Britannia Radio

The Daily Reckoning Wednesday, August 12, 2009 A 'miracle economy' in the Far East - or is it? Consuming wealth - all the way to the poorhouse... China is growing because meddling works... Dan Amoss on what could mow down the green shoots...and more! What Chinese Depression? by Bill Bonner Ouzilly, France Man's hope! Yes, it's the 'miracle economy.' China, that is. Many analysts think it has 'decoupled' from the rest of the world economy. While the rest of the world sinks into the 'worst recession since the '30s,' it is said to be growing at 8% per year. Go figure. Well...when we go figure we figure there's something fishy about it. In fact, we figure it's a fraud. In America, the bear market bounce took a little jig downwards yesterday. Stocks - measured by the Dow - fell 96 points. Oil fell below $70. The dollar and gold remained almost unchanged. But China's revved up so hot she seems likely to throw a rod. We've been telling our Dear Readers to stand clear. At least, that's the case with the Chinese stock market. It's a bubble. And it's getting ready to pop. As for the economy...we figure it's a fraud... Chinese officials have a funny way of counting. When products are shipped from the factory, for example, they are counted as 'sales' even though no one may actually buy them. There are some other ways of keeping score that tend to tilt the game in China's favor - at least, on paper. When you add up all the scores - it shows China a big winner. But by the end of the day, it isn't at all clear that China's economy is growing at such a breakneck speed. In fact, it isn't clear that China is really growing at all - not in a genuine and helpful way. And here...perhaps we should pause. We are about to tell you that China is a scam. It's not really becoming more prosperous. But before we do, we have to explain what prosperity really is. Do you remember the Bubble Years? Of course you do. They just ended scarcely 24 months ago. Well, during those years we were told that we were getting richer. Two forms of evidence were presented - one statistical...the other observational. The numbers told us that GDP was growing. Since economists figure GDP growth is the same as prosperity...they thought Americans were getting richer. There was also the evidence available to anyone with eyes. You could look at any driveway; there you would find two or three cars - new cars...big cars. And behind them was a brand new McMansion...Bubble Era vintage... Yet, both forms of evidence were misleading. Americans were spending. The spending showed up as GDP growth. The faster they spent, the more new cars and new houses they had too. But they were not creating wealth...they were consuming it. They were spending money they hadn't even earned yet. In other words, they were not only consuming their current wealth, they were consuming wealth that didn't even exist yet - it was tomorrow's wealth. You couldn't see this happening by looking at the GDP numbers; instead you had to look at balance sheets. And even then, you needed to look at them with a suspicious eye. On the one side, debt was clearly swelling up; it doubled during the 2001-2007 period. On the other, assets were swelling up too. But the assets were of the overpriced, Bubble Era variety...houses and stocks that were subject to easy correction. And when the correction came, assets declined...and debt grew heavier and heavier. Now, Americans have twice as much debt...and their assets are back to where they were 10 years before. Net result: impoverishment, not wealth. Consuming wealth is not the way to get rich. It's the way to get poor. But it would take someone without a PhD in economics to see such a simple and obvious truth. Given a fellow a computer and an advanced degree in economics and he's ready to believe anything... Yes, dear reader, in His majestic wisdom, God - or whatever wiseacre created this system - set up something so subtle and complex that it is beyond the reach of human tinkering. That's why the meddlers always make things worse. That's how they put the 'great' into the depression of the '30s - by interfering with the markets' natural corrective mechanisms. And now these simpletons think they can stop the correction underway since '07 - with stimulus, bailouts, and boondoggles. Yes, they admit, it was excess credit that put American consumers into such a jamb. But, heck, now we'll let the government do the borrowing. The government will make up for the demand that has been removed from the private sector. The private sector is paying down debt at roughly $1 trillion per year. And now the public sector is adding debt at roughly $1 trillion per year. That ought to do it, right? Ha...ha...yes...why not? And while we're at it, let's round off pi to a whole number so it will be easier for school kids to remember. [There's still time for you to get your slice of the stimulus pie... Because of a legal 'loophole' you could get your first check in the mail as soon as August 19. Get all the details here.] More news from The 5 Min. Forecast: "Here's a quirky idea that's starting to get a little serious," writes Ian Mathias in today's 5 Minute Forecast. "Communities around the country are printing 'scrip' at the highest rate since the Great Depression. "Behold the 'Plenty' - an alternative currency printed and exchanged exclusively in Pittsboro, NC, population 2,500. A couple dozen Pittsboro stores accept it as a dollar alternative, like the local feed store and a produce co-op. "The idea is nothing new... We've chronicled scrips like the Ithaca HOUR and Western Massachusetts' BerkShare for some time. Both have millions worth in circulation. "But according to The LA Times, scrips haven't been this popular since the Great Depression. They've gained significant traction in New York, North Carolina, Michigan, Colorado, Arizona and Massachusetts, with many more communities beginning to experiment. "And we're noticing a decidedly less hippie, more snarky feel: 'The Plenty is not going to get siphoned off to Wall Street,' says B.J. Lawson, president of The Plenty co-op board, 'or Washington, or make a stop in Bentonville on its way to China.' In Mesa, Arizona, locals are using Mesa Bucks to essentially stick it to the man... Bring a sales receipt from inside city limits to the local arts center and they'll give you a percentage of your sales tax back in Mesa Bucks. "So much for 'E Pluribus Unum'" Ian writes every day for The 5 Min Forecast, an executive series e- letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less. It's a free service available only to subscribers of Agora Financial's paid publications, such as Strategic Short Report. This month, at Strategic Short Report, they are going to buy puts on the Canadian bank most ready to fall. And now's your chance to join them. If you want the name of the latest play, just click here to learn more about Strategic Short Report. And back to Bill, with more thoughts: But wait a minute...we're talking about China, not the United States. And we're talking about Chinese meddlers, not the American variety. And we're talking about the Chinese depression...not the depression in the advanced economies. But wait...you're probably wondering... 