Dancing on Tables with Lampshades on Their Heads …

by Bill Bonner

Dancing on Tables with Lampshades on Their Heads …

The Dow rose 100 points on Tuesday. Gold was up one lousy dollar. We’ll take the gold, thank you very much. Because our guess is that this stock market is living not only on borrowed money but also on borrowed time.

With the addition of Chinese Web portal Alibaba, there are now 44 start-ups preparing to enter the public markets. Each of these has a valuation of more than $1 billion.

The last time there was this kind of action in the IPO market was 2000, just before the dot-com bubble blew up. And the last time stocks were this expensive was 2007, when the sub-prime/finance bubble blew up.

That was also the last time share buybacks by US corporations passed the $600 billion mark, which they will do again this year. Yes, dear reader, the party has gotten out of hand – thanks to all the free booze supplied by Ben Bernanke and Janet Yellen. It’s time to look for the car keys.

Share buybacks per quarter, via Capital IQ and Zero Hedge. If you didn’t know whether stocks are expensive or not, you only would have to look at this chart…when buybacks approach the zero line, stocks are cheap and it would actually make sense to buy them back. It sure makes no sense now. This is another example of how the monetary bureaucrats distort markets and perceptions with their policies. Those who think this is not going to end badly are deluding themselves (chart comment by PT) – click to enlarge.

Party On!

This is not to say that it won’t go on longer. And it is not to say that it won’t get wilder, too. There are already people with lampshades on their heads. And girls are dancing on the tables.

But at least no one has called the cops… yet. You don’t want to be there when they do. What might make stocks go up further?

Well, the Fed might decide to hold off on more QE cuts, for example. The economy is not recovering and the Fed knows it. A shock or two in the stock market or bad employment numbers would probably convince Yellen & Co. to stop their “tapering” of QE… at least for now.

Or, like the European Central Bank, the Fed could announce a new scheme of unspecified interventions. Instead of the higher interest rates everybody expects, US interest rates could go lower… and it would be “party on” again, with higher stock prices to boot.

Thanks to the ECB, Italy is now able to borrow at 13 basis points lower than the US. Lenders are giving money to France at a yield 114 basis points lower. Are France and Italy more creditworthy than the US?

Well, that’s just the thing: When it’s party time, people stop doing the math. The eye-shades, pencils and calculators are put away. As long as the music plays, speculators will dance. The IPOs don’t have any earnings? So what? Italy can’t pay back its debt? Who cares? Call us an old fuddy-duddy. We’ll sit this one out.

France, 10 year OAT yield (which stands for obligations assimilables du trésor in case you were wondering…)– 1.43% at present. That makes just as much sense as record share buybacks – click to enlarge.

“Buffett-itis”

We have been talking about investment theory… and practice. Long-term readers will find this unusual. We’ve been writing about money for the last 15 years. Never before have we shown much interest in investing it. What happened?

Friend and colleague Porter Stansberry (the founder of Stansberry & Associates) persuaded us to write a paid monthly investment letter. All of a sudden, we had to think not about economics and politics but about investing! And then, when we got into the subject matter we found ourselves coming dangerously close to the one thing we can’t tolerate: positive thinking.

In economics – at least at a public policy level – positive thinking is a trap. Every intervention is a mistake. Small ones are nuisances. Big ones are disasters. Earnest economists – who believe they can improve the world with laws and policies – are a constant threat to human happiness and progress.

But what about investing? Does positive thinking pay off? You, dear reader, having watched this infection develop… first as a minor scrape on our cynical Efficient Market Hypothesis… and then as a serious case of “Buffett-itis.”

That’s right, we were beginning to think the man from Omaha was right all along: The EMH is seriously flawed. Serious investors who are willing to do the hard work can beat the market. It seems obvious…

The “market” – especially when prices are high and the music is loud – is made up of people who are not serious and who are not willing to do the hard work. If you can put on your positive thinking cap and do a better job of figuring out how much a stock is really worth, you’ll probably do better than the average investor. And if you don’t want to do the hard work yourself, find someone who does…

The unexpected perils of positive thinking….

