Sunday, September 18, 2016

Faking it....

Well, the G20 get together in Hangzhou (The E-Commerce Epicenter of the Planet) just wrapped up (with no real result/outcome) and once again, the Politburo's world class sense of humor was on display for all the world to see. The event featured incredible moments like the verbal confrontation between Susan Rice with Chinese Airport Security officials "Hey! This is OUR Airplane!" and Rodrigo Duterte, the profane Philippine President's presumably state encouraged rant referring to the Leader of the Free World as "a son of a whore" (He's apparently been watching too much US Presidential Debate footage and forgot about all of those pesky Chinese warships which would be only too happy to drop anchor in Manila Harbor if the the US Navy suddenly decided to set sail) and finally, the failure to get a Jetway over to Air-force One so, Barack Obama, the 44th President of the United States of America could actually deplane, causing the Presidential entourage to use the back/kitchen stairway....what a hoot!  My guess is that Chinese officials were hoping to get a photo op of the President and staff sliding down the emergency chutes in an effort to show just how shoddily US Planes are built, but it looks like the White House Press Corps. outsmarted them on that front.



Even after all of the above, and there's much, much more, the most entertaining propaganda piece I've seen in quite some time is the G20 "Hangzhou Paradise on Earth" video....shown above. Oooppsss....at least it used to be out there, but the Chinese Government apparently removed the video from Youtube.  Anyway, if you take my word for it, here's the edited, less ridiculous, Wall Street Journal version. The original featured all sorts of wonderful Hangzhou residents and actors breaking out in song extolling the virtues of life in Hangzhou. The people (there are lots of people in China....have you heard?) clutter and trash have been meticulously removed from the streets and the buildings (and weather) have been fastidiously photo-shopped and edited, replaced with "artist renderings" as to what many of the buildings (and sky) might look like if they were actually completed (clear).  


In an effort to educate myself on the history of this grand city, I took an informal poll of some of my Chinese speaking friends, hoping to find the origin of the word "Hangzhou".  The group was evenly split between "Big Hoboken" and "Shanghai's little bitch".

For those of you who have never been to Hangzhou, I've posted a few pictures here to give you a better idea of what this "Paradise on Earth" really looks like.  Apparently, there are many more city blocks that look like those on the right of the page than those featured in the video.  I also have to disclose, in the interest of transparency, that I've never been there, but I have good friends who travel there frequently. 

Don't get me wrong, their consensus is that Hangzhou is "Ok".  It's not a bad place at all. Like so many large cities (Cleveland, OH for example) it has its' niceties and its' problems.   I'm just saying that perhaps, the "Paradise on Earth" video, like so many publications produced by the Chinese government, might be a tad exaggerated for either political reasons, or perhaps in this case, a bit of comic relief. In any case....whenever I'm in Asia....I don't see anybody singing in the streets.  Most people are working their fingers to the bone, shoulder to the grindstone, just trying to get by. 




As you know, here in Cleveland, we recently hosted the Republican Nation Convention. (Authors Note: There's no singing on the streets of Cleveland either. Americans only sing when we go to Disney World.  You've seen the TV commercials?)   Anyway, for the RNC, we cleaned up the City, planted flowers where piles of trash used to be, gave the homeless temporary homes, summoned thousands of police from all over the country, created a perimeter and a DMZ, a series of "Check-Point Charlies" and generally established a police state (with lots of millionaires and billionaires, luxury hotels, yachts and five-star restaurants) for the week.  Violent crime was kept out of downtown for the most part and the nation's elite were peacefully coexisting among a heavily armed, mildly disgruntled civilian population.  Most remarkably, not one (1) politician, journalist, delegate, billionaire or lobbyist met their maker at the hands of the unwashed rabble they were vying to govern that week.  When the dust finally settled, the Convention was a rousing success and as a self appointed, citizen ambassador, I'd invite any political party to throw a convention here in Cleveland anytime their little hearts desire.  

