Wednesday, 9 March 2022 — Albert Park

By Callum Newman Editor, The Daily Reckoning Australia

[7 min read]

• From bubbles to safe havens
• A global bank contagion
• What about the bailout?

Dear Reader,

In his last edition for The Daily Reckoning Australia, Jim Rickards told you how you can figure out the difference between false narratives and reality. He thought that inflation was one of these false narratives.

But if inflation is a false narrative, then what is the reality of the problems investors face today?

Jim says that asset bubbles are one of these realities that is definitely a problem. And nowhere is this clearer than China. Today’s edition is vital in helping you understand what’s happening in China and what it means for you as an investor.

Best wishes,

Callum Newman,
Editor, The Daily Reckoning Australia

By Jim Rickards Editor, The Daily Reckoning Australia

Dear Reader,

While inflation may not be much of a problem, asset bubbles (especially in stocks) definitely are. A collapse in inflated stock prices may now be underway, partly due to global liquidity concerns surrounding the impending insolvency of Evergrande in China and a shortage of high-quality collateral in the Eurodollar markets.

Stocks have reached new highs in many markets, especially in the US. However, these high levels are based on exaggerated expectations of future growth. In fact, the economy of the US is slowing rapidly, and the slowdown is even more clear in China.

Europe was already struggling, and Australia will experience slower growth because of what’s happening in China. Stocks are overpriced based on many measures including the ratio of stock prices to GDP, multiples of earnings, the Shiller CAPE ratio, and low dividend yields. This combination of overvalued stocks and a slowing economy will result in a serious correction in stock prices in the months ahead.

Residential real estate should remain strong because people are moving out of cities to avoid the crime, density, and exposure to COVID. However, residential real estate will suffer in China because of the partial liquidation of Evergrande, the largest property developer and lender in China, as explained below.

A global bank contagion

We’ve long advised readers that the Chinese wealth management product (WMP) system is the greatest Ponzi in the history of the world. WMPs are sold by banks to retail investors. They are technically pass-through notes structured as units in a pool. In US terms, they are something like a hybrid between commercial paper and ETFs.

The problem is that retail investors are led to believe that WMPs are like bank deposits and are backed by the bank that sells them. They’re not. They’re actually unsecured units in blind pools that can be invested in anything the pool manager wants.

Most WMP funds have been invested in the real estate sector. This has led to asset bubbles in real estate (at best) and wasted developments that cannot cover their costs (at worst). When investors wanted their money back, the sponsor would simply sell more WMPs and use the money to pay back the redeeming investors. That’s what gave the product its Ponzi characteristic.

The total amount invested in WMPs is now in the trillions of dollars used to finance thousands of projects sponsored by hundreds of major developers. Chinese investors are all in with WMPs.

Now, the entire edifice is collapsing as we predicted it would. The largest property developer in China, Evergrande, is quickly headed for bankruptcy. That’s a multibillion-dollar fiasco on its own. Evergrande losses will arise in WMPs, corporate debt, unpaid contractor bills, equity markets, and unfinished housing projects.

What about the bailout?

The Wall Street Journal reported on China’s plans for dealing with Evergrande on 23 September as follows:

‘Chinese authorities are asking local governments to prepare for the potential downfall of China Evergrande Group, according to officials familiar with the discussions, signaling a reluctance to bail out the debt-saddled property developer while bracing for any economic and social fallout from the company’s travails.

‘The officials characterized the actions being ordered as “getting ready for the possible storm,” saying that local-level government agencies and state-owned enterprises have been instructed to step in to handle the aftermath only at the last minute should Evergrande fail to manage its affairs in an orderly fashion…

‘Local governments have been ordered to assemble groups of accountants and legal experts to examine the finances around Evergrande’s operations in their respective regions, talk to local state-owned and private property developers to prepare to take over local real-estate projects and set up law-enforcement teams to monitor public anger and so-called “mass incidents,” a euphemism for protests, according to the people.’

This is the worst possible playbook for managing a financial crisis. The response to a financial crisis has to be centralised so that decisions about how to deploy limited resources can be made rapidly. Some lenders must be saved; some should be allowed to fail.

Retail investors in WMPs should get some kind of relief if only to avoid social unrest. Equity holders should be wiped out. Foreign investors in dollar-denominated debt of Evergrande will be left to fend for themselves and possibly seek relief in their home countries. The point is these types of decisions cannot be made by ‘local-level government agencies’, as proposed by the Chinese.

The government plan is not a serious effort to truncate a financial crisis. It seems designed more to suppress social unrest and perhaps arrest ‘troublemakers’. Western analysts don’t understand this dynamic because they view events through the lens of Wall Street and Washington norms.

The Communist Party of China doesn’t care if Chinese oligarchs or investors in BlackRock ETFs lose money. That suits them fine. They’re communists. This unprecedented combination of a financial crisis and communist indifference could result in full-blown contagion that will not be confined to China and could emerge as a crisis in the US and Europe within a few months.

Evergrande WMP investors are now staging protests at banks after learning that their WMPs will not pay out for two years. Of course, Evergrande will be bankrupt long before that and the investors will get nothing in the end. Chinese regulators believe they have the resources to bailout or restructure Evergrande with some haircuts for creditors.

They probably do, but that misses the point. The damage will not be confined to Evergrande. It will spread quickly to counterparties of Evergrande including other developers and banks. A run on all WMPs will begin.

When a Ponzi starts collapsing, no one wants to be the last one out. Everyone wants his or her money back right away. Chinese regulators are so desperate that they are trying to pay off WMP holders in kind with deeds to real estate that no one wants.