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The FOMC Decision and Financial Markets

by Pater Tenebrarum

No Surprises in Carbon Copy Statement

If anything, the FOMC statement was probably interpreted by Kremlinologists as less hawkish than expected (although the Fed already leaked that fact via the WSJ’s John Hilsenrath on Tuesday, spurring yet another surge in risk assets). The reduction in QE by a further $10 bn. to a mere $15 bn. per month was widely expected, but the feared “change in language” was conspicuous by its absence – in short, there were no hints as to a change in the envisaged time table for eventual rate hikes.

This provoked two hawkish dissents (actually, to call them “hawkish” is a bit of an exaggeration), by regional presidents Richard Fisher & Charles Plosser, i.e., the usual suspects who were never really on board with the Fed’s unconventional policies anyway. Their beef was precisely with the unchanged guidance on the timing of rate hikes. Readers can compare the changes relative to the July statement with the help of the WSJ’s trusty statement tracker.

Interestingly, a number of markets reacted as though the guidance had been changed – gold was down $12, the dollar index jumped to a new high for the move, treasuries weakened. The stock market is usually the last market to get the memo, and at first rallied with some verve, but gave back much of its gain as the initial euphoria faded – however, it still managed to close in positive territory (after all, nothing bad can possibly happen).

The Most Important Datum for Asset Prices

The most important datum for the asset bubble is the pace of money supply growth – everything else is secondary. As always, we caution that there exists no fixed level at which it can be regarded as insufficient to keep all the balls in the air, but generally speaking it is bad news for financial asset prices when it slows down at a time when asset prices are already very high.

In fact, given the narrowing of the rally – as Mish has noted, some 47% of all Nasdaq stocks are by now “technically” in a bear market, as well as more than 40% in the Russell 2000 – we can already tentatively conclude that the current growth rate of the money supply no longer suffices to lift all boats. Most of the stocks that are down by 20% or more from their highs are smaller capitalized firms, which normally tend to be more sensitive to developments in the domestic economy (so perhaps the market is actually trying to tell us something).

Add to that the coming surge in supply – not only the huge Alibaba IPO is in the pipeline, but many others as well – and the “more money chasing fewer stocks” equation certainly looks a lot less favorable than it used to. What remains to be seen is how long it will take for the portion of the market that is still well supported to reflect this changing backdrop.

During the mania of the late 90s, these divergences became so pronounced, that the entire value segment of the stock market was well mired in a bear market by the time the tech and big cap bubble peaked, as a result of which there were actually quite a few cheap stocks available, even as the SPX and the Nasdaq were trading at utterly insane multiples. This dispersion of valuations is definitely not a feature of the current market, which measured on a median basis is the most expensive market ever.

Given that it makes not much sense to buy based on valuations, it only makes sense if one a) believes that the artificial boost will continue forever unabated and b) the “grand experiment” central banks have engaged in will have no adverse consequences. This combination of beliefs has indeed been predominant for some time (hence the bizarre focus on a single sentence in the FOMC statement). It is a modern form of superstition.

US broad money supply TMS-2 (without memorandum items, which currently add approx. $ 90 bn. to the total). The huge bout of monetary inflation since 2008 is what has driven the echo bubble to its current extreme – click to enlarge.

More important than the absolute level of the money-berg is the rate of change in its growth. “Tapering” of QE has been partly balanced by commercial banks creating more fiduciary media (i.e., stepping up their inflationary lending by creating deposits ex nihilo), which is why the growth rate has remained in a fairly tight range at a still brisk level this year. However, tapering may be beginning to take a toll, as the most recent y/y growth rate is at a multi-month low – click to enlarge.

Anecdotal Sentiment

How deeply ingrained the faith in the omnipotence of central bankers has become has been nicely demonstrated in a few recent WSJ articles. One of them reports on a fact we have recently discussed in these pages as well – it is entitled “Stock-Market Bears Turn Docile, Predict S&P 500 Gains”. If one looks at this headline closely, it almost sounds as though the term “bears” nowadays describes “docile” people forecasting more gains!