On the other hand, throughout the whole process, I don't recall anyone from the Cleveland City Council or the Chamber of Commerce saying "Hey....let's produce a crazy video, with artist renderings of partially complete buildings....we can shut down the city, ask/tell a third of the residents to leave and call Cleveland a 'Paradise on Earth' for all the world to see!".....why? You might ask?.....Because it's just plain silly....that's why! Those old guard Maoists, when given access to a cutting-edge special effects department, really can generate a good belly laugh video clip when they put their minds to it.  

What's Really Going On.....

This silly "Paradise on Earth" video is simply a metaphor for the way business is done in China.  As my regular readers know, I've opined, quite openly about the misrepresentation and absurd, silly nature of financial reporting Beijing style.  I've described the weird metrics in ADRs like Alibaba, Tencent, Softbank (I know Softbank is a Japanese company, but the tentacles reach deep into the mainland.) et. al., just to name a few, since the inception of this blog.  I've described "Smoke and Mirrors", acquisition driven Asset Valuations and phantom "written up" profits all fueled by the "Monopoly Money" provided by the PBOC and Central Banks around the world.  Then there's one of my favorite businesses, AnBang Insurance, where a few shopkeepers and farmers from he Zhejiang province (Pingyang County) somehow found themselves in possession of, and capable of deploying more than $30 Billion on a global shopping spree over the past year or so.  How in the world did they figure this out?  Feel free to click on any of the prior links to get some background on what I'm referring to if you are new to this blog.

So what's driving all of this odd financial fury? Let's take a look at the chart below.  We can very quickly discern that the banking business in China is going gangbusters.  China's bank assets in the last three years have increased by 29% while US Bank Assets have remained generally flat.  


Does anyone else think that it's at least a bit unusual that 12 of the top 15 largest businesses in China are Financial Companies?  (PetroChina 5, China Moblile 6 and Sinopec 8, are the oddballs.) In fact, the four largest banks in the world are located in China.  These banks are all larger than any US Bank even though US Nominal  GDP is nearly twice that of China.  To put this in perspective, total Balance Sheet Assets for this handful of Chinese financial institutions are roughly the equivalent of current US GDP.  Amazing....isn't it?

If we compare the top twelve (12) businesses in the US per the Forbes Global 2000,  Today, only four (4) of twelve (12) are Banks. (JP Morgan, Wells Fargo, CITI & Bank of America) the others, Berkshire, Exxon, GE, Apple, Chevron, Walmart, Verizon & Microsoft all "make" something of value which requires financing. This paradox, when compared to the Chinese economy at least suggests that in the US, there is some sort of economic/commercial balance between the folks who build and market things when compared to the folks that finance the growth. This balance is apparently lacking or at least less obvious in China.

If we compare the growth of bank assets from 2000 to 2015 the data is even more perplexing.


When we further examine the ratios we see some interesting trends:
  1. Chinese large bank assets are much more concentrated in relation to GDP (160% vs. 49%) than US Large Bank Assets.  Note that per the FED, the largest 1,792 banks in the US, (assets over US$300 million) have only US$14.5 Trillion in Assets, roughly US$3 Trillion less than the above thirteen (13) listed Chinese firms.   
  2. US large bank assets have grown from 16% of GDP to 49% since 2000, while Chinese large bank assets have actually declined from 171% to 160% of GDP.
  3. Chinese large bank assets have grown about twice as fast as US Bank Assets in both absolute and percentage terms since 2000.
It's clear that the US and Chinese banking systems have been on different paths for quite some time. Obviously, the fastest way to grow a banks assets is to borrow lots of money and rent it out.  After all, that's the banker's job.  That's how you create bank assets (loans).  The only two things that can go wrong with this simplified business model are 1.) The folks you are renting/loaning the money to won't/don't pay you back. and/or 2.) The folks you are renting/borrowing the money from don't believe that you will pay them back....and they won't give you any more money, or worse, they call the prior loans they've made to you.

Now, hypothetically, let's just say that the PBOC proclaimed, through its' regulatory magic, that the above "two things that could go wrong" have been removed from the financial system by decree.

