Money Sage (archive)

Our only question is to ourselves. Why the question mark in the title of this post?

The global slowdown is HERE, of course. The forthcoming condition of the U.S. economy, which is roughly one-quarter of the global economy, is by now known to even the "policmakers" at the FED. (These folk, who have the resources to place themselves at the very top of the informational and analytical food chain, deliberately choose to pretend that they are at the very bottom. Their pretense is very convincing, by the way).

For the Euro zone, growth has been running at at a most unimpressive 2% rate. Factor in the recent commencement of serious real estate bear markets in Britain, Spain, Ireland, and perhaps others in Euroland before too long, and add to this witches' brew the continuing rigidly contractionary policy of the inflation-obsessed European Central Bank (ECB) and voila -- we are looking at slowdown verging onto, if not tipping over into, recession. Depending upon the future policy flexibility of the ECB, or lack thereof, we may wind up looking at a pretty serious recession in Euroland. The tightening credit situation on the Old Continent is no joke.

The key to the seriousness of the slowdown depends, of course, upon Asia, especially China, India, and a few other "emerging economies." And this is where things really start to get interesting. While the robustness of these economies has thus far kept the U.S. out of recession, it is necessary to gauge both their susceptibility to the normal movements of the business cycle and the seriousness of Chinese insistence that the regime is about to get real about slowing the white hot economy in that country. The ruling elite in Beijing is to some extent influenced by western-educated and western-influenced "expert" cadres, who fear that an overheating, over-speculative Chinese economy will experience a bust unless the central bank and government actions slow down the boom before it is too late. Additionally, there are amorphous, but discernible and growing pressures from both the Chinese populace and from key foreign trading partners about the need to limit the downsides of unbridled Chinese growth -- the pollution of the earth's atmosphere, environmental degradation, intensified demand for crucial commodities driving prices sky high. Nor can the regime ignore totally the risk of a punitive western backlash in the form of trade and investment restrictions. Finally, and perhaps most importantly for the ruling "Communist" Party (which in actual fact is about as communistic as the Republican Party of the 1870s and 1880s), there is the intensifying disparity of income and wealth between a minority of urban "haves" and the majority or rural/urban "have-nots." It might be worth bearing in mind that it was this concern which played a critical role in informing the determination of the Bank of Japan to slow the Japanese boom in the very late 1980s.

Which of course brings us to the "analogy" of the great Japanese boom period. We are mindful of the need to be very careful in drawing analogies where same may not really exist. Having made this disclaimer, we must nevertheless note certain rather striking similarities. The cumulative success of the Japanese economy over a thirty plus year period created the near-universal perception that nothing could stop Japan. The economy was ten feet tall. Japanese productivity, the education, discipline, and fervor of the workforce were unmatched. Japan had built up the most modern, efficient, industrial plant, and the most irresistible marketing and pricing machine in economic history. The performance of the equity and real estate markets was stellar, and would continue ad infinitum.

Sound familiar? In the case of China the individual characteristics of the economy are somewhat different (CHEAP labor, CHEAP production, the ability to attract an endless avalanche of foreign capital, a political system in thrall to the type of rapacious, undiluted capitalism necessary to the development of a potentially vast economy). The BOOM however, is the same. As is the universal perception that the Chinese economy is 10-feet tall and is unstoppable.

What is of greatest interest to us is the monetary policy of the PBOC (People's Bank of China) and the liquidity limitation efforts of the government. These are GROWING STEADILY. While they appear to have dented hardly at all the Chinese economic and speculative locomotive, we wonder what Chinese growth -- and proximity to bust -- would be WITHOUT THEM. More critically, we note the near-universal tendency of rising interest rates and declining liquidity to burst bubbles. In the case of China, the equity and real estate markets are still surging. However, it is very misleading and very dangerous to straight line any type of economic or market expansion which has far exceeded the general parameters of the "normal." Our observation is that once a central bank/government embarks upon a "tightening" program, it does not stop until it sees results. Once these results become visible, the invisible tsunami which has caused them is NOT EXHAUSTED, but rather is ON ITS WAY.

Perhaps China is different. However, we doubt it.

As for India, the situation is similar, though not so extreme. Here too the central bank has been trying to reduce liquidity in order to slow a red-hot (though not yet white-hot) economy and market. Here too we remain skeptical that the tightening will stop before a powerful contractionary/deflationary force is unleashed.

We have not here mentioned, except in passing, the world's second largest economy. The Japanese economy is very soft. Growth has virtually halted, and deflation continues. Of course, the Bank of Japan has quite a bit of blood on its hands: the two rate hikes by a central bank known for its gross policy errors but nonetheless desperate to earn its stripes as a strong "inflation-fighter" have made their contribution to undermining what was never more than a weak recovery within the framework of a 20-year depression. (See our piece: "Central Bank Psychosis: The Case of Japan.")
Clearly, the central bank-enfeebled Japanese economy will be making no contribution to global growth. This economy is but a corollary to the key economies -- the US, Europe, and China.

In searching for the straw that may break the camel's back, we return to China. We are wondering if the Chinese government proceeds along hinted lines -- that it will permit overseas investment by individual Chinese investors -- will prove to be that straw, should it in fact occur. The Chinese stock bubble is so excessive that it constitutes the necessary raw material for a financial implosion of significant magnitude. Much of the explosive rise in Chinese stock prices is attributable to the lack of investment alternatives in a financial system where bank deposits earn a NEGATIVE INFLATION-ADJUSTED RETURN. Our hunch is that if a Chinese slowdown/downturn of significance does develop, an implosion of the Chinese stock market will prove to be the catalyst, vehement assertions to the contrary notwithstanding.