However, the topic is simply that the few remaining bears on Wall Street have by now capitulated (and they weren’t really all that bearish to begin with – two of them were looking for a 6% dip – no kidding). The article points to the possibility that the dearth of bears both in the professional and retail investor realm could be seen as a cause of concern, but this is immediately dismissed by pointing to “low interest rates” (in other words, central bank-induced market distortion). As John Hussman has recently argued, while low interest rates do account for a justifiable premium, it is far lower than is generally assumed.

Even more astonishing was however another article, in which the “potent directors fallacy” was on parade in all its glory (title: “A Scary World, But Investors Trust the Fed”). As we always point out, we firmly believe that this blind faith will eventually be put to a severe test. In our opinion, investors who after the events of the past 20 years have still not realized how utterly clueless the Fed is are in for a very rude wake-up call. An excerpt:

“Market fundamentals, from stock prices to interest rates and profit margins, are stretched. Europe is flirting with recession, the U.S. is expanding its Middle East bombing and Ukraine and Gaza are enduring uneasy truces.

And financial markets act as if everything is just fine. Investors widely believe the Federal Reserve and other central banks will do what it takes to keep economies and financial markets healthy.”

(emphasis added)

We would note to this that just because stocks are near record highs and junk bond yields are near record lows, these markets are by no means “healthy”. On the contrary, they are extremely distorted. So the highlighted sentence should actually read: “Investors seem to believe that central banks can keep markets distorted, without anything untoward ever happening to upset the apple cart”. In short, investors have apparently adopted a naïve faith in the miracles of central economic planning (as noted above, it is a kind of modern superstition).

Mind, we are not commenting here on how much longer this faith will persist – we don’t know, and it has already persisted far longer than we thought it would. The air does seem to get thinner with every passing day, but even so it is hard to be certain of when the wake-up call will arrive and what triggers will be involved. However, the article in the WSJ is literally dripping with platitudes and cliches, ranging from the well-worn “there is no alternative” (to buying overinflated assets in distorted markets) to “there is no inflation in sight” and of course the ubiquitous “the Fed has our backs” (paraphrasing).

These arguments are cited in the course of a wide-ranging dismissal of any concerns that may still be lingering in some obscure corners. At one point a fund manager is quoted as thinking that many professionals are actually aware of the market distortion and that it is making them a bit uneasy, but hey, if “there is no alternative”, what can you do? This attitude almost has shades of Japan in the late 1980s. Naturally, it is in many respects a very different situation, we are merely noting the parallels in the psychological backdrop (there was a similarly long list of cliches used to rationalize buying the Nikkei at the time).

Conclusion:

The Fed’s non-statement has provoked very uneven reactions in markets that all depend on the same thing: rapid money supply inflation. There are of course different leads and lags in evidence in these markets, as the traders who are active in different asset classes are often not the same people. These variations in leads and lags are a phenomenon that can be observed on a medium to longer term basis as well, as every individual market’s behavior partly depends on contingent circumstances. However, the more overvalued an asset class becomes, the more vulnerable it will be to unexpected developments. For the moment, everything still seems to be fine, but that is definitely not an immutable condition.

Addendum: Stocks vs. Unemployment Claims

In recent years, the stock market has exhibited a strong correlation with initial unemployment claims, i.e., it has ceased to be a leading indicator, but has rather become a coincident and sometimes even lagging indicator of the economy. We are not sure to what extent this is still applicable in the world of QE and ZIRP, but so far, the inverse correlation has held up well. Below is an updated chart:

Initial unemployment claims and the S&P 500 index. The blue lines are aligned with absolute highs and lows in claims, the red lines with highs and lows in the index. The final two lines are of course only “preliminary” ones that may still have to be shifted in the future. They only show the most recent highs/lows – click to enlarge.

