China’s Great Financial Wall is falling

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Brian Hennessy. China Australia Consult. January 2017

Although China defied predictions of a slowdown in 2016,  Jim Rickards (below) warns that 2017 may turn out very differently.

Jim Rickards is an adviser on international economics and financial threats to the Department of Defense and the US intelligence community. His assessment of China's at-risk economy and its ramifications for the rest of the world is timely. Highly recommended reading.


China’s Financial Great Wall Is Falling

Jim Rickards. Strategic Intelligence. January, 2017.


China is at a crossroads. The world’s second-largest economy defied predictions of a slowdown in 2016 by unleashing massive amounts of government spending and adding mountains of debt to stimulate its economy. China met its growth targets despite naysayers, helping commodity exporters such as Australia in the process.

Yet, 2017 may turn out very differently. China is encountering hurricane-force headwinds that will cause its non-sustainable, debt-driven policies to reach a critical state, which will require a radical response. This response might take the form of a maxi-devaluation of the yuan, much tighter capital controls, a severe downturn in its economy, or all three.

None of the extreme outcomes will be contained to China. Any significant departure from China’s current growth trajectory has serious negative implications for investors around the world.

The headwinds China is facing, which we examine in detail below, include confrontations with President Trump on issues of trade, tariffs and currency manipulation, internal political instability from Chinese President Xi’s efforts to expand and centralise his political power, possible geopolitical crises connected to North Korea, Taiwan and the South China Sea, Trump’s pivot toward Russia and away from China, the Chinese credit bubble, capital flight, and China’s delicate relations with the IMF.

In short, we may be witnessing a break-up in the China-US global condominium that has dominated world growth and world politics since 2001.

In this special edition of Strategic Intelligence, we look at all of the political, economic, and social forces buffeting China today and consider the implications for your portfolio of investments.

This process of connecting the dots is complicated, but using our proprietary models and analytic techniques — including complexity theory, causal inference and behavioural psychology — we are able to cut through the haze of political rhetoric and propaganda coming from Washington and Beijing to bring you a reasoned estimate of what the near future holds in-store for markets as the world’s two largest economies — China and the US — work out their differences…for better or worse.

In addition to our technical models, I have always been of the view that there is no substitute for foreign travel and face-to-face contact with both experts and everyday citizens in the countries we are trying to understand. I recently returned from a week-long trip to China, including visits to Shanghai and Nanjing.

In Shanghai, I met with a group of 40 of the top China economists, mostly from major Chinese banks and brokerages, at an annual event called the China Chief Economist Forum. I was a keynote presenter at their forum; major institutional investors and wealth managers in China comprised the 400 guests in attendance.

In Nanjing, I met with provincial government officials and economic development experts who are building a high-tech research centre of excellence called UTown on the southern outskirts of the city. I was even permitted to enter a top-secret Huawei laboratory used for testing new internet data-mining algorithms. Huawei is closely affiliated with the People’s Liberation Army, and is banned from most business in the US because they are suspected of hacking and espionage aimed at US critical infrastructure.

I also took every opportunity I could find to speak with drivers, clerks, bellhops and passers-by.

That’s not as difficult as it sounds. In a country like China, few citizens have travelled abroad, and they are often eager to practice English conversation with a real American. People you meet in the street are often a better source of information than the experts in the hotel conference rooms. I asked one student if people in China were trying to get their money out of the country. His eyes lit up and he replied, ‘Yes, everybody I know!’

Information gathered on the ground is not limited to conversation. You can learn a lot just by observing. My trip from Shanghai to Nanjing was on one of the new high-speed rail lines being built, under direction from the central government in Beijing. The train was the best in the world. It travels at 200mph and is almost silent as it speeds down specially-welded high-speed rails. I had a business-class seat that was nicer than most airline business-class seats.

The train stations in both cities are spacious, clean and efficient, putting American train stations to shame; in fact, they’re even nicer than some of the newest major airports around the world.

Best of all, the ticket was cheap! Just ¥429.50 (AU$82.63) for a roundtrip ticket. A comparable trip on Amtrak’s Acela would have cost US$400, and the service would have been far inferior — not to mention having to endure the cramped confines of New York’s Pennsylvania Station.

While I enjoyed the ride, a thought crossed my mind. How do you pay for billion-dollar train stations and railroads by charging AU$82 for a 350-mile roundtrip? The answer is: You can’t. The entire enterprise in being financed with unpayable debt. The state-run China Railway Corporation is losing over US$1 billion per year, and various other state-owned enterprises (SOEs) are losing billions more in construction and equipment manufacturing.

