January 27, 2014

Not the Wolf, but the Wuss of Wall Street

Posted in Banks · 62 comments ·
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Do you remember the Undertones My perfect cousin’ about a perfect, mollycoddled cousin who was the apple of his mother’s eye and got on the nerves of all the other less-than-perfect cousins?

Every family has one, although I suspect the Irish weakness for mothers’ filial devotion probably makes the Irish perfect cousin considerably more unbearable. The mothers just can’t help bragging, protecting and becoming excessively agitated at the slightest sign of a cold, a cough or a splutter from the golden one’.

The perfect cousin is the delicate child’ who, at least in the mother’s eyes is always in danger, always susceptible and needs to be always looked after. Any slight threat, such as falling in the playground, mingling with the wrong’ crowd or not taking his daily vitamins, spells disaster for the delicate child and sends the protective mother into apoplexy.

The outsized reaction of financial markets to news of problems in China on Thursday and Friday, reminded me of the delicate child and its mother.

After five years of the ultimate protective mother, the Federal Reserve, injecting cheap money at every juncture, the markets are like the delicate child. Their reaction is hardly the wolf of Wall Street; more like the wuss of Wall Street.

After years when economic reality was wrapped in the soothing balm of quantitative easing, any small threat to the global recovery script prompts wild over-reactions by the wusses of Wall Street. These out of proportion, short-term reactions – such as a massive sell-off on a worse-than-expected number, or a buying surge on the back of a better-than-expected number – are characterising financial markets these days.

This week we had a brilliant example. At the end of the week, the delicate markets sold off dramatically, particularly emerging markets. In fact, now that I think of it, maybe the most telling warning sign should have been when the great and good in Davos were unanimous in saying everything is all right and the world is a safe place again. On queue, the markets sold off. The reason was China, which may come as a surprise to you when you have been told that China was the future.

The fear, highlighted in this column a few times in the past, is that the massive credit easing in China of the past few years has led to a huge bubble in the Chinese banking system. We know from our experience in Ireland that massive credit growth rarely leads to a sustainable period of economic growth – as suggested in textbooks – but, in contrast, leads almost inevitably to bubbles, defaults and bankruptcies.

Defaults never come in ones

In the past few days, evidence of these bankruptcies has emerged in China. At the moment the figures are minuscule in the context of the second-largest economy in the world, but there is one thing we know about defaults: like cockroaches in New York, they never come in ones. When you see one, you know you have thousands.

Deep inside the Chinese banking system are small financing companies, financing millions of sure thing’ investments to millions of people hoping to make a quick buck.

These are the Chinese equivalent of the development land’ financing which emerged in Ireland in the 2000s. Do you remember them? They were the ones sold by all sorts of charlatans who contended that if you bought a field outside Edenderry it would be worth hundreds of millions in time. These scams are a function of the banks having too much money and nothing to spend the money on, so they finance rubbish.

In China the assets’ financed weren’t open fields, but open mines. The mining company comes to the banks and says it wants to borrow money, much like the developer in Ireland in 2005. Instead of lending the company the cash, the banks turn the loan into an investment’ and gather together its high net worth individuals. These people are told to buy a product’ which is nothing more than a loan to a mine (which may or may not work) dressed up as a financial investment’.

This is what the Irish banks and brokers were doing all the time in the development land scam here a few years back. In China this has been going on all the time, but on an unfathomable scale.

Then suddenly one of the mining companies goes bust because there is nothing under the ground. Suddenly people begin to ask questions. How many of these loans are out there? And if there are loans, are the banks safe?

Overnight from having been the growth story of the century, China becomes the place in the world most likely to have an Asian Lehmans. This vista scares the bejaysus out of the financial markets because they start thinking that there is something much bigger and nastier hidden in the entrails of the Chinese banking system.

The delicate child screams for its Mammy (the safety of the stable countries), apologising for hanging out with the wrong crowd (the emerging markets) and wanting to go home (into stable investments).

In a panic on Thursday, the financial markets sold everything risky’ and flew back to the safety of Mammy’s skirt, which in the financial world is the US treasury market. On Friday the sell-off kept going.

All across the world, from Argentina to Turkey, South Africa to Brazil, the currencies of the countries fell sharply on Friday.

When you take a bit of altitude, none of this seems to make sense. Why does a wobble in China affect the value of the South African rand?

The answer to this legitimate question is leverage. The global financial markets are gelled together by huge borrowings. In the past year, many trillions of Japanese yen were borrowed to buy stuff around the world, for example, South African rand. The rand offers high interest rates to investors at 5 per cent; yen rates are practically zero. So the traders borrow in yen and buy rand.