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“Finest Worksong”

by John Mauldin

In theory there is no difference between theory and practice. In practice there is” – Yogi Berra, as cited by Ben Hunt in today’s Outside the Box. Or, to put it in macroeconomic terms, “Why is global growth so disappointing?” In the aftermath of the Great Recession, fearing a deflationary equilibrium (which, as Ben notes, is macroeconomic-speak for falling into a well, breaking your leg, at night, alone), the Fed bought trillions of dollars in assets … and saved the world. Sort of. If you don’t count the reckoning yet to come. The theory was that with all that monetary-policy injections, global growth would spring back to “normal.”

But what did practice show? The global economic engine never fired back up. The central banks’ answer? Do more. So the Fed gave us QE 2 and QE 3, and then we got Abenomics, and now it’s Draghinomics.

Still no real growth. What’s missing? asks Ben. He has a surprising answer. Read on.

Ben works for Salient Partners and writes the fascinating letter called Epsilon Theory. You can subscribe to it for free here, or by emailing bhunt@salientpartners.com.

I had dinner last night with my good friend Richard Howard, who, besides being a charming young Australian lad, is also the wickedly brilliant chief economist of Hayman Advisors, the hedge fund outfit run by my friend Kyle Bass. We try to get together every few months at one of the local eateries and hash out the world. And yes, for those interested, the recent action in Japan has both of us smiling a “we told you so” sort of smile. But also thinking that the magic will last for Abe-sama a little while longer. Actually, we talked about why this trade could take a lot longer than most yen bears expect.

(Side note: As longtime readers know, I had just hedged a good portion of my newly acquired mortgage this year by shorting the yen using 10-year put options. Just for grins, I called my broker [a.k.a. The Plumber – Eric Keubler of JPMorgan] and asked how much my position was up. I know, I bought 10-year options and shouldn’t check more than once a year at most, but I was just curious – so sue me. Anyway, with a 5-yen move in my favor I expected to see a rather nice profit. It turned out the profit was about 3% of what I was expecting [not a typo]. That seems odd, I said. No, he told me, all the volatility in the option price has collapsed. The complacency in the currency market and especially in the yen-dollar market is simply massive. This made me glad that I bought 10-year options, as I fully expect that the volatility will have to reappear in the future – unless human nature has somehow changed without sending me a memo. But it goes to show you, gentle reader, that you can be right on the trade and lose money, perhaps a lot of it, if your timing sucks. Ironically, I can get roughly the same trade today for only a few dollars more than I paid five or six months ago, with the 5-yen advantage to the home team. Go figure. I plan to add to this trade, so if you are watching and know when I’m going to do it, you will know that volatility is exceedingly high when my personal situation allows me to execute.)

Richard and I then went on to talk about the interesting decision by CalPERS to completely exit hedge funds. I think the consensus as we left the table was that it is both an odd decision and a perfectly reasonable one, depending on your perspective. Please note that in their press release CalPERS used 5 years and 20 years as their retrospective time horizons. The intervals between 1994 and 2009 and the present just happen to be very convenient time periods to compare overall portfolio returns for CalPERS and for equity markets in general versus hedge funds. If you used 2000 or 2006, your internal rate of return would suck, and your portfolio performance would be less than flattering. Still, hedge funds in general have not performed as well for the last five years as they did in the past, and in general they didn’t offer the downside protection in 2008 that they did in the prior correction of 2000-2001.

In my opinion, CalPERS was not very good at choosing hedge funds, and their timing in entering and exiting a number of their funds wasn’t any better. You can go to any number of pension funds and find far better results than CalPERS achieved. To be fair, I would suggest that the majority of hedge funds are not worth the fees they charge, as they simply provide leveraged beta. Choosing hedge funds is as much an art form as it is a science. Kind of like choosing stocks.

I mean, every asset class has its own particular rhythm. As we all know, over the very long run stocks generally do well. But there are some periods of time when the performance numbers don’t live up to the promise. Those are called secular bear markets, and we had one beginning in 2000. I don’t think we have come to the end of it, and so we still live in a world where we have to look for absolute returns. That’s just the way I see the data.