China’s accomplishments, while impressive from the outside, are being achieved with a mountain of unpayable debt. How and when that debt gets refinanced, inflated away, or goes into default is one of the most important questions hanging over global capital markets. That is the question we now turn to in detail.

The Trump challenge

In an interview with Chris Wallace on Fox News Sunday on 11 December 2016, then President elect Trump was asked about a phone call he had taken from the President of Taiwan. Trump replied as follows:

‘I fully understand the ‘one-China’ policy, but I don’t know why we have to be bound by a ‘one-China’ policy unless we make a deal with China having to do with other things, including trade…. I mean, look, we’re being hurt very badly by China with devaluations with taxing us heavily at the borders when we don’t tax them, with building a massive fortress in the middle of the South China Sea which they shouldn’t be doing, and frankly with not helping us at all with North Korea. You have North Korea, you have nuclear weapons, and China could solve that problem and they’re not helping us at all… I don’t want China dictating to me…’

That one quote neatly summarises the bundle of challenges confronting China as a result of the election of President Trump.

The first challenge is that Trump is plainspoken, and does not hide behind the usual diplomatic babble. That can be difficult for the Chinese to tolerate because their culture is dominated by the concept of ‘face’, or the need to avoid direct conflict or embarrassment. When Chinese lose face as the result an adversarial thrust, they try to regain face by being adversarial in return. The result can be an escalation of tensions independent of the policy substance involved. That can make agreements more difficult to achieve.

The quote also lists the main areas of contention — trade, tariffs, taxation, currency manipulation, North Korea, Taiwan and the South China Sea. US policy for the past 16 years through the Bush and Obama administrations had been to soft-pedal all of these issues in return for cheap manufactured goods and China’s willingness to finance trillions of dollars of US government debt.

Now Trump is changing the rules of the game. He’s saying that lost jobs in the US are not worth the cheap goods and cheap financing. He’s betting that China has no alternative but to keep producing those goods and keep buying US debt even if the US imposes tariffs to help create manufacturing jobs in the US.

Trump is willing to use leverage from the geopolitical sphere on issues like Taiwan, North Korea and the South China Sea in order to get concessions from China on the currency issue and China’s trade subsidies, such as state support for money-losing export sectors like steel.

Trump’s actions are not limited to words. His team is now packed with seasoned officials and advisers who have been vocal critics of China’s trade policies for decades. The new US Trade Representative, Robert Lighthizer, has a record of imposing tariffs on unfair trading partners going back to the Reagan administration in the 1980s. Trump’s transition adviser on trade, Dan DiMicco, is the former CEO of Nucor steel, and has been on the receiving end of China’s steel-dumping.

Another senior Trump adviser, Peter Navarro, is an academic and outspoken critic of China; he’s also the author of Death by China. Navarro’s work is a roadmap for the kinds of policies Trump will pursue. While Obama advisers, such as John Kerry and Jack Lew, were mostly talk and no action, the Trump team is ready to rumble.

The problem is that China may not have much to offer, despite the pressure. Trump may not realise that China’s currency is going down not because of government manipulation, but because of market forces in the form of capital flight. In fact, China’s main currency manipulation today is an effort to strengthen, not weaken, the yuan, although those efforts appear to be failing. China may not be in a position to keep buying Treasury debt, either. China’s reserves are dropping, and it has become a net seller of Treasuries.

It looks like the days of cheap foreign finance are over for the US regardless of Trump’s policies. This does not mean US interest rates will spike, despite recent increases. The US will simply force US banks to buy the Treasury debt that China cannot. To the extent that China still runs trade surpluses, it is allocating its reserves into gold, euros and SDRs — and away from US dollars.

The bottom line is that China cannot end its subsidies to exports because it needs the jobs that its export industries create. The Chinese Communist Party is an illegitimate regime that will remain in power only so long as it provides jobs and a rising standard of living for the Chinese people. Once the Chinese job machine stalls out, popular unrest could emerge on a scale much greater than the 1989 Tiananmen Square protests. This is an existential threat to Communist power, and will not be allowed to happen for that reason. Therefore, the subsidies will continue.

China cannot prop up the yuan indefinitely because it will run out of reserves and go broke in the process. In effect, Trump is trying to force China to adopt policies on trade and currency that it cannot pursue for political and financial reasons. And Trump’s leverage (the ‘art of the deal’), including North Korea, Taiwan and the South China Sea, involves matters of existential importance to the Chinese, where there is no room for compromise.