Picture Zhou Xiaochuan, the Governor of the PBOC, sitting in the dark/dank basement of 32Cheng Fang Street, running a printing press, 24x7, filling dump trucks with money and sending it to the above banks with explicit instructions to make loans and build GDP. There will be no repercussions if things go south. There will be no defaults. We will roll it over if it doesn't flow cash or show profits. We will refinance the refinancing. We will keep non-performing loans (NPL's) rock solid at 1.5% no matter how much money we loan out. If you need more money, come and get it, the presses are rolling 24x7. (See: The Theory of Financial Relativity in this blog) More money printed means more loans. More loans means more bank assets and more GDP. I believe Ben Bernanke coined the term "helicopter money" years ago, but it looks like the Chinese bankers were actually implementing "dump truck" money well before Ben coined the phrase.

So where does all of this money go?

Enter: Hank Paulson

There's no need to go over Hank's storied career in detail here, there's been lots written about his amazing life.  Let's just start, for the sake of brevity, with the relevant highlights.

Hank was born in Palm Beach, and moved to Illinois when he was a young boy.  He somehow pulled himself up by his bootstraps, rising up from the mean streets of Barrington, doing his best to take advantage of every break that came his way.  It was a tough life and he grew up fast.  Hank managed to get into college, joined a really fun fraternity and eventually graduated with a degree in English from Dartmouth in '68 and an MBA from Harvard in '70. The world was Hank's Oyster and he was about to go pearl diving.

After graduation, Hank, ever vigilant for opportunity, spotted a "help wanted ad" in the Washington Post and was lucky enough, without any inside political connections whatsoever, to land a job as an assistant to John Erlichman during those fun filled Watergate days in the Nixon White House (1972-1973).  Luckily for him, Hank had no idea what was going on at the hotel and knew nothing about the break-in.  Erlichman, reputed to be a kind, gentle, nurturing boss, apparently must have intentionally kept Hank out of the loop just in case things went awry with the burglary.  This makes perfect sense. Most good managers never hesitate to throw themselves on a grenade to protect their underlings.

As luck would again have it, when the Watergate smoke cleared, Hank landed a sweet job at Goldman Sachs in the spring of 1974 right when all of that burglary nonsense, that the liberal press made such a big deal out of, started to hit the fan.  Looks like old Hank got out of the White House just in the nick of time.  He always had a knack for timing.  Erlichman became Hank's prison pen pal and Tricky Dick, of course, resigned in August of 1974.

This bump in the road didn't slow Hank down one iota.  As is his nature, he worked his ass off at Goldman where he and the gang developed and marketed all sorts of amazing, money-making products. Goldman was a gold mine.  Hank, as we now know, is one of the founding fathers of the proliferation of  all sorts of wonderful financial products like Collateralized Debt Obligations (DCOs) and Mortgage Backed Securities (MBSs).  Goldman made markets for products that heretofore hadn't existed.  The Goldman Sachs logo was prominently splattered on the front page of nearly every large ADR IPO since their first significant foray with the PetroChina IPO in the spring of 2000. Cutting edge stuff.

In 1999, with great fan fare, Hank was named CEO of Goldman and had amassed a tidy little fortune along the way, probably about $600 million at the time, mostly tied up in Goldman Stock.  It's safe to say that without his stewardship and guidance at Goldman, our financial markets wouldn't be nearly what they are today.  His hard work and a little bit of luck had finally brought Hank's ship into port.

As luck would again have it, his yearning for public service and his desire to give back to the "people" was finally fulfilled when George "dubuya" tapped him for the Treasury Chief gig in 2006. What luck! He got out of Goldman just before the financial crisis hit.  Moreover, he was able to dump $500 million in Goldman stock tax free (a little tax break created by Congress to attract private folks to the public sector).  What CEO wouldn't take the job if it came with a $200 million signing bonus?... ...ummmm.....I mean tax forgiveness.  Even more importantly, Hank could grab the top spot at the Treasury where he could help Lloyd, Jamie and the rest his buddies get through the totally unexpected, super-surprise, global financial meltdown that nobody could have possibly seen coming.  History has shown, and we now know this for a fact, that nobody could have possibly seen the crisis coming since that's how all of the bankers testified during the Congressional hearings.  They were all under oath doing "God's work" at the time..... so it must be true.