All that said, I can totally understand CalPERS’ decision to exit the hedge fund world. First, their entire hedge fund investment portfolio was less than 2% of their total portfolio. Even if their hedge fund portfolio was crushing it, that wouldn’t move their overall needle. They were paying $135 million in fees for the privilege of being continually second-guessed by their critics. Frankly, if they had asked me, I would have said, either go large or go home.

And there’s the problem. They really can’t go large. Let’s say they put 10% of their fund into hedge funds. That means at least $30 billion. I don’t think you can allocate $30 billion appropriately from the standpoint of public pension fund responsibility. I wouldn’t even begin to know how to do it. Two or three billion? Absolutely. It would be difficult, but it could be done.

The problem is, you don’t want to become too big a portion of any one fund. Seriously, there are not that many good large funds. Most hedge funds are way too small to be considered as potential investments by CalPERS. So if you are CalPERS you are size-constrained and limited to a small universe of very large hedge funds. Which is not typically where you find hedge fund alpha. And you don’t want to have 100 different funds, as the complexity of tracking all that is enormous.

So you either end up with a portfolio that is ridiculously spread out and is going to regress to the mean, that is, to general market performance; or you going to be over-allocated to some fund that will prove to be a time bomb just when your public relations team is being overwhelmed with something else. I’m not sure who in the universe is in charge of the rules on timing, but it does seem that things are structured so as to cause the greatest possible embarrassment.

So I can certainly understand extremely large public funds leaving hedge funds. I do think that they should consider what other forms of alternative investing might make sense. Pension funds have one commodity that very few other investors have: they have time and lots of it. Most of them sell their time for ridiculously cheap premiums in the fixed-income market. Perhaps figuring out how to increase the return on your patient cash would be the way to go. And that’s not a bad strategy for individual investors as well. Just saying…

That’s the news from beautiful, sunny Dallas. It is time to go ahead and hit the send button as The Beast is lurking in the gym, waiting for me. Have a great week, and enjoy Ben Hunt’s essay.

Your ready to get on a plane again analyst,

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China's central bank said to inject $81bn into system

 

China's central bank recently unveiled measures to support small rural banks and other financial institutions

China's central bank is said to be injecting 500bn yuan ($81bn; £50bn) into the five biggest state-owned banks to counter slowing growth in the world's second-largest economy.

The People's Bank of China (PBOC) is reportedly giving each bank a $100bn low-interest loan over three months.

The move may be the first of several stimulus measures, analysts say.

It is aimed at lifting business confidence and investment following a string of weak economic data.

China's economy showed more evidence of a slowdown with industrial production and foreign direct investment hitting multi-year lows in August.

The five lenders said to be receiving the stimulus are the Industrial & Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China and Bank of Communications.

The move was first reported by local Chinese news website Sina.com. Other media reports cited a government official and a senior Chinese banking executive.

Chinese banking shares traded in Hong Kong rose on the news.

'Bigger steps'

Economists say the move may have a similar effect to a 50 basis point cut in China's reserve requirement ratio, which is the amount of money China's commercial lenders must deposit with the PBOC.

Some also believe the capital injection is meant to pre-empt any possible liquidity shortfall ahead of China's major Golden Week holiday, which starts on 1 October.

Louis Kuijs, China economist at RBS, said policymakers have been under pressure to "take additional, more significant measures to ease the policy stance and shore up growth".

"It increases the money base. If not constrained by caps on loan-to-deposit ratios or other administrative regulation, it would increase the banks' ability to extend credit," he said.

"In our view this measure reduces the chance of other, bigger steps in the monetary sphere in the very short term. We think it is likely to see measures such as supporting infrastructure and the property market."

Growth target

China has been looking to adopt more market-based reforms

There are rising concerns that the government may miss its target for economic growth of 7.5% this year.

However, China's Premier Li Keqiang said last week that the country was on track to meet its growth target and that its structural reforms were progressing.

Following the 2008 financial crisis, China unveiled a massive stimulus programme to keep its economy afloat.

