Governments will not warn investors or consumers. They never do.

By David Scott | Monday 13 November 2017


We are seeing the unfolding of the biggest new driver of the world’s financial, monetary and geopolitical arrangements in 50 years. China and America are clearly now vying for global hegemony. The US is still the bigger economy in dollar terms – weighing in at $18,600bn, compared to China’s $11,200bn. Adjusting for living standards, though, or “purchasing power parity”, China has been in top spot since 2015. President Xi commands the bigger army – boasting 2.5m active personnel, rather than 1.5m in the US. But America spends $650bn (£495bn) a year on defence – outstripping China fourfold. And, crucially, the US has over 5,000 nuclear warheads and 19 aircraft carriers, compared to 300 Chinese nukes and just two aircraft carriers, the second launched earlier this year.

While Trump is buffeted by politics, though – often unable to get his way in Congress – Xi is a dictator, so can broadly do what he wants. America is the world’s most indebted country and China is its biggest creditor. An aggressive move in global bond markets and Beijing could send yields on US debt spiralling, threatening America’s recovery. Xi is undoubtedly China’s most powerful leader in a generation. The emerging markets now account for 55pc of world economy and rising. As China forges ever-closer ties with India, Russia and across Africa, it is taking on a global leadership role. China – and the economies across south and central Asia associated with its One Belt, One Road initiative – will account for a massive 46pc of global growth over the next five years, according to the economist John Ross. The US and EU numbers are, respectively, 24pc and 10pc.

The financial system is loaded with anomalies, deformations and mispricing’s - outcomes which would never occur on an honest free market. For example, the junk bond yield at just 2% in Europe is now below that of the "risk-free" US Treasury bond owing solely to the depredations of the ECB. Draghi has purchased $2.6 trillion of securities since launching QE in March 2015, and during the interim has actually bought more government debt than was issued by all the socialist governments of the EU-19 combined.

Mario Draghi knows that maintaining the so-called stimuli now involves more risks than benefits, but he also knows that eliminating them could make the Eurozone deck of cards collapse. But despite the massive injection of liquidity, he knows that he cannot disguise political risks such as the secessionist coup in Catalonia. A trap does not let Draghi raise rates, something that is urgent when the ECB is significantly behind the curve because the economy will suffer. It is a warped economy that is so weak that it cannot stand a rise of 0.5%, an economy where zombie companies soar. According to the BIS, the number of zombie companies has shot up in the last two years to 9% of large companies and experts believe the number is significantly higher for smaller companies. The trap of the so-called stimulus plan is what it has always been. Once the period and quantity announced have been covered, the ECB itself is hostage to the perverse incentives it has created. We are told that there is no bubble, but the ECB cannot stop its repurchases for fear of a collapse in financial markets. We are told that fundamentals justify financial and political complacency, but if you mention a 0.5% increase in rates, governments and companies turn white. If there is no bubble, it is the ideal time to stop something that no longer fulfils its function of mitigating panic.

What we see today in the valuations of sovereign bonds is not normalization of excessive yields, but a feel good atmosphere generated by a single operator, The ECB. And that always brings negative consequences. The financial system cannot heal if rates are kept at ridiculous levels, as much of the banking industry has warned. The ECB’s obsession with inflation leads it to ignore the three reasons why prices do not rise as they would like. The accumulated overcapacity after years of demand and subsidy policies. Disinflation from technology and efficiency, which is very positive and democratizes the use of goods and services for all income segments. And third and the most important for Europe an aging of the European population, which leads to changes in consumption patterns. In addition to higher taxes on the middle class and families, due to the increase in spending on pensions. Those pension systems also suffer from low rates, because the income from social security payments is invested in government bonds with negative real returns. That is, savings are eroded.

President Donald Trump on Friday pushed for freedom and economic openness in a forceful speech that portrayed Washington as a more respectful trade partner to Asian nations than China has been. Speaking at the Asia-Pacific Economic Cooperation summit in Vietnam, the president also warned against mistreating his country, accusing some countries in the region of "product dumping, subsidized goods, currency manipulation and predatory industrial policies. “We can no longer tolerate these chronic trade abuses, and we will not tolerate them," Trump said. “From this day forward, we will compete on a fair and equal basis," he added. "We are not going to let the United States be taken advantage of anymore. I am always going to put America first the same way that I expect all of you in this room to put your countries first. “Additionally, Washington will "no longer tolerate the audacious theft of intellectual property, we will confront the destructive practices of forcing businesses to surrender their technologies to the state and forcing them into joint ventures in exchange for market access," he said.