Further, even more icing on Hanks cake, as Treasury Secretary his decisions regarding the allocation of TARP funds and which institutions would live and die were unchallengeable.  Unfortunately, most of Goldman's competitors were in really rough shape.  No matter how hard Hank tried, he knew in his heart that they simply could not be saved.  I understand he cried himself to sleep many a night whimpering "I could have done more to save Lehman, Merril and Bear....God forgive me, I could have done more..."  This agony was all part of the cross Hank had to bear, but like the true pro he is. he made his decisions and never looked back.  With time and appropriate grief counseling, he would, of course, get over it.

In 2009, after making sure his friends at Goldman were doing OK, tossing the last few symbolic handfuls of dirt on the financial graves of Bear Sterns, Lehman Brothers, Merril Lynch, and many of Goldman's former competitors, he resigned as Treasury Secretary and turned over the job to Tim Geithner.

I must say, Hank's odyssey has been one of the most amazing journey's in the history of US finance, forging personal success and barely skirting disaster every step of the way.  Hank's a true American hero.

Hank's Plan

So this week Hank came out with a position paper "Demystifying Chinese Investment" from his Chicago think tank, describing why American business people should embrace selling their assets to Chinese acquirers.  As you know, Hank has been a Sinophile for years and is, of course, known to be an expert on "all that is China".

The bullet points of the paper are:

  1. There are tremendous benefits which would inure to both the US and Chinese economies if a successful, well-thought-out FDI program is implemented by both governments. 
  2. Every Foreign Direct Investment (FDI) has political dimensions which must be addressed on the National and local levels.  Objections, stereotypes, regulatory obstacles and misgivings must be overcome for a specific FDI to succeed. 
  3. Advice to governments  is: a.) Embrace FDI; b.) Avoid making industries/segments completely off limits and review proposals transparently and consistently; c.) Avoid tit-for-tat political wrangling.  Let each FDI proposal stand or fall on its own merit. d.) Complete the Bilateral-Investment-Treaty, normalizing the investment process framework.
  4. Advice to Investors is: a.) Don't over-pay.  (Personally, I'd extend this rule to any investment, not just FDI); b.) Get local grass roots support for your investment. c.) Be transparent. 
  5. The Sales Pitch:  If there are any Chinese or foreign investors out there looking to consummate a significant FDI deal, the Paulson Institute is ready, willing and able to put the players together, run government interference and cut through some of that pesky bureaucratic red tape.....for a presumably modest fee of course. The Paulson Institute, like many of the larger health care providers (Cleveland Clinic, Mayo, Johns Hopkins, etc) and Religious Institutions in this country is, after all, "not-for profit".  Yet, I'd suspect that Hank's services don't come cheap. That 's just the way he rolls.
Everything Hank recommends about inviting Chinese Investors to buy US assets is absolutely correct and makes perfect sense.  Economic cooperation is good for everyone, be it acquirer and acquiree.  Resources are best marshaled and utilized.  Efficiencies and synergies are gained and total cost to produce is reduced.  The aforementioned would be absolutely, 100% accurate....ummmm....if China's economy, financial system and currency were actually real.

American business people would be happy to sell assets to Chinese Investors, North Korean Investors or Extra-Terrestrial investors if the price is right and if the acquirer actually has the money to buy them. What Hank's analysis isn't taking into account is the gravity-defying, high wire act of the RMB.   Selling "real" assets for converted RMB at today's exchange rate would be tantamount to having a buy one-get two-free sale on US assets.  (Based solely on the relative expansion of the money supply and Chinese debt levels, the RMB is worth a nickel....not 15 cents)  Buy a Rockefeller Center, get a Waldorf Astoria and a Pebble Beach for free!

Don't get me wrong.  I'm sure Hank is a great guy.  He's a family man and environmentalist.  He loves his grand-kids and Bobolinks.  He's a brilliant forward thinker who is always one step ahead of the curve (and the regulators) on global financial issues.  We just disagree on this topic.

Coincidentally, as I've described above, Hank's always been lucky enough to be able to get out of harms way just before the dog-shit-wrapped-in-cat-shit hits the proverbial fan.  I'm suspecting his chronic good fortune was likely honed during his early Erlichman, pre-Watergate, cat-like, "get out while you can" survival training.

More importantly, Hank's also (presumably) a compensated TV spokes-model for the Chinese Government. If we look at Hank's track record, he's also, again coincidentally, the Typhoid-Mary of global financial contagion. Everywhere he's gone, Administrations have fallen, people have lost their jobs, millions of bank accounts and Trillions of dollars of savings and equity have been wiped out (except for his) and a US President actually resigned.  Economies have been crushed and lives have been ruined.  Yet, Hank has always managed to emerge unscathed.  He's the ultimate survivor.  He's made a career out of managing institutions which coincidentally cause an incredible mess.  He's further extended his career by jumping, again coincidentally, into a taxpayer funded public sector role as the Treasury Chief, charged with the solemn responsibility to save us all from the mess that his former institutions had created on his watch. He has an amazing gift....and is really an incredible, lucky guy. My hat's off to him.  He made hundreds of millions of dollars while everyone around him got sucked down a rat hole.  That, my friends, takes real talent.


The Global Shortage of Fake Businesses

Ok, let's recap what we have so far.  At this point we have a Chinese Central Bank printing money like there's no tomorrow.   We've got a protected RMB with scores of traders (Soros, et al) waiting in the wings to short it the moment they smell blood.  We've got a US regulatory environment and domestic internal controls which couldn't spot a fraud if it had a sign around its' neck.  We've got giant, fake businesses with dubious financial statements (Alibaba, Softbank, Tencent, Ant Financial, JD.com, et al) which are operating out of the reach of the SEC, FBI, US Courts and civil sanctions.  We've got Chinese businesses scooping up US$ and Euro denominated assets all over the globe with "Monopoly Money" and Hank Paulson showing them how to do it.

Moreover, here in the states, we've also cultivated a culture where it's nearly impossible for good folks like Hank Paulson, Jamie Dimon, Lloyd Blankfein, John Stumpf, et al, to effectively do their jobs.  I'm sure you've heard about the Wells Fargo fraud by now, where 5,300 rogue, loan-wolf, nearly-minimum-wage employees independently masterminded a diabolically clever scheme, opening nearly two (2) million fake accounts & credit cards for their customers with fake email addresses and confirmations, ostensibly in an effort to meet sales quotas and keep their near-minimum wage jobs. The fraud was so sophisticated that it went undetected by WFC's security super sleuths for years.  In the bank's defense, how could any executive team possibly manage hundreds of billions of dollars and be expected to do things like address, customer and data verification as well?  Regulatory demands and public scrutiny are really tough on upper management nowadays and it will only get tougher.  When will it all end?  CEO's have to deal with things like this on a regular basis now. All of these unruly underlings are continually committing financial crimes on their own, with no document-able knowledge or legally provable awareness by upper management.  Snotty, ungrateful little bastards. Books are cooked, fake records are created, money is shuffled and audit trails are destroyed. The sheer paperwork related to the discipline, firing, blame delegation, investigations, fines, damage-control, re-hiring and designing the fake retraining programs so that nothing like this ever happens again, or again, or again, is mind boggling.  It's obvious to any unbiased observer that these big bank CEO's and management teams all deserve gigantic raises for having to deal with this rogue-employee criminal element and the resulting mess on a regular/daily basis.  Further, we need to get the regulators off their backs and let the CEOs and senior managers do the jobs that they are paid (handsomely) to do. Hopefully, with effort and time, none of these scams will ever happen again, or at least never become public knowledge.....or hurt the stock price.....but again, I digress.

So anyway, where is all of this going?  The one thing that seems to be in short supply, in order to accomplish Hank Paulson's visionary vision of Chinese Investors staking claim to significant chunks of US and European assets is:

Fake Businesses!

Yes indeed.  Once a central bank prints all of that money they've got to get it into circulation, and that's no easy task.  For example, if Janet Yellen stopped by my office tomorrow and told me that, through several intermediaries, she was going to give me any amount of money I'd like, without the usual capitalism-imposed strings, like having to pay it back at some point, and/or the tacit requirement that the assets have to be managed at a profit and provide cash flow, you can rest assured that I'd own most of Cleveland and a good chunk of North America in short order. I'd need hundreds of Caribbean and Panamanian Shell companies, bank accounts (and bankers) to accomplish this massive undertaking.   Within a year I'd go global.....looking at vacation properties on the Amalfi Coast and the Maldives.  Pizza or Garudhiya today?  A Maldives deal should be easy...not too difficult atoll.....the sellers already likely have a "sinking feeling".

Now, let's also say, hypothetically of course, that Janet has hundreds or thousands of good friends just like me. She makes similar offers to all of us.  Let the feeding frenzy begin.

Anyway, as Jack Ma, Masa Son, Pony Ma and the other good old boys have come to realize, the pressure is off once you know you can count on the PBOC.  You can just travel around the globe and buy stuff without worrying about those pesky capitalistic cash flow constraints.  Full speed ahead!  (See The Theory of Financial Relativity).

The Perfect Fake Business:  Fosun International

Moving right along, the proliferation of extraordinarily goofy, large businesses around the globe has reached, an entirely new, nearly epidemic level of silliness.  Throughout this blog I've discussed the ideal attributes that a truly goofy, large business must have in order to be used as an effective conduit for deploying Monopoly Money.  Let's take a deeper dive into the numbers of what I might consider the poster-child of a large, goofy, fake businesses specifically designed to spend dump truckloads of freshly printed Renminbi.  I'm referring of course to that titan of Chinese conglomerates, the Berkshire Hathaway of Beijing.....Fosun International, Ltd.

Fosun is a business with interests, literally, all over the place.  It's an incredible hodgepodge of interrelated, incestuous businesses. They have interests in Wealth Management, Insurance, Steel, Mining, Investment Properties, Health, Internet Finance and my favorite operating segment... "Happiness".   Here's the Corporate Structure.



I've attached links to their 2015 and 2010 annual reports for your amusement.

Bullet points below.  Note, I used a "smiley face" for the bullets since Fosun is all about spreading happiness:


From 2010 to 2015 Fosun increased Total Assets from 74 Billion RMB (US$ 11 Billion) to 406 Billion RMB (US$ 63 Billion).   To put this in perspective, Fosun has grown Assets from virtually nothing to about the same as Dow Chemical, or Union Pacific Railroad in just a few years.

Roughly 2/3rds of these assets (US$ 42 Billion) are comprised of Investment Properties, Properties Under Development, Investments In Associates and Joint Ventures, Available for Sale Investments and the associated Intangibles. Most of these assets, (US$ 32 Billion) according to Footnote #60 of the 2015 Annual Report (pg. 227) are actually "Financial Instruments" i.e.) Investments/Securities Available For Sale, Loans Receivable,  etc.

Footnote  #4 (pg, 147) of the same report describes 47 separate related entities, associates and joint ventures which comprise the substantial activity of the group.  The footnote concludes by stating "The above table lists the subsidiaries, associates and joint ventures of the Group which, in the opinion of the directors of the Company,principally affected the results of the Group for the year ended 31 December 2015 or formed a substantial portion of the net assets of the Group. To give details of other subsidiaries, associates and joint ventures would, in the opinion of the directors of the Company, result in particulars of excessive length."  So there are apparently many more related entities to try to keep track of and audit.  Interestingly, a few of these related entities are Alibaba Companies (MyBank & Cainaio)

In 2015 Fosun reported assets under management by it's Insurance Segment amounted to 180.6 Billion RMB (US$ 28 BilliIon) or 44% of the groups total assets.  In 2012, the group's insurance segment was comparatively non-existent with roughly US$ 90 Million in assets.  Virtually all of these assets, the groups first foray into Euro and USD denominated assets, were acquired in the last two years. 


Is it just me or does the "Pramerica Fosun" logo look conspicuously like the Prudential Rock?....and the name sound oddly like "Primerica"?....another large US insurer?  Some folks buying life insurance from this business might feel a bit misled.  But I'm sure everything is absolutely fine and no copyright or trade-name laws have been violated.  As you also might suspect, it's relatively difficult to generate profitable organic growth in the insurance business, so it makes lots of sense to just buy the assets (US$ 28 Billion) overseas as fast as possible, omitting that tedious due diligence work.  

