North Korean Video Still — Kim Jong-un watching ballistic missile test December 2015
On cue, one week ahead of expiry on China’s 6-month freeze on large share holders selling their stock, the markets crashed twice. Stocks in China fell in the first week of 2016 for a combined loss of 24% and have remained volatile through the rest of January. After the crash last August, when the markets steadied in response to government prohibitions on trading, the rest of us were left counting to six—January 2016 was the ‘next’ possible date for a market crisis in China. The market anticipated lifting of trading restrictions by one week and the government responded by keeping the restrictions in place. The CSI 300 moved down another 5% on the second Monday of the year giving up 20% of its value in two weeks nearing the August bottom by mid-January 2016.
On January 21st Billionaire George Soros commented on the economy in China, “A hard landing is practically unavoidable. I’m not expecting it; I’m observing it!” (Bloomberg Television, World Economic Forum, Davos).
CSI 300, China (3173 on 19 January; 3076 on 21 January; 3026 on 26 August 2016) Bloomberg Chart
The pattern established last August of “the national team” bailing out the markets by pouring yuan into the system every afternoon returned in the first weeks of January. Their presence can be detected in the ‘up ticks’ in the otherwise precipitous fall of the CSI 300 from its 22 December 2015 peak to revisiting the August bottom.
- GDP is slowing. Full-year growth announced 18 January as 6.9 percent—lowest since 1990 but in line with the government 7% percent expectation—betrays suspicions that Beijing is still cooking its ducks. Long range expectations put growth at 3% raising the question of whether getting there will follow a smooth decline, or Soro’s bumpy road.
- With lowering GDP China teeters on the edge of the debt trap. Foreign debt is magnified and increasingly difficulty to service as GDP drops and national wealth vanishes. Debt denominated in foreign currency is doubly burdened by the falling yuan.
- Seven years of central banks flooding liquidity into the markets begs the question of how much of that stimulus found its way to enterprises in China. Foreign currency debt was estimated at $1.5 trillion at the end of September 2015.
- The yuan is effectively pegged to a soaring US dollar, moves to tie it to a basket of world currencies notwithstanding. China must now face down foreign investors finding ways to short the yuan in anticipation of a sharp devaluation instead of the intended steady depreciation.
- The flight of the yuan out of China in 2015 are estimated at $1 Trillion or 7 more than 2014. The runaway valuation of the USD in recent months raises questions. The rise in the Euro is also implicated as the two currencies rose while all others were falling and gold remained more or less static.
- Defending the yuan cost $0.5 trillion last year lowering foreign reserves to $3.3 trillion. Estimates are that another $0.1 trillion was spent supporting the yuan in the first 12 days of January 2016.
- Finally, there is the problem of linkage: what is the effect of market fluctuations on the average citizen?
Wall Street analysts have traditionally used two completely separate discourses for talking about the economy: Wall Street and Main Street. In this view the antics of the trading floor do not disrupt the daily routine of ordinary people. Despite market gyrations small businesses still function—the barber and the beauty salon still open on time and see their regular customers walk in through the front door. This dual analysis holds up under most market conditions. However, during the few epoch making crashes both Wall Street and Main Street have felt the pain. In one case in particular—the 1929 crash—the consequences lingered for over a decade engulfing the entire world economy.
In China conditions on Main Street are problematic. Glossed over as a necessary evil in transitioning the nation to modernism—after 30 years of spectacular expansion—a slowing economy is revising that analysis. Rather than a short-term inconvenience, conditions on Main Street can be increasingly seen as the “end game” of powering national growth.
Here are the leading troubles on Main Street:
- Outmoded production—an over reliance on coal threatens national health making living conditions unbearable. China simultaneously the world leader in using renewable energy and burning coal for electrical generation.
- Dirty air—air pollution warnings were issued in over 50 urban centers over Christmas 2015.
- Empty concrete cities—entire cities built but not occupied that once added to the GDP now pose serious financial risks.
- Poor planning—new streets and neighborhoods lack social functioning.
- Bad urban form—the over reliance on hi-rise building to provide housing—fails to deliver community life. Worse still the residential towers waste energy consuming more energy than alternative human-scale building types.
- Too many cars—the over reliance on cars for personal transportation puts into competition the demand for building more modern highways with the necessity of building mass transit. Here too China is innovating by using licensing fees to push electric vehicle adoption in its largest cities.
As GDP slows China’s reliance on foreign capital, fuel and imported technology grows unsustainable on Wall Street.
All else being equal, the ultimate measure of market success will be found on Main Street, not Wall Street. The ‘wellbeing and happiness’ index is the best measure of the health of middle class. Central planners ignoring human scale on Main Street put at risk the health of the entire nation. However, proper valuing of Main Street is still a hard won prize even for western economies where chasing the profit motive overwhelms social values.
The Great Depression of 1929 did not end, and the world was not back on its feet, before World War II wrought wholesale destruction. It took putting the US economy under central management; aligning US industry with government planning (Eisenhower’s “military-industrial complex”); and destroying and then rebuilding much of Jaan, western Europe and England before the global economic engine got going again.
That brings up the other question facing China: are all things equal?
China’s client state of North Korea detonated a nuclear bomb 3 january 2016. The 5.1 seismic event detected along the country’s northeast coast will take weeks to assess before the west will know what kind of test was conducted—hydrogen or atomic.
That seems like the wrong way of solving four relatively simple problems:
- Cleaning up industrial pollution;
- Switching power generation from coal to renewables;
- Adopting electric vehicles and
- Building sustainable urban form.
Of course, these are western values built on sometimes elusive ideals: an equitable distribution of wealth, a well managed economy, and a growing middle class. As the west struggles to maintain the fragile balance between Wall Street and Main Street, its No. 1 customer for three decades has just extended to 6 months the trajectory of its market crisis. It is all well and good that the markets in China represent but a fraction of the overall economy. Critics still liken China’s economy to a monumental Ponzi scheme. If both Main Street and Wall Street show signs of weakness, then where are we to look for China’s strength?