'What Chinese depression? China is booming...isn't it?' Well, here's a question for you: if China were really growing at 8% per year, how come its electricity consumption is going down? Answer: Because the Chinese bureaucrats can jiggle and jive the numbers for employment, GDP, and inflation. But the number of kilowatt-hours consumed in China is just a number. It is not computed. It is not seasonally adjusted. It is not tortured by statisticians nor tormented by economists. It is just a number. And that number is a smaller number than it used to be. Oh, and here's another number. China's exports for July were down 22% from the year before. Here's another question: how can an export led economy grow when its exports are collapsing? Again, we have an answer: when it is not really growing. According to the meddlers, China is growing because meddling works. China is spending $586 billion (proportionally nearly 3 times as much as the US) to keep its economy booming. The program must be working, say the economists, because China's economy is still growing. But is it? Most of the money is spent on infrastructure. The Chinese are doing what the Japanese did before them. Japan bailed out its banks and spent trillions on infrastructure. There were years when little Japan was pouring much more cement than the entire USA. - channeling rivers, building bridges to nowhere, and creating highways for no one. What did they get for their money? Well, you could say they got a lot of infrastructure...and the most cemented-up country on the planet. Is that a good thing? We don't know. But one thing they didn't get was durable economic growth. Why not? The easy answer is because an economic system is too sophisticated to yield to these ham fisted interveners. Another way to look at it is because the economy had already spent too much...creating too much capacity. Adding infrastructure that could handle more capacity was not a solution. "Keep in mind," says The Richebächer Letter's Rob Parenteau, "China needs at least 9% growth to soak up the 24 million new Chinese workers who come of age each year - something even the Chinese Premier doesn't like to mention." [You remember how hard the Asian currency crisis hit US markets in 1997? A total "miracle" reversal in the Far East could have much greater impact, especially in today's already battered environment. Take the steps to protect yourself... See here.] But heck...it's summer. And in the sum...sum...summertime, we're not going to criticize our fellow man. Instead, we're just going to laugh at him. In China, for example, the government's stimulatory programs are having the same flaccid results they got in Japan. Prices are going down. The Chinese feds are trying to get people to spend more money - just as they did in Japan. But people do not spend more when prices are falling. They wait for a better deal. And as they wait, consumer demand falls...forcing prices down further. Japan has gone through almost two decades of on-again, off-again consumer price deflation. Now it's China's turn. Consumer prices in China have been going down for the last six months...and are now reported falling at a 1.8% annual rate. How could prices be going down in a booming economy? Well, because the economy isn't booming. Instead, it's burdened with overcapacity - just like Japan's. And like Japan's it is probably doomed to go through a long period of re-adjustment...before a durable recovery can begin. Until tomorrow, Bill Bonner The Daily Reckoning --------------------- Special Offer --------------------------- The Daily Reckoning PRESENTS: The market has been on the rise, giving the 'green shoots' crowd more to crow about. However, as Strategic Short Report's Dan Amoss points out below, there are seven lawn mowers in the real economy that could easily mow down these green shoots. See below... Green Shoots Do Not See the Mowers by Dan Amoss Jacobus, Pennsylvania The rising market is driving the majority of the economic data supporting the "green shoots" crowd. The Index of Leading Economic Indicators, which has been pointing up for a few months, is heavily influenced by the stock market. Now, stock market bulls are pointing to the Leading Economic Indicators as a reason to buy stocks. It's circular reasoning, plain and simple, and it is now in vogue to the extent that now is a very dangerous time to be holding stocks. Here are six lawn mowers from the real economy - the parts that don't revolve around Wall Street of Washington, DC - that could easily mow down the green shoots: 1. Stabilizing numbers for continuing unemployment claims are painting a misleading picture. In reality, hundreds of thousands are rolling off of the traditional six months of benefits into extended unemployment benefits rolls. The recent payroll data was temporarily inflated by a rebound in auto production from depression levels, and the government's hiring of census workers. Also, the unemployment rate fell because the number of people actively looking for work keeps falling. There are absolutely no signs that those who were laid off will find a new job anytime soon. 2. The federal government's income tax receipts are still collapsing. Paycheck withholding tax receipts are still falling sharply. As data services like TrimTabs have demonstrated, income tax receipts are far more accurate gauges of trends in personal income than the highly massaged employment figures from the government. Falling tax receipts translate into a higher threat of confiscatory marginal tax rates in the future, deficit monetization and more inflation. 