Common prosperity, uncommon brutality

Monday, 27 September 2021 — Laramie, Wyoming

[8 min read]

Well, thank goodness we dodged that financial crisis. The worry last week was that the looming financial collapse of leveraged Chinese property developer Evergrande would be China’s ‘Lehman moment’. And like the collapse of Lehman Brothers in 2008, it would usher in a disorderly and chaotic deleveraging in world financial markets.

For now, it looks like the communists who run China’s financial system are going to stiff foreign creditors and try to reschedule or restructure Evergrande’s domestic obligations to creditors, investors, and savers. You can do that in a financial system with a closed capital account. That simply means that even if it wanted to, panicked money couldn’t cross the border or find safe harbour.

Of course, there’s no such thing as panicked money. Money doesn’t have a mind of its own. Investors (usually, but not always) DO have a mind of their own. I say usually, but not always, because in markets driven by liquidity and momentum, it doesn’t pay to think TOO hard. You buy, hold, hope, and then buy again on a dip if you can.

That may be what’s happening this week around the world. Unless you’re exposed in a meaningful way to Evergrande’s dollar-denominated bonds, the impact of the story will be indirect. That’s what I told publisher James Woodburn last week in a recorded conversation (available to some, but not all, subscribers). What did I mean?

Real estate is a big driver of Chinese GDP AND demand for Australian commodities. Local and regional Chinese government authorities make money selling real estate to developers. Developers make money leveraging up and selling apartments, houses, and structured financial products (often promising higher yields) to savers and investors.

It’s a lot of activity for activity’s sake. Whether anyone gets rich (or poor) from it is another matter. The relevant point for Aussie investors is what a slowdown in Chinese GDP growth might mean for commodity prices and commodity demand. The prices have already reacted (iron ore especially). But long-term final demand for resources?

That depends on what happens next in China. What I suggested to Woody is that China actually began a process of cracking down on capitalism, capitalists, and leverage last year. Remember Jack Ma? Chairman of Alibaba — China’s version of Amazon and at one point a trillion-dollar company?

Around this time last year, Ma was getting ready to take a new financial services company (Ant) public. He gave a speech in which he criticised the Chinese banking system and Chinese financial regulators. Not long after, Ant’s initial public offering was cancelled and Ma disappeared. Where is he now?

Good question. No one’s really seen him. A few reports here and there have reported him playing gold, educating himself on the importance of ‘common prosperity’, and otherwise tending to his reduced empire. But the simple explanation is that Ma is under the thumb (or iron fist) of the Chinese Communist Party and its head, Xi Jinping.

That phrase ‘common prosperity’ is one the CCP has used to criticise China’s superstar CEOs like Ma. In a collectivist political economy, you can’t celebrate or venerate individual success or brilliance. And though Deng Xiaoping once said that ‘to get rich is glorious’, he didn’t mean TOO rich.

Ma got too rich. And too big for his britches. So the party took him down a peg or four. And then they systematically reduced the amount of leverage available for property developers. This, too, was with an eye toward the ‘common prosperity’. Booming Chinese house prices threaten to make them unaffordable for millions. If there’s inequality in a one-party state, it’s the party’s fault.

To keep the public on side and the billionaires and speculators in check, the communists have been on the counterattack. Evergrande’s forced deleveraging is one aspect of that. China’s latest attempt to ban Bitcoin [BTC] (late last week) is another aspect. In a command economy, the state gets to decide how rich is too rich and what money is REAL money.

Mind you, China’s communists aren’t the only people concerned with (and cracking down on) private money and cryptocurrencies. In the latest Bonner-Denning Letter, I’ve written about the demonisation of cryptocurrencies and stablecoins by central bankers, regulators, and government officials. It’s almost like it’s a concerted attack to stop Satoshi Nakamoto’s monetary rebellion dead in its tracks.

Nakamoto released bitcoin into the world in response to the last financial crisis. He started a monetary war in which decentralised money — secured by cryptography — posed a theoretical threat to the State’s control over money. That control is the source of political and military and social power to many states.

Well, the State is fighting back. Just after my newsletter went to press, President Joe Biden nominated a central-planning communist to head the US Office of Comptroller of the Currency. It sounds like a bureaucratic and boring job. But the job is to define and defend the State’s right to say what money is.

Biden’s nominee, Saule Omarova, wants to ‘end banking as we know it’. In academic papers, she’s argued for replacing retail banks with accounts held by the public at the central banks. Those deposits could then be directed by a new national investment authority to invest in projects designed to produce more equity in society and fight climate change (and enhance the ‘common prosperity’).

Omarova will find lots of people who agree with her on the problems with current financial architecture, especially the slowness and cost of the payment and settlement system. But to radically remake that system so that the State is not only the sole creator of money (central bank digital currency) but ALSO the chief allocator of capital in the economy?

That’s straight up central planning-style communism from the heady days of the Soviet Union. We already know what it does. It creates a two-tiered society. The planners and ‘deciders’ get fat jobs with the government or government-controlled enterprises. The vast majority of the population gets poorer and is slowly starved into submission, when they’re not actually jailed (or killed) into submission for having the ‘wrong’ views about freedom, the Rule of Law, sound money, and private property.

Who will win the battle over money? Good question! Here’s an encouraging thought…the real revolutionaries are always at the margins of polite (and civil) society. They are small in number but loud in voice. And when they control the media, government, and the entertainment industry, they SEEM louder and more prevalent than they really are.

And this time around, they are one step behind the technology. Private money, decentralised finance, and technology that secures and promotes privacy are working against them. What do they have? Bullhorns, legislatures, and batons. Will it be enough?