The result is likely to be confrontation rather than cooperation. This outcome involves costs for both sides. US consumers may pay more for Chinese goods. China’s factories may slow down as a result of higher costs. Some US manufacturing jobs may be gained, but job losses in other sectors (entertainment, technology, pharmaceuticals and aircraft) may offset those gains.

The greatest danger may be a maxi-devaluation of the Chinese yuan, which is discussed in more detail below. Once the Chinese realise they will not be rewarded by the US for trying to prop up their currency, they may just let it crash to reap the benefits of even cheaper export prices to offset the US tariffs. We’ve seen this movie before. It happened in the 1930s. It was called The Great Depression.

Internal political instability

China’s problems are not entirely external, and are not limited to the new Trump administration. China is now embroiled in an internal political struggle around the efforts of President Xi to make himself the most powerful Chinese leader since Mao Zedong.

In reaction to the excesses of the Mao era, including the disastrous Great Leap Forward, which caused famine in the 1950s, and the destructive Cultural Revolution of 1966–76, China developed a new model of collective leadership under Deng Xiaoping beginning in the 1980s.

Deng himself was never president; he held a series of lesser posts. However, he was the architect of the current presidential system, and was regarded as China’s ‘paramount leader’ from 1978 to 1987. Deng held what the Chinese call the ‘Mandate of Heaven’, a quasi-religious concept that has bestowed legitimacy on Chinese emperors for over 3,000 years.

The new model still had a single leader, but the leader was chosen by consensus among the Central Committee members of the Communist Party. Each leader was elected to a five-year term (in rigged elections), and was permitted to serve a second five-year term (some did, some did not).

Importantly, at the beginning of a leader’s second five-year term, he would designate one or two likely successors. Those designated successors would then jockey for position among the Central Committee members. Slowly, a consensus would emerge around one figure. That individual would then be selected as president at the end of the current president’s second term.

This system ran like clockwork through the presidential terms of Li Xiannian (1983–1988), Yang Shangkun (1988–1993), Jiang Zemin (1993–2003), Hu Jintao (2003–2013), and so far in the first term of Xi Jinping (2013–2018).

President Xi’s first five-year term expires in March 2018. He is certain to be elected to a second term, but he has so far deviated from the script by not designating any potential successors for a smooth transition in 2023. At a minimum, this will make Xi more powerful after 2018 because it will eliminate the lame-duck factor.

Some observers fear that Xi’s real ambition is to capture a third-term running until 2028. This would be similar to Vladimir Putin’s gymnastics in Russia, where he has used various means to hold power since 2000, and is expected to remain in power at least through 2020.

Xi has also pursued an ‘anti-corruption campaign’ that has conveniently resulted in the arrest of two of his most powerful rivals, Bo Xilai, the highly-ambitious former mayor of Chongqing, and Zhou Yongkang, the head of China’s internal security apparatus. This pattern also mimics Putin’s Russia, where corruption is tolerated as long as it is for personal enrichment, and does not transmute into political power. Those who aspire to power are brought down and arrested by the leadership.

The question of whether Xi will disrupt the two term system and seek a third term is open for now. Xi’s actions could provoke a backlash that will cause him to lose the Mandate of Heaven. At a minimum, the political uncertainty resulting from Xi’s moves makes policy responses to Trump’s provocations more difficult to predict.

Policymakers are likely to make political, rather than economic, calculations in their decision making. Economic policy optimisation will suffer as a result.

China also suffers from a host of internal contradictions to its global economic ambitions. Internet censorship, which I experienced first-hand during my recent visit, maintains Communist control in the short-run, but stifles the creative exchange of ideas crucial to technological advances. The internet was originally invented by the Pentagon not as a news or social media platform, but as a way for the best thinkers to exchange ideas quickly during our Cold War rivalry with Soviet scientists.

China’s one-child policy beginning in the early 1980s has led to two demographic disasters. The first is that growth in the working-age population is now flat, which is a headwind for economic expansion. The second is that a cultural preference for male children has led to sexselective abortion and female infanticide, creating a gender skew of 20 million men in their 20s and 30s with no prospect for marriage. Through adverse selection by women, the unmarried men are the least attractive and least skilled.

Many of these men are being forced into military service and sent overseas to supervise mines and industrial enterprises in Africa and South America. In any case, they are ripe for anti-social behaviours, representing a threat to social stability.

