3 Minute Gold News
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A 3 minute synopsis of the interview with Jim Rickards, author of Currency Wars: The Making of the Next Global Crisis and the forthcoming book The Death of Money: The Coming Collapse of the International Monetary System, and portfolio manager of the West Shore Funds, by Amanda Lang from CBC News – Lang & O’Leary Exchange
Worry About China
Wealth Management Products
Smooth or Rapid Decline
WORRY ABOUT CHINA
We are right to be worried about China for a couple of reasons.
1. Independent of any structural problems, and there are a lot of them in China, Chinese growth is bound of slow down.
This is something that Paul Krugman, Princeton economics professor, pointed out in 1994.
When you’re starting from a very low base you can grow very rapidly with factor inputs – labour input, moving from the country to the city, bringing in foreign capital, bringing in new machinery.
If you apply all of that you are going to get enormous growth.
But eventually you run out of those factor inputs.
Other people have cheaper labour so employment is a little bit tight in China now, there’s not as much migration from city to country, a second machine doesn’t increase productivity when you already have one – all of those things slow down. That’s natural.
2. China has mismanaged its economy.
China has a lot of structural problems that could cause a much more rapid collapse in their growth.
Number one is their reliance on investment, and not just investment but wasted investment – mostly in infrastructure.
Investment is a very good way to grow an economy assuming the money is put to good use.
It’s even okay to borrow if you are investing in things that are more productive, and have a higher return than the cost of borrowing.
The problem is that’s not what China is doing.
They probably did it until around 2002. Then they went off the rails.
We’ve all heard the expression ‘Ghost Cities‘.
Jim’s been to China and visited ghost cities and future ghost cities that are under construction. There’s miles as far as the eye can see. They’re building not just multiple buildings but multiple cities – each with multiple skyscrapers, hotels, recreation centers and apartment buildings.
From what Jim saw, the cities were all empty and they were building new ones as fast as they could.
That does create jobs and GDP in the short run. But the problem is that the money is completely wasted. You can’t occupy it. You can’t use it. It becomes obsolete and you’ve wasted it.
So, you really have to take Chinese GDP today, and if you adjusted it for the write off of what is wasted, it wouldn’t have even been as high as it has been.
That adjustment is coming.
Look for a rapid decline in Chinese growth.
WEALTH MANAGEMENT PRODUCTS
The investment in infrastructure is a mixture of State capital, bank capital (except to the extent that banks are government controlled so an extension of State capital), and a lot of private capital.
Wealth management products are very popular in China.
A Chinese saver gets almost no interest by putting their money in a bank – just like the United States.
People want higher yields so the banks offer WMP with 5, 6, 7% yields, and people flock to them.
Here are the problems:
1. The investors think they are bank guaranteed products. They’re not.
The money is taken and invested in these projects where it’s wasted on infrastructure investment. They basically can’t pay off the debt over time.
2. So, it’s a Ponzi Scheme.
You get new investment and use it to pay off the old ones and extend the pie. That’s exactly how a Ponzi operates.
The Chairman of the Bank of China said it’s a Ponzi publicly so there’s no mystery there.
How long can it go on?
Until something happens – a failure, a fraud, maybe a banker commits suicide.
Some kind of catalytic event will cause a panic, and everyone is going to run down and try to cash them in, think they’re bank deposits, find out they’re not, and they’ll have to shut down the banks.
Jim’s not saying it’s the end of China – but he’s saying you’ll have a major financial collapse.
The government will have to come in and bail it out.
The government has the money. China has $4 trillion in reserves and what Jim is talking about may be a $1 trillion problem.
So they’ve set themselves up through wasted infrastructure investment, opaque financial products, and Ponzi financing.
They’ve set themselves up for a collapse.
SMOOTH OR RAPID DECLINE
The best case scenario is where there’s a smooth transition – where investment is dialed down, some write-offs are taken, consumption is dialed up, and China re-balances its economy from investment to consumption.
That is possible.
But even that, just the math, it would take growth down to maybe 4 – 4 1/2% per year.
This is because when investment is so big and you dial it down then you have to bring up consumption, and you are going to reduce your growth rate significantly.
So that’s the best case – that China goes down to 4 – 4 1/2%.
The worst case is that you have a much more rapid collapse – where it goes down temporarily to close to 2%.
It’ll come back.
Jim isn’t saying that China is going to collapse or fall off the face of the earth.
But the world is not ready for this.
China is 10% of Global GDP. If you take China’s growth rate down from 7% to even 4 or 4 1/2%, let alone 2% which is possible, that’s going to have a major impact on the entire world.
So, that’s what we’re facing.
Whether it’s a smooth transition or a messy one it’s going to be a very painful one for the world.
Another Week on Wall Street
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