Until next week,

Dan Denning,
Editor, The Rum Rebellion

PS: I generally never trust the mainstream media to give me an accurate picture of what’s going on — anywhere at any time. That’s the case now when watching Australia — especially Melbourne — from afar. The mainstream media portray the Victorian Police as cracking down on far-right, anti-vaxxer ‘nutjobs’ who have the audacity to desecrate the Shrine of Remembrance by protesting there.

But it’s even worse on social media — where the algorithms suppress independent media voices. Even worse, social media is filled with the worst kind of armchair keyboard warriors cheering on police violence against the public in the name of health and safety. You begin to realise why Germans in the 1930s cheered on measures designed for your own ‘safety’ — even if it meant cracking skulls.

The pictures coming out of Melbourne of riot police firing rubber bullets at people on the streets, body slamming people to the ground, or violently restraining and arresting people for not wearing masks are shameful. They’re an indictment of public officials and health authorities caught in the grip of a psychosis about eradicating a virus that the rest of the of world has managed without turning themselves into a police state.

Anyone cheering on those images of uncommon brutality needs to have a good hard look in the mirror and ask themselves what kind of country they want to live in. One where the state has the power to declare an indefinite emergency and then enforce house arrest on millions of people with riot police and violence? Or one where the people are sovereign and ruled by laws, not by a handful of unelected and unaccountable public officials.

‘He who takes what isn’t his’n
‘Pays it back or goes to prison’

19th century American businessman Daniel Drew

What we were looking for in the Evergrande story was a hint…a clue…an advance warning of things to come.

What happens when you can’t pay your debts? How does it end?

With a bang of inflation? Or a whimper of deflation?

Our prediction: Both.

Every bubble blows up. Every excess has to be resolved. And every debt gets settled — one way or another.

Typically, a bubble brings on a case of ‘irrational exuberance’.

The irrationally exuberant investor pays too much for his assets. The irrationally exuberant businessman stretches too far…borrows too much…and overextends himself. The irrationally exuberant empire invades Afghanistan.

But no one and nothing is ever evergrande, of course. It is only occasionally grand.

And when the occasion passes…so does the grandeur.

Too much excess

‘And then what?’ is our question today.

We have the answer too: the end of the world as we have known it.

An excess of private investment usually produces an excess of capacity…and excess output. Too much, in other words.

Then, when the bubble epoch passes…the excess is usually reckoned with in a DEFLATION. Prices fall…until demand picks up enough to clear the market.

The investors and producers, who misjudged the situation, and their suppliers and employees, suffer the losses.

That’s what happened in the US after the crash of 1929.

Private industry had expanded in the Roaring Twenties…by the 1930s, it produced far more autos and electrical appliances than the market could absorb.

Prices — for stocks, as well as consumer items — collapsed. The price of milk, for example, fell so low that dairy farmers dumped it on the ground rather than sell it.

Stock prices dropped for nearly three years, from 377 Dow points in October, 1929, to only 44 in July of 1932.

Then it took 25 more years, a Great Depression, and a Second World War for prices to recover.

Asian bust

A similar thing happened more recently, when the Japan Inc miracle economy blew up in 1989.

The Japanese, too, had invested heavily to meet the demands of world consumers. Japan was the world’s big success story of the 1970s and 1980s. And by the end of the 1980s, it was on top of the world…with nowhere to go but down.

Which is where it went…

Stocks fell 80%. 32 years later, they have still not recovered.

Most likely, the coming bust in China will take the same path.

It is an economy that grew by investing huge amounts in capital improvements — factories, infrastructure, malls, and housing.

Now, it must mark its excess capacity to market…which will mean much lower prices for just about everything.

Deflation, in other words.

But not the end of the world.

What goes up…

But the US is different.

It is not an economy on the way up — like the US in 1929, Japan in 1989, or China today.

It is an economy on the way down.

And for the last 20 years, it has lived in a bubble world…like an aging action hero, who can no longer do his own stunts.

Instead of investing money in new businesses, new technology, and new infrastructure, it squandered trillions of dollars on vanity projects, stock buybacks, executive compensation, and ghastly government boondoggles, including a 20-year, dead-end war in Afghanistan.

Yes, the business cycle naturally expands and contracts. It breathes in and breathes out. Sometimes inflating. Sometimes deflating.

Naturally and normally, after a period of price inflation comes a period of price deflation. That is to say, the bubble seeks its pin…and always finds it.

But what is especially inflated in the US?

Asset prices. Those are the things the Federal Reserve has been inflating. And those are the things — stocks and bonds — you can expect to deflate in the coming crisis.

(Housing is a special situation. Houses are not overabundant, but artificially-low interest rates have made them very expensive.)

…Must come down

But taking asset prices down a peg is not the end of the world either. What is the end of the world is when the feds block the markets from correcting…when they insist that assets can’t go down…and when they rig the whole economy to protect their own wealth and privileges.

So let’s walk through what is likely to happen.

First comes the obvious and inevitable market crash. For the fourth time this century, the stock market — extremely overpriced — tries to correct.

Left alone, this would clear up the many grotesqueries now blemishing the markets and the economy. Stocks would get cut in half, at least. Many companies would go out of business. The rich wouldn’t be so rich.

And then, the survivors would pick up the pieces and build a healthier economy on the ruins.

Fed’s disastrous rescue

But that is not going to happen.

Because the feds will come to the rescue. They will give the economy another dose of that magic elixir — fake money. And that money will not only be used to prop up the stock market, but also to finance sweeping new squander projects of the government.

And this time, the cat will be out of the bag; everyone will see consumer price inflation getting worse. And it will be obvious that the Fed cannot stop it.

The bond market — the foundation of the whole capital structure — will heave and crack.

And the end of the world as we have known it will come front and centre.

Stay tuned.

Regards,

Bill Bonner,
For The Rum Rebellion