But in recent years, Beijing has been unveiling more targeted measures aimed at addressing problems such as a possible property bubble and rising local government debt.

Mr Kuijs said this stemmed from a desire by Chinese authorities to rein in financial risks that arose from its initial, much broader stimulus.

"The problem is that the use of such targeted, specific instruments runs counter to the envisaged reform of monetary policy. That reform is supposed to be making monetary policy more indirect, market based," he said.

"However, several of the measures and new instruments introduced this year move monetary policy in the opposite direction, making it more direct and less market oriented."

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Fed Bringing Stock Turbulence to Traders as VIX Climbs

By Callie Bost and Jeff Kearns

As investors try to decode the Federal Reserve’s next step, options traders are betting that regardless of what happens, it’ll be a rocky ride for stocks.

Expectations for future price swings have jumped in the past month, with the Chicago Board Options Exchange Volatility Index rising 11 percent since Aug. 22 to 12.73. At the same time, the market has been so calm lately that a gauge of historical volatility is at 5.9, near a three-year low. The ratio between the two measures reached a 19-month high this week, according to data compiled by Bloomberg.

Economic stimulus from the central bank is set to end next month, leaving investors wondering how long interest rates will stay near zero as data from manufacturing to consumer confidence show signs of expansion. The Federal Open Market Committee will release a policy statement at 2 p.m. in Washington today, along with updated quarterly projections for growth, inflation, unemployment and the future path of interest rates. Fed Chair Janet Yellen is due to speak in a press conference afterward.

“The market is itchy and anxious about what the Fed will say,” Dan Deming, a managing director at Chicago-based Equity Armor Investments, said in a phone interview. “Traders and market participants are anticipating some movement here. The times the Fed has tried to rein in liquidity provisions and taken the IV out of the patient, it hasn’t gone too well.”

Policy Change

Fed policy is more likely to change at this meeting than past ones, economists at Jefferies Group LLC and Nomura Holdings Inc. wrote in recent reports. Officials will probably remove the “considerable time” language to make guidance more data dependent, according to a report from Jefferies this week. Nomura said in a note last month that the FOMC will probably make “substantial” changes to their forward guidance.

Yields on 10-year Treasuries (USGG10YR) have climbed to 2.59 percent, near a two-month high. Fed fund futures show the odds the central bank will increase its benchmark rate by July 2015 have risen to 55 percent from 51 percent at the end of August.

“People are starting to think the Fed is poised to start raising rates,” Robert Pavlik, who helps oversee $4.5 billion as chief market strategist at Banyan Partners LLC in New York, said by phone. “We might be in for a little bit of selling pressure, especially if they remove the language about keeping interest rates low for a considerable period of time.”

The VIX, a gauge of 30-day implied volatility derived from options on the Standard & Poor’s 500 Index, dropped 9.8 percent to 12.73 yesterday as the equity gauge rallied the most since Aug. 18. While it has risen in the past month, it’s still within three points from a record low.

Relative Calm

A measure of the S&P 500’s actual swings in the past 20 days has stayed relatively calm, reaching 5.06 on Sept. 5, the lowest level since 2010, data compiled by Bloomberg show. The VIX closed 2.6 times above the 20-day realized volatility Sept. 15, the highest since January 2013.

Weakness in the U.S. labor market and deteriorating conditions in Europe may persuade Fed officials to remain accommodative, according to Adam Perlaky, chief strategist at New York-based broker New Albion Partners LLC. He cited this month’s jobs report, which showed the smallest U.S. employment gain so far this year and declining workforce participation.

“I would be surprised to see any change in language,” Perlaky said in an interview. “The last few meetings have been ‘nothing to see here’ events.”

While the S&P 500 is less than 0.5 percent away from a record high, gains have stalled around the 2,000 mark. The U.S. equity benchmark is already up 8.2 percent this year. The two most-owned VIX contracts are calls expiring tomorrow with strike prices of 19 and 20, Bloomberg data show.

