The Countdown Clock on a China Shock Keeps Ticking Louder
We’ve written numerous times about the likelihood of a Chinese credit crisis, and the risks of contagion from such a crisis in China and the global economy.
Despite long-standing concerns, this issue simply won’t go away.
China has repeatedly turned to more debt, lower interest rates, currency devaluation and other cheap tricks of economic stimulation (really pulling demand forward without solving problems) to boost its economic output one more time.
The problem is that such tricks are subject to what economists and statisticians call ‘diminishing marginal returns’.
This means that stimulus can have some temporary benefits when first used or if used in a recession. But over time, the stimulus effect grows smaller and smaller.
Eventually, the gimmicks result in ‘negative marginal returns’ where the debt trick not only does not provide stimulus but reduces growth.
What you are left with is no stimulus and more debt, followed by a debt death spiral, which leads to default, confiscation or hyperinflation.
Now China seems to be at the end of this road.
Is a global Great Depression next?
From the 1980s until a few years ago, the Chinese economy grew at an annual rate of over 10%. Now annual growth is 6.4% and promises to drop even lower.
Even those figures are overstated because China ignores wasted investment included in the government figures.
Some analysts put actual Chinese annual growth in the 3% range.
When the crisis emerges and China suddenly has to correct its economy, a currency devaluation of 30% or more and massive write-downs are the best outcome.
The worst outcome is something more closely resembling the Great Depression on a global basis.
It’s almost too late for China to correct this path because of the inflexibility of political and civic institutions, and intolerance for dissent.
It may be too late for the Chinese to change the outcome, but it’s not too late for individual investors to pivot away from exposure to China.
Gold gives off clues on the markets health
Gold has had a nice run lately, trading around US$1,325 per ounce as of this writing, after briefly trading up to the US$1,340 per ounce level last week.
This has been an impressive rally off a base of US$1,185 per ounce as recently as last fall.
I am frequently asked where gold prices are going next and for my analysis of the price of gold.
My answer is that investors should spend less time forecasting the price of gold and more time discerning what the price of gold is forecasting for other markets.
Many factors go into the price of gold (real rates, dollar strength, safe haven investing, central bank purchases, etc).
But the gold price itself is a powerful leading indicator about other markets.
Gold’s recent rise says that central banks will keep interest rates on hold or even lower them later this year.
It says that inflation is not on the horizon, stocks will move sideways and economic growth will slow down.
In that kind of sluggish, low-rate environment, the opportunity cost of owning gold goes down and therefore the price of gold goes up.
The price of gold can be considered to be in a ‘bear rally’ (due to low growth) rather than a ‘bull rally’ (due to inflation), but a rally is a rally.
As an investor, you should not worry so much about the price of gold.
You might worry more about what the price of gold is telling you about other markets and the economy ahead.
All the best,