3. Last Friday's aggregation of July same store sales in the retail business confirms that end demand for many products remains bleak (aside from auto sales in the "cash for clunker" program, compliments of the ballooning national debt). For perspective, gasoline prices in July 2009 were about 35% lower than the $4-plus per gallon level of July 2008. One would think that this would be a major tailwind for retail, but it's not. 4. The federal government is spending other people's money like a drunken sailor, yet a good portion of the sugar high "stimulative" effect of this spending on GDP will be offset by lasting cuts in state and local government budgets. 5. The bond market will continue balking at absorbing trillions in new Treasury bond supply to fund the deficit. Rising mortgage rates, which are tied to Treasury Note yields, will limit the positive impact of refinancing those few homeowners that have any equity left in their homes. 6. Has the market noticed that the FDIC is stalling on its duty to shut down and eat heavy losses at several zombie regional banks - Corus, Guaranty, and Colonial to name a few? When it when it does so, it will have to draw down tens of billions of dollars from its emergency line of credit with the Treasury. These factors all indicate that the economy is most certainly not returning to pre-credit bubble conditions. Yet the stock market is pricing in a return to such conditions - especially in the rallies in junk stocks that we've seen since the market lifted off on July 13. I'll add a seventh lawn mower: the growing risks posed by debt bubbles in China and other emerging markets... "This process could end next week, or next year. That's the annoying part about bubbles: they tend to expand until the last patsy has bought in, and there's no telling how many patsies there are." The Chinese government realizes that its stimulus spending and pressure on banks to expand lending is inflating a massive bubble in the Chinese stock and property markets. The problem with unsustainable economy activity is, of course, that it must eventually end. Michael Cembalest, the Chief Investment Officer of J.P. Morgan Global Wealth Management, describes the Chinese lending bubble in his Aug. 6 "Eye on the Market": And in China, while there are positive recovery signals, I've never seen a country expand its loan base by 34% in one year without massive inefficiencies and asset speculation in its wake. Only 5% of this year's loans went to private enterprises (which employ 75% of the urban workforce), as 95% went to state-owned enterprises or provincial entities. While there have been substantial productive improvements in rail and other infrastructure, our contacts in Asia also indicate that funds designated for stimulus are ending up pushing up land price auctions to 4 times the original bids. This is mal-investment on a monumental scale. But for now, the Chinese have much more room to borrow and inflate than the US (which has spent the last few decades doing so). Eventually, the market will cut them off. The end will not be pretty, and at some point in the future, shorting Chinese stocks may be one of the best short selling opportunities in history. But in the meantime, it makes no sense to bet against China. The Communist government has proven very efficient at stealing the resources of its people (via inflation and taxation) and channeling them into whatever infrastructure project they deem necessary. This process could end next week, or next year. That's the annoying part about bubbles: they tend to expand until the last patsy has bought in, and there's no telling how many patsies there are. There are already signs emerging that the furious pace of loan growth is slowing down. Today, Bloomberg reports: "China Construction Bank Corp. will reduce new lending by about 70 percent in the second half after a surge in loans in the first six months increased credit risk, President Zhang Jianguo said in an interview. "CCB, the world's second-largest bank by market value, plans to extend about 200 billion yuan ($29 billion) of loans, down from 708.5 billion yuan in the first half, said Zhang, 54. The company's new lending through June 30 was 42 percent more than for all of 2008." Lots of debt loans are being made, but as long as loan growth is running hit, they will be hidden. Once loan growth stalls, bad loans will come to light, and the Chinese government may implement its own version of TARP to recapitalize its banks. But the situation in the US is different... Society has too much unaffordable debt at nearly every level. To top it off, we have a Federal Reserve run by central planners who not only misdiagnose their own complicity in the credit bubble, but also remain smugly confident that they can withdraw excess reserves before fears of inflation pick back up. This is turning out to be the financial market's largest ever game of chicken: the Treasury and Fed acting in a brazen manner to depreciate all forms of US paper (government debt and dollars), and, with each passing year, foreign creditors with fewer and fewer reasons to hold the liabilities of a bankrupt government that's accelerating its move deeper into bankruptcy. The ingredients add up to the potentially explosive move up in gold- related assets. The more developments I see regarding economic fundamentals, and fiscal and monetary policy around the world, the more I want to own gold, and sell most stocks. Regards, Dan Amoss for The Daily Reckoning Editor's Note: Dan Amoss, CFA, is managing editor for Strategic Short Report. Dan joined Agora Financial from Investment Counselors of Maryland, investment adviser for one of the top small-cap value mutual funds over the past 15 years. As a buy-side analyst, Dan refined his value investing approach by meeting with corporate executives and sell- side analysts and writing proprietary research for the fund's management team. Dan alerted readers to Lehman's collapse five months before it occurred, showing readers how to play the bankruptcy for a $200,000+ profit. Check out Dan's latest report, which details another bank that's about to go belly-up, and find out how you can play this possibly money-tripling opportunity.