But when the panic sets in, they sell the rand because they want to own dollars and not be exposed to the risks in places like South Africa. So the rand falls, for no real reason other than people are worried about China and this fear prompts them all to buy dollars and yen and Swiss francs.

This is what happened all over the world on Friday. Investors sold everything and scuttled home to safety. The wolves of Wall Street at the faintest hint of trouble turned into the wusses afraid of their own trades – the ones they were probably bragging about a few days ago.

But what about the threat of a Chinese Lehmans, is it real? Who knows. Is there a risk that all those dodgy loans will go bad?

Yes! Can’t the central bank with the most foreign reserves in world handle this? Maybe

Perfect cousins, like the Undertones’ Kevin, who had a degree in economics, maths, physics and bionics’ will tell you that Chinese fundamentals’ are sound.

David McWilliams writes daily on global finance and economics at globalmacro360.com


    • Lius

      First up is best dressed Adam :-)

      • Cheers Lius, but I didn’t get an email alert for your comment, which is the whole point of the ‘Subscribe’ thing (as I’m sure you know) so lets hope it sorts itself out in a minute.

        • The Same boring contributors Here on a full time basis Who think they have a god given right to dislike newcomers and even gang up on unsuspecting Strays who dare post on there page,?

          • SMOKEY

            Yes regular and few. In talk radio a regular caller is “death” to the show.
            Our “Irish talk radio” isn’t talk radio at all. Same old tired, recycled, plain uninspired garbage day after day after day…..just like this blog has become.
            Still, McWilliams track record is pretty damn awesome.
            He cant help it if the clowns on his blog are boring.

  1. So there’s a chance that the Irish experience was just a microcosm of the real cosmic event to come. Maybe those American programs about survivalism should be taken more seriously.
    But while everyone is looking at Chinese economics, didn’t Singapore invest heavily in the West back 4 or 5 years ago? Or am I red flagging a red herring?

  2. michaelcoughlan

    Hi David.

    First of all congratulations;

    http://www.independent.ie/business/media/profits-grow-at-mcwilliams-media-firm-29948769.html

    A sublime rebuff to the bonbons of this world waiting for top down approaches to solve their problems. What I find most remarkable about you Dathi is that having been trained as a classical economist you reinvented yourself as a media professional and have done so very successfully.

    I (like you) trained professionally in my case as a construction manager and took your advice and my own advice to stay out of the madness for at least a year before the bust. But I have come to the same conclusion that doing the job properly means you are surplus to requirements in your chosen profession and hope to emulate your example of reinvention this year.

    best regards,

    Michael.

  3. michaelcoughlan

    Hi,

    I’m not sure if any of you can see my previous posts about David increasing the profits of his media company but if you can the reason I posted more than once is that for some reason the post is awaiting moderation even though it is complimentary.

    Regards,

    Michael.

    • michaelcoughlan

      It seems the inclusion of the names of the names of the top down cult renders a post “awaiting moderation”. It seems that their posts on previous topics have also been removed. It’s a pity because I just found a line to a you tube video which shows how the 2nd law of thermodynamics proves the existence of God. I know ye are out their lads:

      http://www.youtube.com/watch?v=lUAumWDW5b0

  4. Afternoon all, hope life is good. Now a little bit of housing keeping as I have recieved lots of complaints from readers that the discussion is veering off topic a bit too regularly. All messages that do not relate to the articles they are being posted under or fit within the conversation within the comments, will be deleted. The comments section is left open for people to discuss and comment on my articles. Anyone is allowed post a comment but repeated bending of the guidelines will result in the user being deleted from the site.

  5. michaelcoughlan

    Hi David,

    In the article above you state that the investors scuttled for safety. Where is safe if China goes down the pan?

    regards,

    Michael.

  6. Paul Divers

    Good Article.

    From the article linked to by Adam:

    “Governments of left and right united to create a crony corporate socialism. Just like communism, an oligarchy were protected from their irrational exuberance, subsidized (without consent) by ordinary citizens’ taxes.”

  7. capitalism_cataclysm

    Banks are bullying the fed not to taper, that’s all the fuss is about.

  8. Pat Flannery

    So, if I understand you correctly David, Wall Street has been weakened by an overindulgent mother, the Fed. I think we can all agree on that. But I’m not sure I understand this bit: “the most telling warning sign should have been when the great and good in Davos were unanimous in saying everything is all right and the world is a safe place again. On queue, the markets sold off. The reason was China, which may come as a surprise to you when you have been told that China was the future.”

    The part I am having difficulty with is “everything is all right and the world is a safe place again” on the one hand and “on queue, the markets sold off. The reason was China”, on the other. I just don’t get the connection. Maybe I’m just being dense.

    How could fear of “a huge bubble in the Chinese banking system” be reconciled with “the world is a safe place again”? Isn’t China a central part of the investment world, safe or unsafe?