This is another fiasco in the making because investors will dump that unwanted real estate, which will collapse the property market in turn. The Chinese are only looking at what’s inside the four walls of Evergrande and are ignoring the fact that their entire property and financial system is on the verge of a world historic crack-up. We’ve predicted this all along. If you still own Chinese stocks, it’s not too late to get out of those positions. It will be soon.

All the best,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

By Bill Bonner Editor, The Daily Reckoning Australia

Dear Reader,

When an empire passes its prime, it still steps up to the plate like a star slugger…but history serves up sucker pitches. Thrice this century, the American deciders have swung so hard they ended up on the ground.

Now, they take another swing.

The madness grew over the weekend. CNN reported that ‘The Russian Tea Room in New York City suffers as Ukraine invasion escalates’.

And here’s Business Insider:

‘A growing number of American veterans are preparing to join Ukrainians in their battle against Russian military forces, The New York Times reported.

‘Ukrainian President Volodymyr Zelensky has in recent days called for an “international legion” of volunteers, and many civilians from other countries, such as the United Kingdom, have heeded his call.

‘James, a medic who fought in Iraq and Afghanistan, told The Times that he couldn’t “stand by” and watch Russia’s assault on Ukraine.’

Apparently, James couldn’t just stand by and watch the assault on Iraq either — he joined the attack. But here at the Letter, we always favour the underdog, the lost cause, and the diehard. So we wish him well. He may need it.   

But when madness spreads, there is no use asking questions or making ironic comments. The worst are hot…full of indignation and righteousness. (James thinks he knows which side God is on.) The best keep their mouths shut.  

It might be a year…or maybe 10 years…before the question marks come out again. Then, we will ask: ‘What was that all about?’  

But for the moment, an ill wind blows, and the trash takes to the air. Business Insider again:

‘A restaurant in France seeks to clear its name after fielding confusion surrounding poutine, its signature dish — fries doused with cheese curds and gravy — and Russian President Vladimir Putin, the leader who announced an invasion into Ukraine just over a week ago.

‘La Maison de la Poutine, or The House of Poutine, tweeted on Friday that it received “calls of insults and even threats” over its namesake dish.’

Recall the ‘weapons of mass destruction’ scam of 2003. Americans girded their loins for battle. Contrary opinions — including ours — were unwelcome.  

France refused to join the war. So Americans dumped Bordeaux wine down the drain and ordered ‘freedom fries’ with dinner…one of our readers even suggested that the US Air Force — already conducting long-distance bombing raids — might want to drop a bomb on Paris, too. (We were living in Paris at the time, but we didn’t take it personally.)

It turned out; the French were right.

We believe the US empire hit its peak around 1999. Since then, it’s been one strikeout after another. US$8 trillion were lost fighting ‘terrorists’…then, after the Mortgage Finance Crisis, another US$10 trillion (measured by US debt increases) was spent making the rich richer than ever…followed by trillions more in stimmie cheques, non-repayable ‘loans’ and other jackass programs in the wake of the COVID virus.

Altogether, US government debt went from barely US$5 trillion in 1999 to US$30 trillion today. And the Fed’s negative interest rates encouraged borrowing in the rest of the society too — bringing the grand total of debt, public and private, added since 1999, to US$66 trillion.

But lo…now, a new panic. A new distraction. A new war. Another sucker pitch. The media stirs up the masses. The crowds in the cheap seats roar their approval. Diners switch back to French dressing from Russian dressing. And here we aim to do our part, too. We propose to change the name of the old familiar suicide sport to ‘Freedom Roulette’.

Meanwhile, the Pentagon is sending fighter jets. The Biden team is sending money. Yes, we’re ready to fight to the last drop of the Ukrainians’ blood!

The feds are also fighting with sanctions — aiming to hit the Russian public where it hurts, but most likely hitting our own feet. The sanctions did not aim specifically at Russian energy companies. But in the fog of war, supply lines come undone, and missions creep. A headline this morning tells us that the feds also want to cut off Russian oil sales to the US. And India Punchline adds this:

‘On the whole, the situation in the energy market is becoming very complicated, as western oil companies which had invested in Russia are forced to quit due to the sanctions. These include big players such as BP which has a 20-percent stake in Russian giant Rosneft, Shell with 27.5 percent stake in the Sakhalin-II LNG facility and a 50 percent stake in the Salym Petroleum Development, ExxonMobil (Sakhalin-1) and so on.

‘Apart from the impairment these companies will suffer running into tens of billions of dollars, their exit will also strain Russia’s ability to maintain such high production levels and continue to meet its commitments under the OPEC+ agreement. Now, the already-tight global market for crude — which saw Brent crude top $115 per barrel in early Thursday trading — can ill-afford these downstream hits from the sanctions against Russia. Evidently, crude prices still have nowhere to go but up from here. Expert opinion is that if oil price touches $125 per barrel, the US economy slides into recession.’

The most long-lasting damage to the US will probably come from the holes it shoots in its own money. The dollar is now the Facebook and Instagram of international commerce. It is what everyone uses. But people don’t like being de-platformed from their money any better than they like being cancelled or censured by their favourite social media. They look for alternatives.

Most likely, the Russians will find workarounds. Then, the workarounds will compete with the US-dominated financial system and eventually maybe even replace it. And then, with even fewer people eager to finance the US’s excess spending, interest rates will go higher…the Fed will print more money, and prices will rise even further.

Chaos will spread.

Regards,

Bill Bonner,
For The Daily Reckoning Australia