China’s Slow-Motion Sleight Of Hand Shatters

Submitted by Raúl Ilargi Meijer  –  The Automatic Earth

Marion Post Wolcott Natchez, Mississippi, grocery window 1940

The Chinese stock markets broke through 2 circuit breakers today, breakers that were introduced only a few months ago in response to the market selloff, triggered by a surprise yuan devaluation, in August. The first breaker, at -5%, forced a 15-minute trading halt. The second one, at -7%, halted trading for the rest of the day.

For many people, today’s bust can’t have been a huge surprise, because it’s been known for some time that a ban on stock sales by parties holding a 5% or larger stake in a company, is set to expire on Friday. Beijing may panic again before that date, but it can’t force stakeholders to hold on to large portfolios forever either.

Xi and his crew should have stayed out of the markets from the start, but that’s not how they see the world. They still think like apparatchicks, and don’t understand that markets are opposed, at a 180º angle, to top down control. You can either have a market, or you can have central control.

They pumped up the housing market for all they could, and when that bubble blew they tricked their people into buying stocks. And now that one’s fixing to die too, and that didn’t take nearly as long as the housing bubble. The central control team is frantically looking for the next carnival attraction, but it won’t be easy.

They should have stayed out of all markets. Just like western central banks. All interference by governments and central banks can only make things worse, a fact at best temporarily hidden by the distortions they force upon markets.

And we shouldn’t forget that expectations for China as the world’s economic savior determined western central bank ‘thinking’ to a large extent over the past decade. Like so many others, central bankers too are incapable of spotting a Ponzi when it’s staring them in the face.

Now the Chinese bubble is bursting, and set to spill over into and over the global economy with dire consequences, we are all exposed to that much more than was ever necessary. All the PBoC, Yellen, Kuroda and Draghi managed to accomplish was a dran-out illusion, a slow-motion sleight of hand.

Here’s something I was writing over the weekend, prior to today’s market action:

China underlies all problems the world faces economically today. Since at least 2008, the global economy has been a one-dimensional one-way street, in which all hope was focused on China. Western companies and stock traders were so confident that China would lift the entire planet out of its recessionary doldrums, they leveraged themselves up the wazoo to bet on a China-based recovery. It was the only game in town, and it was merrily facilitated by central banks.

The People’s Bank of China threw some $25 trillion at the illusion, the Fed, ECB and BoJ combined for probably as much again. One way of looking at it is that if you weren’t sure on how bad the recession really was, now you know the numbers.

But today China is close to entering its own recession, whether Beijing will admit it or not. The official GDP growth goal of 6.5% looks downright silly when you see this graph thatCharlene Chu sent to BI:

CEIC and the National Bureau of Statistics; Charlene Chu, Autonomous ResearchFrom the article:

Secondary industry comprises about 40-45% of GDP. [..] In China, GDP is classified into three industries, primary (agriculture), secondary (manufacturing and construction), and tertiary (services). [..]

This slowdown in the secondary industry is part of China’s intentional shift toward an economy focused on services and consumer consumption rather than manufacturing.

The first line there is educative, the second is nonsense. Manufacturing in China is plunging because ‘we’ don’t buy their overcapacity and overproduction any longer. And neither do the Chinese themselves. Primary industry, agriculture, may grow a little bit, but certainly not much.

Tertiary industry, services, may also grow a bit, but Beijing can’t just flip a switch and get people to buy services on a scale that can make up for the decline in manufacturing. Neither can it retrain tens of millions of workers for jobs in that illusive services sector, let alone on short notice.

This decline will take years for the Chinese economy to absorb, since so much of it is based on overleveraged overcapacity and overproduction. The spectre of massive job losses hangs over the entire ‘adjustment’ process, both in China itself and in countries that -used to- supply it with commodities. Mass unemployment in China in turn raises the spectre of severe social unrest.

As I said in 2016 Is An Easy Year To Predict, China has got to be the biggest story going forward (rather than oil, for instance), and it would have been already, to a much larger extent than it has, if there were less denial involved. And less debt.

Like the west, China will have to deleverage its enormous debt burden before it can even start thinking of rebuilding its economy. Which is precisely what they all seek to deny, loudly and boisterously, not only as if a recovery were feasible without dealing with the debt, but even as if more debt could mean more recovery.

This debt deleveraging will involve such stupendous amounts of -largely virtual- money that the situation, the bottom, from which rebuilding will need to take place will be one at which today’s societies will be hardly recognizable anymore.

Debt deleveraging comes with deflation. Spending will plummet, unemployment will shoot up, production will grind to a halt. Power will shift from established political and economic parties to others.

Obviously, this will not be a smooth transition. The clarions of war sound in the distance already. What is crucial to realize is that none of it can be prevented, other than perhaps the warfare; the economic parts of the play must must be staged. All we can do is to make it as bearable as possible.

The people on the streets, as always, will bear the brunt of the downfall. We only need to look at Greece today to get a pretty good idea of how these things play out.

It won’t be all straight down from here, but the trend will be crystal clear. It didn’t start all of a sudden today, but China’s double circuit breaker is a useful sign, if not an outright red flag. One thing’s for sure: we’ll make the history books.