    You go on to argue, correctly, that the wusses of Wall Street always retreat massively to the safe haven of the Dollar when the world looks like a dangerous place, in this case the perceived danger being a Chinese banking meltdown.

    It’s your statement that “Davos were unanimous in saying everything is all right and the world is a safe place again” that throws me.

    BTW Martin Scorsese’s “The Wolf of Wall Street” was the best porno flick I’ve seen in a while. I hope they did not cut it too much in Ireland.

  9. It Seems that the scurry to safety also included a purchase of gold bullion the price of which rose a lot on Thursday and some on Friday.

    Here is Richard Russell on his choice between unbacked US dollars or gold backed Yuan as the world reserve currency.

    http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2014/1/28_Richard_Russell_-_Stocks_To_Crash_As_U.S._Lies_To_Its_People.html

  10. “All across the world, from Argentina to Turkey, South Africa to Brazil, the currencies of the countries fell sharply on Friday.”

    Measured by what , David.
    The currencies are all measured against them selves in a weighted basket of currencies.

    All currencies can be dropping an equal amount as measured by the real economy and the nominal price of goods yet the currencies themselves will have shown no change one measured against each other.

    All boats sink on a falling tide.

    The real measuring stick, gold, showed all currencies dropping not just the above mentioned.

  11. Pat

    My comment about Davos is that it is a counter-cyclical indicator, populated by people who’s eyes are firmly in the rear view mirror and rarely on the road ahead!

    Best

    David

  12. StephenKenny

    Pat
    That’s interesting. My interpretation of what David was saying was that any authoritative statement implying that, in the view of the US government, the economy is ‘mended’ will result in a a decline in the various financial intervention policies (interest rates at almost 0, buying under performing investments from Wall Street at par, and so on).
    This would leave them facing up to making money in the real economy, rather than on an economy based on government intervention (The Greenspan ‘put’ and onwards). This would have a significant effect on the various market indices.
    Going ‘cold turkey’ after 15+ years of interventions (as Greenspan put it, ‘taking away the punch bowl’) would be difficult.

    • Pat Flannery

      David & Stephen,

      Thanks. I think I get it. A bit like: “if he/she said ‘good morning’ I would put my pajamas on and go to bed”.

      You are saying that when Washington says “things are looking great” it is time to sell because daddy is about to cut off the free beer.

      But I still wonder if the Yanks are not misjudging the Chinese. Tightening would reduce demand for Chinese products and depress both the U.S. and the Chinese economies. Have they thought this through?

      The Chinese could generate demand elsewhere in the world. They are attempting to do exactly that already in Africa and South America. They are also trying to inflate their own domestic demand. Where would that leave the Dollar? China has to have an outlet (just as Germany). This is a delicate dance.

  13. Dr Bill

    Hi David,

    You may be interested to know that “My Perfect Cousin” was indeed a real life person (I actually know him very well)

    In the fashion of all annoying perfect cousins he studied medicine and became a surgeon, later he left that career and followed his passion for aviation eventually becoming an airline captain.

    Dr Bill.

    • Dr Bill

      This is a wonderful piece of information. I too have a cousin who is known as “Eamon, the doctor”. I always wondered was cousin Kevin real and now I know he is. Do you know where I can contact him?

      Best

      David

  14. Worth a read:

    “Is the World Re-balancing?”

    http://yanisvaroufakis.eu/2014/01/28/is-the-world-re-balancing/

    Does anyone else think it’s odd, in the Age of Austerity, that a dangerous crush develops when 1,500 kids try to get into a city centre night club on a Monday night?

    http://www.independent.ie/irish-news/young-woman-now-okay-and-talking-after-crush-near-popular-dublin-nightclub-29956807.html

    • capitalism_cataclysm

      the drinks were being sold at austerity busting prices.

    • David NZ

      Very interesting article – if the excess savings aren’t turned into investments that produce the incomes that can be used to pay off the debts then it’s going to be global stagnation.

      In the US they have been cushioned by and still have
      - cheaper energy (shale oil)
      - reshoring of manufacturing (lower dollar and cheaper energy)
      They also have
      -ideological constraints preventing fiscal expansion and preventing replacement of a large decaying infrastructure.

      If the last constraint was eased growth would be quite high.

      China has
      - wages rising
      - its own currency and a pragmatic govt that will act to prevent a large scale disruption of industry by credit events within its own borders
      - a search for ways to rebalance its economy so that it relies more on the spending of its own people and so that it is less affected by global events. In order to increase aggregate demand from its population it will have to make provision for retirement, healthcare and housing needs of its lower income citizens, so that they feel secure enough to spend more.