This mix of adverse demographics, technological bottlenecks, and political intrigue are all detriments to China’s economic development under the best of circumstances. With new challenges thrown at China by the Trump administration, internal instability may act as a force multiplier to external pressure, leading to a breakdown of the social order.

Geopolitical instability

The tensions with China around Trump’s policies on trade, tariffs, and currency manipulation are a sideshow compared to the much larger issue of Trump’s pivot to Russia.

From 1946 to 1989, geopolitics was fundamentally a matter of managing the Russia-US condominium of world power. China was potentially powerful — as recognised by President Nixon in 1972 — but was in fact weak, poor, isolated and chaotic. Russia and the US controlled the world. All other countries were allies, satellites, proxies, or irrelevant. Flashpoints erupted in Berlin, Cuba, Vietnam and Afghanistan, but American and Soviet troops never fired on each other. The risks of escalation to nuclear war and the end of civilization were too great.

Since 1989, a tripartite world order has emerged involving Russia, China and the US. The strategic goal in a three-party game is to align with one of the other parties to the detriment of the third. The US played this two against-one game well from 1989 to 2009, but has failed utterly since then.

The fall of the Berlin Wall in 1989 — coupled with the liberation of Eastern Europe, the 1991 collapse of the Soviet Union, Russian withdrawal from Afghanistan, and the emergence of a democracy in Russia — resulted in close US-Russia ties, to the point that US ‘experts’ designed much of the Russian legal and financial infrastructure.

China was the odd-man-out in the aftermath of the violent suppression of the Tiananmen Square demonstrations in 1989. I made my first journeys to Red China during this period, in 1992 and 1993. I met almost no Americans, and was under constant surveillance by internal security service ‘minders’ posing as mandatory guides.

It was during this odd-man-out stage that China executed its first maxi-devaluation, taking the USD/CNY cross-rate from 5.7 to 8.7 almost overnight in 1994. It was also during this period that China perfected the manufacturing juggernaut and transportation networks that led to its export success, massive reserve accumulation, and unprecedented economic growth.

The game changed dramatically in 2000 as the US pivoted away from Russia toward China. The election of Vladimir Putin in 2000 involved an assertion of Russian nationalism, including territorial claims in the Russian periphery of Georgia, Ukraine, Moldova and the Baltic Republics. Putin was reassembling the old Soviet Empire into a new Russian Empire.

Meanwhile, China’s manufacturing prowess and willingness to buy US Treasury paper made it the ideal trading partner for the US. The Bush administration deftly embraced China and made Russia the odd-man-out. US-Russian relations hit a low in August 2008 when Russia invaded Georgia, a US ally. Bush was too preoccupied with the global financial crisis and the war in Iraq to muster much of a response.

Beginning in 2009, the Obama administration failed to notice that Russia and China were playing their own version of the three-party game with the US as the odd-man-out. Russian Chinese cooperation expanded in initiatives such as the Shanghai Cooperation Organisation, the BRICS institutions, the New Silk Road initiative, and bilateral deals on currency swaps, oil and natural gas, pipeline infrastructure and arms sales.

Obama was lulled into complacency by Chinese purchases of Treasury debt even as China’s currency manipulation, trade subsidies, and damage to US manufacturing metastasized. By 2016, US relations with Russia were at a postCold War low, while relations with China were on a downward trajectory. Russia and China had never been closer since the mid-1950s. The US was the new loser in the three-party game.

With the rise of Donald Trump, the US is back in the game, this time with the promise of much closer relations with Russia and confrontation with China. Putin seems willing to pursue this round with his new best friend, Donald Trump. China is beginning to feel the chill of once again being the odd-man-out.

Russia and the US are the two largest energy producers in the world. With cooperation from Saudi Arabia, they can dictate the global price of energy. The appointment of Rex Tillerson, former CEO of ExxonMobil, as Trump’s Secretary of State puts the use of the energy weapon in deft hands. China will be pressured for cooperation on issues such as the South China Sea, North Korea’s nuclear program, and its Taiwan relations.

As is the case regarding concessions on trade and the currency, China is being asked to make concessions it cannot give. Beijing regards Taiwan as an integral part of China, a temporary ‘breakaway province’, not a separate political entity. China’s position on Taiwan is existential and non-negotiable.

China, likewise, has little room for concessions on its claim of near-complete control of the South China Sea. That arm of the Pacific Ocean is rich in fish, which China needs to feed its people. China is unwilling to share the catch with Vietnam and the Philippines. Numerous boardings, collisions and seizures have already taken place. A greater armed confrontation there is just a matter of time.