Trump said he did not blame China, the world's second-largest economy, or other countries for "taking advantage of the U.S. on trade," repeating a message he delivered in Beijing the previous day. Those who play by the rules will be Washington's closest economic partners, Trump said. "Those who do not can be certain that the United States will no longer turn a blind eye to violations, cheating or economic aggression. Those days are over. “We cannot achieve open markets if we do not ensure fair market access," he said, adding that unfair trade "undermines us all. “The world's largest economy will also sign bilateral trade agreements with Indo-Pacific nations that abide by fair and reciprocal trade, he continued. "What we will no longer do is enter into large agreements that surrender our sovereignty. “Trump pulled his country out of the Trans-Pacific Partnership agreement, pegged as the world's largest trade deal, in January on concerns about American jobs. The U.S. leader also praised the economic transformation of many Asian nations, including Vietnam, Indonesia, Thailand and the Philippines, saying Washington has been an active partner in Asia-Pacific since the U.S. first won independence. ‘I am always going to put America first,’ Trump said, adding "We seek friendship and we don't dream of domination.“Since Washington's withdrawal from the landmark accord in January, the pact's 11 remaining members have been discussing how to move ahead with the agreement, which seeks to remove tariffs across certain industries as well as safeguard labour, environmental and intellectual property rights. A framework was expected at this week's APEC summit, but nothing final has been revealed so far.

It is easy for those of us in the West to overlook how important China has become to the world economy, and also the limits it is reaching. Many of the limits were pushed further so that Xu zinging could ensure his dynasty at the recently convened 19th Communist convention a meeting that takes place every five years to refresh the leadership of the Chinese communist party. The current system has been able to avoid defaults on loans. The issue is that these problems don’t really go away; they get hidden, and get bigger and bigger. At some point, all of the manipulations by government officials cannot hide the problem of too many apartments and too many factories of all kinds. A postponed debt collapse is likely to be much bigger than if market forces had been allowed to bring about earlier bankruptcies and facility closures. Chinese officials are now talking about reining in the growth of debt. There is also discussion by heads of Central Banks about raising interest rates and selling QE securities (something which would also tend to raise interest rates). China will be very vulnerable to rising interest rates, because of stresses that have been allowed to build up in the system. We are likely now in the lull before the Chinese storm. There are many things that could push China toward a debt crisis. These days China is so big that the rest of the world is likely to be affected.

Wealth doesn’t come from the creation of money, especially a fiat (paper money) system. With too much fiat money and too much credit, eventually the economy becomes exhausted and engulfed with debt and mal-investments. The treatment for this is a correction and you have to allow the excess debt to be liquidated. You have to get rid of the mal-investment and you have to allow the real economic growth to start all over again. But that wasn’t permitted in ’08 and ’09, which is why there’s been stagnation. It's hard to believe that today we have real negative interest rates (where the interest rate minus inflation is a negative number) and yet we are not in a boom.  A shortage of money isn't the problem here; rather, it’s a lack of understanding of markets and how capitalism works.

Western Society is over-taxed and over-regulated. This is resulting in a destructive system that has divided societies into two groups: those who haven’t recovered from the Great Financial Crisis versus those who are getting very rich because they're on the receiving end of the new money created by the Federal Reserve and other Central Banks. The people who get to create the credit also get to distribute the credit, which always results in a situation where money becomes unfairly distributed, as its allocation is no longer dependent on productivity. In addition we still have a system where we encourage people to borrow money that debt doesn’t matter. Politicians are not going to cut taxes, and they are not even going to admit that they spend too much money. Our politicians won’t admit where the real problem lies: overspending, monetizing the debt, and therefore letting the monetary system take over the whole world through the monetary system of financing wars, financing welfare and a military industrial complex. All of this will not change until this whole thing comes apart when this bubble of all bubbles explodes. This eventual event will be driven by the marketplace and when it comes undone, the powers that be will no longer be able to prop things up just by printing more money in the same fashion that they have done over the last 10 years.

Governments will not warn investors or consumers. They never do. Banks won’t warn consumers because they need consumers to spend and take up loans and invest money in markets. Institutions won’t warn people for precisely the same reason. And certainly central banks won’t warn consumers. They are all in the confidence game. The underlying data is getting uglier. Things are slowing down and not by just a bit, but by a lot.  Nobody wants recessions, they are tough and ugly, but our global economy is on based on debt and debt expansion And all that is predicated on keeping confidence up. Confident people spend more and growth begets growth. But here’s the problem, despite all the global central bank efforts to stimulate growth real growth has never emerged in allot of places we are getting less growth than the debt were piling on and all this is with rates still near historic lows.

David Scott is an Investment Manager & Market Commentator at Andrews Gwynne

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