      Europe has
      - the German export machine
      - the German demographic downturn
      - a large young unemployed Southern European population.
      If Germany was to enable the expansion of Southern European small business through internal transfers, Eurobonds etc growth within the Eurozone could be reasonable.

      Personally I think it much more likely that moderating forces within the US and China will enable the US-Asia axis 4 or so more years of life before demographic downturns in the US and China make both countries turn more inward.

      2018 would be the year of doom I’d say, when lots of chickens come home to roost.

      Perversely it may be that the savings vaccum cleaner operating from the US (mentioned in the article) may be being kept in existence by the hobbling of the Euro due to German reluctance to allow Eurobonds and fiscal transfers within Europe or to allow the breakup of the Eurozone.

  15. cooldude

    It seems there are not only problems in the China’s banking system but also much closer to home in HSBC. Regular customers were unable to withdraw relatively small amounts of cash unless they produced evidence of what they would be doing with the money. Meanwhile the Bundesbank calls for a “wealth tax” in any European country affected by a bank being under capitalized. Looks like there are still serious problems throughout the global banking system and they want tax payers to foot the bill for their stupidity. That’s unusual isn’t it??

    http://iacknowledge.net/a-closer-look-at-china-and-hsbc-are-they-running-out-of-cash/

  16. cooldude

    More good news from across the pond. RBS will loose around £8 Billion this year dashing any hopes of reprivatisation. Most of the losses come from their dodgy mortgage practices. Couldn’t happen here though??

    http://www.dailymail.co.uk/news/article-2547066/RBS-hit-3bn-bill-hopes-slide-sell-election-Bank-faces-huge-new-mis-selling-scandal.html

  17. cooldude

    You couldn’t really make it up when it comes to the arrogance of these RBS bankers. Despite costing British tax payers over £80 billion in bailing them out in 2008 and losing £8 billion in 2013 they want a 200% increase in their bonuses. This is what you get when you reward failure. Shut them down before they lose any more.

    http://www.iii.co.uk/articles/143906/rbs-wants-200-bonuses-despite-£8-bn-shortfall

  18. joe hack

    I read here that if some people complain that others are spoiling there ability to debate on this blog then those others are censored. There is only one way to spoil debate and that is to censor, some evidence of this can be found above this post. The dulness and medioracy demonstrate above is plain to read. Censorship is and always was wrong and censorship has never solved anything those that support it are blind to censorship consequences. Shameful
    I am complaining about how dull this blog is as result of a Shameful censorship.

    • michaelcoughlan

      Hi Joe,

      No one was censored. A couple of posters were removed for abuse of privilege. When asked to stop diverting the blog they refused to accept the request. Censorship isn’t wrong if it stops someone from inciting hatred or violence etc and especially isn’t wrong if it enhances debate etc.

      regards,

      Michael.

      • joe hack

        I take it that you include incitement of hatred of other people opinions. Well just stop doing it if that’s what you believe. Incitement to hatred is what you have been about. But it didn’t not work on me it only works on the weak of mind. Shameful what are you afraid

  19. Posted at http://www.lemetropolecafe.com

    http://deutsche-wirtschafts-nachrichten.de/2014/01/27/bundesbank-stimmt-zwangsabgabe-auf-sparguthaben-zu/

    describes that the german centralbank BUBA did agree on the suggestion of the IMF to “confiscate” 10% of all german saving accounts and potentially also real estate values in the future case it is needed. They view the potential of the 3853 billion Euro savings in the Euro-zone. It would start for people with wealth above 250’000 Euro, and that is not just the rich, especially if they price your house or apartment to (their) fantasy!

    tick, tick, tick …

  20. Germany now ranking extremely high as a tax haven, and Turkey riaisng interest rates from 4.5% to 10%.

    Who is this related?

    You think it isn’t?

    The whole is based on a well known network, or better to say well designed legal loopholes to emable capital flight. But that’s another story.

    So what happens to the German DAX after Erdogan raises interest rates, Eurostoxx 50 is up 0.9%, DAX up 1.1%.

    So now it is waiting for the FED tonight…again.

    Are you waiting for the FED? Or are you one of those who is NOT a player?

    over and out.

  21. “If the Fed starts to do more QE because they think the economy needs help, there’s no real case to stop because they haven’t gotten the economy self-sustaining. Now, you and I and the people who read and listen to KWN believe that the money printing only causes problems. Right now that is a minority view, but eventually it will become the mainstream view.”

    http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2014/1/29_Fleckenstein_-_Year_Of_Fantasy_Is_Over,_Expect_Turmoil_Now.html

  22. We are going into the greater depression.
    –Doug Casey

    http://usawatchdog.com/bond-market-bubble-in-search-of-a-pin-doug-casey/

    Bond Market is a mother of all bubbles

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