“We’ve seen the market lose steam,” Justin Golden, a New York-based partner at Lake Hill Capital Management LLC, said by phone. “Some investors might just be using this as an opportunity to hedge and that may be why we’re seeing the VIX wake up a little bit.”

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Which Global Hegemon Is on Shifting Sands?

by Charles Hugh Smith

Given that all the leading candidates for Global Hegemon are hastening down paths of self-destruction, perhaps there will be no global hegemon dominating the 21st century.

Which nation with aspirations of global dominance (i.e. hegemony) has these attributes?

1. The nation's recent prosperity is based on a vast expansion of credit.

2. The nation has 100+ million obese/diabetic citizens.

3. The citizens have little say over central government policies that favor cronies.

4. The nation faces demographic headwinds as the number of people in the workforce declines and the number of retirees balloons.

5. Large regions of the nation suffer from chronic water shortages.

Hmm, sounds like the U.S. is a match so far.... Let's add a few more attributes:

6. The nation's credit expansion has relied on a largely unregulated shadow banking system.

7. The nation is in the midst of an unprecedented housing bubble.

This could still be the U.S., but America's unprecedented housing bubble popped in 2006--the current bubble is a mere echo bubble. Let's add a few more attributes:

8. The nation is beset with unprecedented "external" environmental costs as a result of rapid and largely unregulated industrialization.

9. The nation suffers from large-scale desertification.

10. Over half the nation's monied Elites have either left the nation or plan to leave and transfer their financial wealth overseas.

The only nation with aspirations of global hegemony that fits all these attributes is China. The conventional China Story holds that the 21st century will be China's century, much like the 20th century was America's.

But this story overlooks the vast demographic, health, environmental and financial problems built into China's land, people, and Central-Planning systems of finance and governance.

Consider two charts drawn from John Hampson's recent overview of Problems in China:

China's shadow banking system, which provided the majority of the credit that fueled the current expansion, is imploding:

Not coincidentally, China's unprecedented housing bubble is also imploding:

China's system allows only a limited number of options for savings and investment; other than bank accounts that have lost money when real inflation is accounted for, the primary option available to households is real estate. As a consequence, an enormous percentage of the nation's household wealth has been sunk into empty apartments which act as "savings."

But a physical flat in a high-rise building is not a financial asset like a savings account: it is a physical object that degrades with time and whose value is set by supply, demand and thr availability and cost of credit.

If the building is not maintained properly, elevators break down, pipes start leaking and fixtures corrode, and the value of an unmaintained building drops to zero in terms of habitability within a decade or so.

100 million apartments become an enormous mal-investment of one-time wealth as they slowly become uninhabitable due to poor construction and/or maintenance.

China has been building infrastructure at a break-neck pace for 30 years, and this has created the mindset that almost every structure will be torn down and replaced with something grander every 20 years or so.

As a result of this mindset, very few structures are maintained. Why bother if it will be torn down and replaced a few years down the road?

But tens of millions of apartments cannot replaced every decade or two.

In effect, China has squandered its one-time wealth generated by rapid industrialization, and absorbed the still-uncounted environmental and health costs of this industrialization that must be paid in shortened lives, higher healthcare costs and environmental cleanups for decades to come.

Few promoters of the China Hegemony-in-the-21st-century Story mention the estimated 114 million people in China with diabetes--over one third the population of the U.S.-- or the roughly 500 million people in China with elevated blood-sugar levels that put them at risk of developing diabetes or related lifestyle diseases. China ‘Catastrophe’ Hits 114 Million as Diabetes Spreads.

How much of the nation's surplus wealth will be devoted to fixing the environmental and health costs that are already visible? How much of the wealth is actually phantom wealththat will vanish as the housing bubble based on an unprecedented credit bubble pops?

The China Story based on demographics, health, environmental damage and financial Central Planning is a quite different one from the China will be the global hegemon in the 21st century story. Given that all the leading candidates for Global Hegemon are hastening down paths of self-destruction, perhaps there will be no global hegemon dominating the 21st century.

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