One Good Ponzi Deserves Another

By David Stockman  |  December 10, 2019

A turbulent history has taught Chinese leaders that not every problem has a solution and that too great an emphasis on total mastery over specific events could upset the harmony of the universe. 

– Henry Kissinger, On China (2011)

Once upon a time, there was something called “event risk.” It hovered over financial markets, eventually evolving into the even scarier concept, the Black Swan.

Apparently, no longer.

The Federal Reserve has so completely destroyed honest price discovery and so thoroughly euthanized fear of risk that the End of Days itself would likely elicit a new round of dip-buying.

The fact is, Black Swans, Red Swans, and an Orange Swan too circle everywhere. There is very little reward left atop the Mother of All Bubbles.

Staggering risks metastasize by the day. But algorithms and day-traders remain nonplussed. They operate under the delusion that the Fed and other central banks will never again allow markets to correct by more than a few percentage points.

Meanwhile, the economy is running out of steam. When this bubble cracks, Corporate America’s CEOs and CFOs will perform their appointed catalyst function, triggering inventory, labor, and asset liquidations that might finally finish Main Street.

Along the way, they’ll get some major help from that Red Swan.

Indeed, China’s economy has been driven by debt accumulation and prodigious spending for fixed assets, both industrial and public infrastructure.

It’s a giant Ponzi of course, based on the erroneous notion that you can borrow and invest your way to sustainable prosperity, even if you’re building the economic equivalent of pyramids and white elephants.

But even Beijing now recognizes that $41 trillion of bank debt alone on a $13 trillion economy is a recipe for disaster, even had it been spent on market-determined productive assets rather than empty airports, unused highways, bridges to nowhere, ghost cities, empty shopping malls, and 65 million unoccupied apartment units.

All of these will drag on the Red Ponzi for years to come, even while today’s unsustainable debts come home to roost.

As Chris Scott notes, China’s leaders continue to signal “business as usual”; they’re not panicked about any of this. But the slowdown trend is unmistakable. And it’s rapidly heading for crisis.

Confidence Game

By Chris Scott

With the Sunday’s tariff deadline fast approaching, we’ll finally see a concrete development in the U.S.-China trade negotiations, however small.

Both sides are leaking to the press that they’re working hard to announce yet another truce, blessing financial markets with the hope of postponing the new tariffs.

Backing off the brink would give more time to talk terms of the so-called “phase one” deal that President Trump hailed last October as all but formalized. Since then, there’s been no indication that Beijing is eager to finalize an agreement.

Leaks aside, the Donald has been silent so far for this latest micro news cycle, and he could always decide that the U.S. economy and stock market are strong enough to weather what would be the most painful round of tariffs yet.

New Tariffs Are Not Priced In

The levies already in effect on shipments from China have largely spared consumer goods, but those set to be imposed Sunday will cover smartphones, computers, toys, power tools, clothing and the like.

It will also mean that the total value of Chinese goods subjected to tariffs will be equal to the total value of all imports from the country – a grim turning point for those who were expecting a de-escalation.

So, brace for comment from the Tweeter-in-Chief. Thanks to the obvious signals that both sides are frantically looking for an off-ramp to avoid new tariffs, markets have effectively priced in the status quo.

U.S. stocks have not discounted the imposition of these tariffs on Sunday, despite the fact that there’s been no announcement that the administration will back down.

Beijing Thinks It Can Wait

I still keep in touch with Chinese policy advisors who I knew working over there as a trade representative and later covering the trade relationship from Washington, and I had a phone call last night with a Peking University Professor who speaks with trade officials on a regular basis.

Ever since Beijing – at the direction of Xi Jinping and the hardliners – reneged last May on key promises outlined in a 100 plus-page draft agreement, the plot hasn’t changed. There is no political appetite in Beijing to make any concessions. Zero.

What Beijing is willing to do is slash its retaliatory tariffs on U.S. farm goods and ramp up purchases of the stuff we grow – if the Trump administration rolls back tariffs already in place.

