades, and they are “fading”?! Are we living on the same planet?

To which I said:

Big things fade too. Or as the French say: Un éléphant se trompe énormement.

Un éléphant se trompe énormement. In English: the bigger you are, the bigger your mistakes. There’s also a wordplay in there with the sound elephants make and a trumpet (trompette in French). But yeah, China’s industry is fading, and I don’t want to get into semantics about the meaning of the term fading. Two days ago, I posted ths from Bloomberg:

China Factory Gauge Drops as Shutdowns Add to Slowdown

A Chinese manufacturing gauge fell as factory shutdowns aggravated a pullback in the economy [..] The government’s Purchasing Managers’ Index (PMI) fell to an eight-month low of 50.3 in November, compared with the 50.5 median estimate of analysts in a Bloomberg survey and October’s 50.8. Readings above 50 indicate expansion. “Today’s official PMI reading points to continued downward pressure on manufacturing activity,” said Julian Evans-Pritchard, China analyst in Singapore at Capital Economics. “The recent cut in the benchmark rate will do little to boost economic activity unless followed by a loosening of quantitative controls on lending, which policymakers will remain cautious about given concerns over mounting credit risk.” The final reading of another manufacturing PMI for November from HSBC and Markit was 50.0. It was unchanged from a preliminary reading.

My comment then: ‘It’s close to contraction, and that’s a long way away from 7.5% growth.’

Between the lines, we’ve been able to see for a while that China is quite a ways away from that 7.5% growth target, and a near contraction PMI reading would certainly seem to confirm that suspicion. Of course, nearly everything we get from China are ‘official’ numbers, and having faith in those wouldn’t seem to make a lot of sense.

Which made it sort of amazing to see an official government report issued that Jamil Anderlini wrote about for the Financial times on Friday, but which Reuters had already covered 10 days before that. These are government researchers, and that makes you wonder what the message is, and how it’s sent: is Beijing exaggerating the waste for political purposes, or acknowledging just a part of it? My bet would always be on number 2, Xi and Li are not sitting pretty or relaxed these days, and making their own faults look even bigger than they are does not seem to be the way they would go. Here’s some excerpts from Anderlini’s piece:

China Has ‘Wasted’ $6.8 Trillion In Investment

“Ghost cities” lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8 trillion in wasted investment since 2009, according to a report by government researchers. In 2009 and 2013 alone, “ineffective investment” came to nearly half the total invested in the Chinese economy in those years, according to research by Xu Ce of the National Development and Reform Commission, the state planning agency, and Wang Yuan from the Academy of Macroeconomic Research, a former arm of the NDRC.China is this year on track to grow at its slowest annual pace since 1990, and the report highlights growing concern in the Chinese leadership about the potential economic and social consequences if wasteful investment leaves projects abandoned and bad loans overloading the financial system. The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government.

To wit: iron ore stocks are down 50%. That’s all China not buying anymore, plus the industry that invested hoping they would. Overcapacity everywhere. US shale, you name it. What does not have overcapacity these days? Oh well, yeah, care for the poor and the elderly, you’re right. I sit corrected.

Mr Xu and Ms Wang said ultra-loose monetary policy, little or no oversight over government investment plans and distorted incentive structures for officials were largely to blame for the waste. “Investment efficiency has fallen dramatically [in recent years],” they say in the report. “It has become far more obvious in the wake of the global financial crisis and has caused a lot of over-investment and waste.” [..]

Much of the investment in recent years has been funnelled into real estate projects, but apartment sales and prices have fallen this year, leading to fears of an impending property crash. Most of the industries that feed the real estate sector, such as steel, glass and cement, are awash with overcapacity and have been hit hard by the property downturn.

Misallocation of capital and poor investment decisions are not the only explanation for the enormous waste in China’s economy. A significant portion of China’s post-crisis stimulus binge was simply stolen by Communist Party officials with direct responsibility for boosting growth through investment, according to separate estimates by Chinese and overseas economists. Jonathan Anderson, founder of Emerging Advisors Group, the consultancy, estimates that about $1tn has gone missing in China in the past half-decade as a result of weak oversight and the enormous opportunity provided by the investment boom. “That translates into maybe 5% of GDP per year worth of skimming off the top,” he says.

“Think about it: every local government wakes up one morning in 2009 and finds that the central authorities have lifted every single form of credit restriction in the economy,” he says. “With no one watching the till, it would be awfully hard to resist the temptation to sidetrack the funds, squirrelling them away in related official accounts or paying them out through padded contracts to other connected suppliers and friends.”

That last bit doesn’t cover he situation. Beijing has relied on the shadow banking system, not just tolerated it, to get China to grow at the numbers it has. And local governments have taken the bait, and taken the shadow loans, so they would look good to their superiors, building whatever they could build, useful or not, roads, bridges, apartment buildings.

I don’t know if we will ever know the size of the shadow banks in China, but there can be no doubt that it’s mind shattering. And if an official government report says $6.8 trillion was spent on nothing, do we even want to know how much shadow loans were spent that way?

In 2009 and 2013, the report says, ‘half the total invested in the Chinese economy’ was ‘ineffective investment’, i.e. money wasted on bridges to nowhere. A more or less accepted number for total official Beijing ‘invested’ is $15 trillion in 5 years, and we now know that the ‘waste’ got bigger as time went on, and totaled about half of the total investment. And that’s just what Beijing put in; it’s anybody’s guess what da shadows added, and how much of that never went anywhere.

Here’s an idea of how that compares to the US, itself not exactly a slacker when it comes to stimulus:

Reuters, 10 days earlier, said this about the report:

China Wasted $6.9 Trillion On Bad Investment Post 2009

China has acknowledged that it is overly-dependent on investment to power the world’s second-biggest economy, but re-ordering the growth model takes time. Investment contributed to 42% of China’s economic growth between January and September this year. Exhorting caution, Xu and Wang said China wasted between 4.7 trillion yuan and 13.2 trillion yuan each year between 2009 and 2013 on investment with zero efficiency. The money wasted on such projects peaked in 2013 at 13.2 trillion yuan, or 47% of China’s total fixed capital formation for that year, their calculations showed. Investment quality had fallen so much recently that nearly two-thirds of the 67 trillion yuan that China wasted from 1997 were spent after 2008.

I don’t know if you can still follow it, but this adds up to absolute insanity. The $6.8 trillion number for money spent on ‘zero efficiency’ is but a cautious estimate by people who both have no access to, and are not supposed to know about, the Chinese equivalent of Don Corleone and the five families. Here’s a bunch of GDP numbers in the west for comparison, PPP GDP data from Wikipedia, for perspective:

France Population 66 million, GDP $2.6 trillion
Britain Population 64 million, GDP $2.45 trillion
Germany Population 87 million, GDP $3.6 trillion
Japan Population 126 million, GDP $4.8 trillion
USA Population 319 million, GDP $16.8 trillion
China Population 1,357 million, GDP $16.1 trillion

When you see those numbers, the $6.8 trillion spent on absolutely nothing productive in China should make you cringe and shudder. China took a big lighter and burned off half of Britain or France’s GDP each and every year just to look better. And not because it was so independently rich and could easily afford it, but because it wanted to look richer than it was, if only for a day, or a year. We all have had that wish at times.

And that’s without adding in the shadow banks, who were pivotal in making the local officials look even twice as grandiose than Beijing’s loose policies were already allowing them to be. China has been running on free debt for years, and who cares about paying it back? It’s no different from the US, is it? Or Europe, or Tokyo. It’s all just a big collection of big debt bubbles. And China looks like it might well be the biggest of them all.

If that PMI number, shaky as it may be both because it comes from the Communist Party and because of its own inherent flaws, dives below 50, and China starts contracting and moving even further away from it 7.5% growth target, I’d literally say there’s no telling what will happen. But it won’t be pretty, that I can tell. It won’t even be funny. Look at all the steel, copper, aluminum, producers in the west who have heavily invested in and on China growth. And don’t get me started on oil producers. Yeah, China’s going to stockpile and save the industry. Sure.

China, like the entire world, is doing much worse then anyone’s willing to tell you. But the entire world still is. And so is China. Enter Elephant stage left.