Some perspectives on the fascinating economic experiment that is China from Eric Peters, CIO of One Asset Management, as told in his traditional third-person style.
Anecdote: “We’ve become anesthetized to the absurdity of Chinese growth,” said the CIO.
The accelerating rate of credit expansion relative to GDP has no precedent. “They’ve run off the cliff so fast that people seem to think they’ll actually make it to the other side.”
China figured out the fiat currency game. “A government can monetize its debts, provided it avoids two extremes internal to its economy; inflation above the socially acceptable level of 5%, or deflation that leads to mass unemployment.”
So long as inflation remains within those bounds the Beijing Boys can stuff bad loans made to steel mills into the Great Wall Asset Management company, which is financed through a bond,
bought by some bank, guaranteed by the government.
The bad loan disappears in a monetary blur. This abuse of fiat currency has allowed China to grow in such an extraordinary and uninterrupted manner.
“But a government is also bound in their abuse of fiat by an external constraint – it can only monetize bad debts up to the point that this leads to uncontrolled capital outflows.”
Once monetization passes a threshold, people lose faith in money’s value and they sell it. Where that threshold lies remains a mystery of mass psychology. All we know is that faith is not something a government can undermine in a straight line, then stop on a dime. Loss of faith is one of mankind’s greatest non-linear phenomena.
“Money today is fairly electronic, so the Chinese can slow outflows with fifteen phone calls to their banks and money-launderers.” You can stop your companies from buying foreign firms too, which Beijing did this week.
“So China really comes unglued when inflation rises, when people start exchanging paper money for hard assets. Like real estate and commodities. Both of which have been surging beyond any fundamental justification.”
* * *
As a bonus, here is Peters musing on various opter topics, generall grouped under “Gravity”
Gravity: “Can the market reposition without sucking itself into a black hole?” asked the CIO, more to himself than me.
“The handoff from monetary to fiscal stimulus happened so fast that no one was prepared.” The world was positioned for secular stagnation, a natural rate of interest at 0%.
“We created risk parity and clever ways to earn carry, applying increasing layers of leverage to achieve unnatural returns.”
The momentum of flows into these strategies lifted their returns. “How can we adjust to today’s very different world without breaking something?”
* * *
Gravity II: “Do rates just keep moving higher until the pain is too much for markets?” continued the same CIO.
“A 100bp rise in real rates breaks the market.” With so much debt in the world, a rise in interest rates is self-limiting. Which means the Fed will need to come back into play.
We ultimately need fiscal stimulus that’s financed by the Fed.
“I used to think the Treasury would issue ‘Rebuild America’ bonds that the Fed would buy. But now I expect the Treasury will have to issue ‘Make Trump Great Again’ bonds, bought by the Fed.”
* * *