China could help with regard to North Korea’s nuclear program. China has many transportation, banking and food chokepoints it could use to stop North Korea’s bad behaviour. The problem is that China fears North Korea will retaliate by opening its border with China and allowing millions of desperate North Korean citizens to flood into China as destitute refugees. The result would be social and economic destabilisation in Manchuria, a part of China already suffering from its rust-belt status.

Given a revival of the Russian-US condominium of power on friendly terms, and China’s inability to deliver concessions demanded by Trump, the prospect for US-China geopolitical relations is poor. This will only worsen the already deteriorating economic relations between the two largest economies in the world.

China’s credit bubble

The confrontations between the US and China on trade, currencies and geopolitics will begin immediately at a rhetorical level, but may take a year or two to play out at a policy level. Supply chains, long-term contracts and reserve positions don’t turn on a dime even when new administrations are sworn in.

Yet one issue that will not wait, and which remains a ticking time bomb, is the Chinese credit bubble. That bubble is primed to explode with or without new policies from Trump. When it happens, and how it happens, will have profound implications for your portfolio.

The dimensions of the problem are vast. China’s growth has become captive to what economists call ‘Goodhart’s Law’. This law says that, when an economic metric becomes the goal of policy, it loses meaning as a metric. Goodhart’s Law applies in the case of Chinese GDP. Once the Chinese government decided to ‘target’ GDP growth of 8%, or 7%, or 6.5% more recently, GDP growth lost its meaning as a reliable guide to Chinese economic performance. Instead the Chinese hit the economic target by noneconomic means merely to say they hit the target.

This goes back to my train ride from Shanghai to Nanjing. If you have a 6.5% GDP growth target, it is easy to achieve that just by building infrastructure, which counts in the ‘investment’ category of a standard GDP definition. Billion dollar train stations and rail lines count as investment and, therefore, they count for GDP as well, whether the railroads ever make money or not. The same is true for highways, pipelines, and even entire cities.

On various visits to China, I’ve seen so-called ‘ghost cities’ stretching to the horizon, entirely empty of residents and businesses. Yet the construction costs are added to GDP, even though there are few, or no, paying tenants. (I’ve spoken with some business owners who do occupy offices in ghost cities, paying no rent; they just make the buildings look partially occupied to help the sales office attract others).

The problem is that the rail-transportation infrastructure I found so impressive — and most of the other infrastructure in China — was built with debt. The debt was financed by the mega Chinese banks on government orders. Since the buildings don’t have tenants and the train tickets are heavily subsidised, there’s no way that debt can be repaid. Instead, new loans are made to pay interest on the old debt, or the debt is refinanced or rolled-over in a never ending stream of zombie lending.

The banks finance their lending with customer deposits or sales of wealth management products — WMPs, something like the CDOs that brought down Lehman Brothers. WMP’s have been described by the former Chairman of the Bank of China as the greatest Ponzi scheme in history. Banks rely on sales of new WMPs to redeem the old ones at maturity. The projects financed by the original WMPs cannot repay.

How big is this mountain of debt? Total Chinese debt at all levels (household, corporate, bank and government) is now more than 250% of GDP, as shown in the chart below.

However, this 250% figure understates the problem. It does not include the WMPs which are technically investments kept off the balance sheets of books. It also does not include provincial obligations that take the form of guarantees that will have to be bailed out by Beijing. The real debt-to-GDP figure is easily 500%. It’s like owing $100,000 on a MasterCard when your salary as a waiter is $20,000 per year. That’s a sure recipe for bankruptcy.

Most of the debt is coming from the corporate sector. But these are not normal corporations as we understand them in the US. These are mostly SOEs, controlled by the government, and which may have to be bailed-out by the government when the system finally crumbles. Much of this debt is denominated in US dollars, so the situation is made even worse by the strong US dollar and the global US-dollar shortage, which make US dollar-denominated debt much harder to repay.

The debt system is propped up for now by more debt and dishonest accounting. If the banks were forced to write-down bad loans, the system would have collapsed a long time ago. One dysfunction that cannot be finessed is cash flow. As every entrepreneur and small business person knows, cash never lies. You either have it or you don’t. Because of excessive debt and inability to pay, cash-flow problems are now reaching epidemic proportions in China.   