But the Trump administration sees those tariffs, and the threat of more, as their only leverage.

If Trump blows this whole thing up with a tweet, stocks go down, but he still has leverage.

Shrouded in Secrecy

Zhongnanhai (Jong – NAN – High) is China’s version of the Soviet-era Kremlin, serving as the headquarters of the highest levels of the government.

While state T.V. will regularly broadcast footage of top officials sitting stiffly around long tables at the compound, it’s layout and functions are mostly shrouded in mystery, as is everything else about the Communist Party’s governance.

As an aside, I will say I was invited inside Zhongnanhai one night in the mid-2000s. I was passing by the back gate of the former imperial garden during an exploratory stroll after a late-night indie rock show at a nearby café. I’d been photographing old men lined up along a bridge who still fish in the lake that extends under the tall, glistening tile-covered walls into the compound when I noticed an endless line of massive dump trucks driving up the wide street and into the gate. (I think they were bringing soil for the gardens that feed Party leadership.)

Out of curiosity, I walked up to the gate and a driver slowed to a stop and hollered a hello from his lofty cabin under the buzzing yellow glow of the ornate, red-square-reminiscent street lamps.

“You want to go in?” he asked with a grin.

I looked at my camera, and then through the gate into the darkness, and after a moment of hesitation, I passed on the one chance I will ever have in my life to enter what was once Mao Zedong’s palace. The thought of being detained on suspicion of espionage was a little too much.

The View from Zhongnanhai

It’s not just the physical place that’s off-limits to the public (despite my mysterious invitation). The schedule for some of the Chinese government’s most important meetings is kept a secret. For instance, sometime soon the Central Economic Work Conference will be held there.

Insiders expect that the conference will convene sometime within the next two weeks, and top officials will set policy goals for the economy and financial markets.

As you might expect, there’s no transparency into the individual views of various members of the Politburo or those of the heads of the major executive departments. We have to wait until a meeting readout is released from important events such as the coming conference. There are few quotes from officials, rather statements are attributed to the personified “meeting.”

But we already have clues as to the level of confidence Beijing has in its ability to steer the ship through an economic slowdown and the tremendous risk a mountain of debt poses to its financial system:

“‘The year 2020 will be the year to finish building a moderately prosperous society in all respects… China shall achieve its first centenary goal,’ said the meeting.”

“The basic trend of steady long-term growth for China’s economy remains unchanged at present and for a period to come… we will stress transforming external pressure into motivation for deepening reform and furthering opening-up, and focusing on running China’s own affairs well…”

Translation: The economy is fine. The restructuring of our economy to a consumer-driven one is going according to plan. Trade war gives us great propaganda to rally public support for our government.

There were also signals that China would lean hard on fiscal stimulus, though officials will likely hold off on opening the monetary policy floodgates.

This is a contrast to the tone Beijing has taken when faced with economic challenges in the past, such as in 2008 and in 2015.

This is a confident tone that does not suggest any rush to reach a trade deal.

In This Universe…

This is the most politicized market in history. And the Tweeter-in-Chief is still in charge. So, the situation is changing almost by the minute.

It’s “Impeachment!” in Imperial Washington and all over the Mainstream Media. It’s “Easy Money!” on Wall Street and across Bubblevision.

And it seems as if the whole world has, indeed, gone mad.

Amid this chaos, prices will continue to rise and fall, trends will continue to develop and dissipate.

Well, The Stockman Letter is made for times like these. And we’ve updated our design to help us better navigate to not only the safest harbors but also the most promising opportunities.

The stakes are as high as they can be heading into 2020. Markets appear to be straining, catching up to an economy that’s been weak and getting weaker for years.

The Donald is tied up in the day-to-day movements of the major stock indexes like no president before him. The increasingly desperate incumbent will do anything he must to hold the White House.

It’s a major tipping point. And there’s no telling what the Donald’s great disruptions could do to your wealth.

You’ve got to be nimble to win in this market…

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR