There’s a good ole fashioned market panic taking place in the Far East. Buyers of Chinese stocks have become scarcer than hen’s teeth. Even the highly visible hand of the Chinese government can’t arrest the freefall.
On Monday, for example, the Shanghai Composite Index collapsed nearly 9 percent. This was in the face of bans on selling shares and direct stock purchases by Beijing. Shrewd individuals sold despite the government’s outright threats and demands not to.
No matter how you look at it, government efforts to prop up the market are futile. They won’t fix the fundamental imbalances. Market distortions and malinvestments from years of cheap credit have pushed the market out of orbit. Total collapse is the only solution.
“The Chinese economic boom since the global financial crisis in 2008 has been fueled primarily by debt — with total debt levels surpassing the United States,” reported CNN. “Even the recent stock market boom has been driven primarily by rising debt levels to pay for stock purchases. By one recent account, approximately 35 percent of freely traded shares are purchased with debt.”
In addition to borrowing massive amounts of money to buy stocks, China has also borrowed massive amounts of money to buy cement. No kidding, China’s economy used 6.6 gigatons of cement between 2011 and 2014. To put this in perspective, the U.S. used 4.5 gigatons of cement over the last 100 years.
Liquidating Commodities and Mining Jobs
No doubt, China’s cement mania has far overshot its real limits. The move back towards reality will be painful. Massive debts must be written off. Defaults must be worked through. Bankruptcies must be liquidated.
The situation in China, in other words, is deflationary. Ground zero, at the moment, is the Shanghai Composite Index. But that’s not all…
In terms of GDP, China is the world’s second largest economy. According to the International Monetary Fund, and the notion of purchasing power parity, they’re the world’s largest economy. By either account, deflation in China also means a deflating world economy.
This phenomenon can be best observed by watching industrial commodity prices. Debt fueled growth in China resulted in false demand. Mining companies ramped up production to meet this demand. That false demand has been cut off at the knees.
“All main commodity price indices are expected to decline in 2015, mainly due to abundant supplies and, in the case of industrial commodities, weak demand” forecasts the recently published Commodity Markets Outlook from the World Bank. Naturally, when supplies are abundant and demand is weak prices fall…and mining jobs disappear.
“The world’s biggest mining companies are hemorrhaging jobs as they downsize to cope with a prolonged China slowdown and a commodity-price slump that they no longer expect to end soon,” explains the Wall Street Journal.
“Anglo American PLC, the U.K. mining titan, on Friday announced the most dramatic jobs cut yet in the ailing industry, saying it would lop off 53,000 employees over several years—including 6,000 cuts in corporate offices that amount to $500 million in savings. That would result in a 35 percent reduction of its current workforce of 151,000, though much of it would come through the sale of mines, not direct layoffs.”
Deflation with a Capital D
Job losses. Mine closures. Downsizing. A commodity-price slump. This is deflation with a capital D…and once it starts, it feeds on itself. Here’s why…
The burden of outstanding debt increases when there’s deflation. In an over indebted economy, like China or the United States, this is the death knell for the financial system. If deflation persists, bankruptcies increase, capital markets break down, and the economy falls into a depression as unemployment soars.
When the economy deflates, a self-reinforcing cycle develops. Prices rapidly decline but so does spending, which accelerates personal, business, and government bankruptcies. As businesses fail the unemployment rate skyrockets. This scenario scares politicians and central bankers alike.
Central bankers prefer inflation to deflation. When the economy is overheating and consumer prices are escalating the central bank can cool prices by increasing interest rates and contracting the money supply. When the economy falls into deflation their monetary powers are compromised.
Of course, the solution for central bankers to deflation is inflation. It won’t be long before contagion from China takes hold of world markets and economies. If you thought the measures taken following the 2008 financial crisis were extreme, you ain’t seen nothing yet.
Sincerely,
MN Gordon
for Economic Prism
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