Writing in the Epoch Times in late 2016, China observer Valentin Schmid reports:

‘If firms can’t borrow more or squeeze their suppliers, they will go bankrupt. According to research by Goldman Sachs surveying companies in China, four have defaulted on $3 billion worth of bonds since the middle of November. These defaults are a break with the record in the previous five months from June to October, when only three of the companies surveyed didn’t meet their payments. Given that China’s companies are drowning in debt, this squeeze on cash flow does not bode well for stability in 2017.’

Of course, China could try to grow its way out of the debt problem. This is like the waiter in the above example suddenly getting a $50,000 raise so he can manage the payments on his $100,000 MasterCard debt.

This is where the Trump administration seems set to throw a monkey-wrench in China’s already dubious growth plans. Trump’s plans for tariffs, taxes and a strong yuan will slow China’s growth at exactly the moment it needs to grow faster. Geopolitical analysts at Stratfor summarise the situation as follows:

‘Clearly there are no easy answers to China’s debt problem, which is looking grimmer by the day. The only painless escape would be on a wave of economic growth, but at this point that seems unlikely. Achieving growth rates of more than 10 percent is much more difficult for an economy that is already the second-largest in the world, and the global economic environment is not half as favourable to China as it was 15 years ago because the developed world is struggling to manage debt problems of its own. At home, Chinese wages are considerably higher than they were in 1991, and the economy is less competitive. Because China’s working-age population will soon begin shrinking, ending the productivity gains from the decades long “demographic dividend,” these wage hikes will make it harder for the country to achieve prodigious growth.’ 

China is faced with a mountain of unpayable debt, weaker growth, and a stronger dollar that will make the debt even harder to repay. China has only one feasible solution — to use its hard currency reserves to bail-out the entire banking and SOE sector, and to try starting over with a relatively clean balance sheet. The problem is that the reserves needed for a bailout are evaporating, and liquid reserves may hit zero by the end of 2017.

China’s losing battle with the ‘Impossible Trinity’

China is in a classic battle against what economist Robert Mundell called the ‘Impossible Trinity’. It’s impossible because governments always lose.

The impossible trinity arises when a government tries to pursue three policies at once — an open capital account, a fixed exchange rate, and an independent monetary policy. Right now, China is trying to keep a relatively open capital account to satisfy the IMF and foreign investors. It is trying to fix the exchange rate higher than the market rate to satisfy US critics, including Trump.

And it is trying to maintain an independent interest-rate policy so that it does not have to raise rates in lockstep with the Federal Reserve.

The problem is that, if China does not raise rates, reserves will flow out of China via the open capital account in search of higher dollar yields. This tends to weaken the currency. But China is propping up the currency by using even more reserves to buy yuan to fix the exchange rate. Adair Turner, former Chairman of the UK’s Financial Services Authority, writing in Project Syndicate, puts the matter succinctly:

‘If they [Chinese savers] shift their money abroad, the managed exchange rate will become unsustainable: even China’s $3 trillion of foreign-exchange reserves, down from close to $4 trillion in 2014, look small next to $30 trillion of financial assets. Every Chinese citizen is legally entitled to take $50,000 out of the country each year, and if just 1% of adults have the wealth to do so, that could mean annual capital outflows of $500 billion.’ 

Either through capital flight or exchange-rate management, reserves are disappearing. The situation is worse than even Turner describes. Of the US$3 trillion of remaining reserves, about US$1 trillion is illiquid because it was invested in hedge funds, private equity funds and direct investments, such as gold mines in Africa. That’s a form of wealth, but it’s not liquid wealth. Another US$1 trillion must be kept as a precautionary reserve to bail out the banks and SOEs, as discussed in the previous section. That leaves only $1 trillion US liquid reserves to defend the currency.

Actual capital outflows are not the US$500 billion per year Turner estimates. They’re closer to $1 trillion per year. At this rate, China will effectively be broke by the end of 2017. Then the mountain of debt turns into an avalanche, triggering a global financial crisis.


China’s growth over the past 30 years has been spectacular, and the results are clearly visible in its new infrastructure, trade surpluses, and its huge reserve position. But the growth was built on sand.

Most of the real wealth China accumulated has been squandered on wasted investment and military show. That waste was debt-financed… and the debt cannot be repaid. The rise of Trump means the end of China’s growth path, which might have barely kept the game going, and made the debt sustainable for a few more years.

China is being squeezed by the strong dollar, internal social stress, and an emerging US Russian détente. The centre will not hold. A global financial catastrophe of unprecedented proportions is about to unfold.

The only safe havens are cash and gold. There will be some short-term trading opportunities involving short positions in the Chinese currency and stocks.

Jim Rickards





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