In it's review of the $US 1.8 Billion Ironshore purchaseA.M. Best said it was "worried about Fosun’s credit profile and financial leverage and how it would affect the insurer".  At the same time, A.M. Best assigned a negative outlook to each of its' ratings for Ironshore.  CFIUS is also examining the transaction to make sure no US laws were violated.

As a point of reference, Progressive Insurance (You know Flo and her "name your price" tool?), one of the largest auto insurers in the US, also has roughly US$30 billion in total assets, about the same as Fosun's Insurance assets.  Fosun managers must be incredible visionaries to have accumulated about the same level of highly profitable insurance company assets in just two short years. Again, I'm sure that all of these asset valuations, although their composition, or quality is not discussed in the annual report, are rock solid.  Keep those PBOC printing presses rolling.

For some reason, management has chosen to finance all of the folly with short term debt.  The schedules on page 54 and 55 are illuminating.  93% of outstanding debt is due in less than five years.  As far as we can tell, at least from this schedule, they have no long term financing.  Fosun increased outstanding debt from US$ 14.6 Billion to US$17.6 Billion in the last year.  The company also has Bank Credit facilities in place with "Major Chinese Banks" of roughly US$ 33 Billion, of which US$ 12.5 Billion is currently used.   Management, with good reason, must be extremely confident these facilities will be renewed.  The unused portion of the credit facilities in 2015 was US$ 20.5 Billion.  You'd think that this disclosure might warrant a little more discussion (i.e. Which banks are involved?, what are the terms and conditions?, interest rate(s)?, etc.)  In 2010, these facilities were US$ 10 Billion of which US$ 6 Billion was used.   Keep those PBOC printing presses running.

If we examine footnotes #4 and #62 we see that certain Commercial Properties and "Available for Sale Assets" are carried on the books as "Level 3" assets worth roughly US$ 8.5 Billion. This represents 13% of Total Assets.  If you recall my post on "The Fine Print" back in December of 2015, Level 3 Assets are valued using "Unobserveable Inputs".  i.e.) The Carrying Value of these assets isn't LIFO or FIFO it's actually...SAYSO.  There are lots of studies on this phenomenon, but generally, Level 3 Assets are generally impaired and more likely to be eventually written off than not.

The company has changed dramatically since 2010.  In 2010, Operating Groups consisted of a.) Pharmaceuticals and Healthcare; b.) Steel; c.) Property and d.) Mining.  The Insurance, Internet Finance, Wealth Management, Investments and "Happiness" Operating Groups (29%) of 2015 Revenue didn't even exist.  Even though senior management has no discernible experience in these industries, luckily, they've figured out how to run all these businesses very quickly.

Mr. Market has actually treated Fosun like a penny stock.  Per the chart below, converted from CNY and HKD at year end conversion rates, we compare the presumably managed earnings to the stock price. Oddly, even though Fosun's Balance Sheet is primarily comprised of financial assets, when  the Chinese stock market nearly doubled and subsequently crashed, it had no apparent impact on YOY Net Profit or the per share stock price.  From 2014 to 2015 Net Income increased from US$ 1.11 Billion to US$ 1.23 Billion (10.8% Increase)  The stock price increased form $1.32/share to $1.56/share (18.2% Increase). Like Alibaba, Tencent and other ADRs, Fosun's earnings and stock price are also impervious to economic downturns and show rock solid earnings increases no matter what's going on around them.  Probably a flight to quality in uncertain times....don't you think?



Now for some real fun!  Beginning on page six (6) of the 2015 Annual Report, some of the 2015 Achievements were listed as:



The above is not atypical. The entire 255 page report reads this way. It's a flowing, meandering, diarrhetic river of buzzwords, disturbing grammar and typos. I earnestly invite you to take a look at the report and experience this phenomenon for yourself.  Much of the Report is unreadable and virtually meaningless. I'd grant that some of the terminology might easily get lost in translation, but seriously, Google translator could have done a better job. Again, I have to emphasize, this is the actual, unedited, "cut & paste" text from the Fosun Annual Report.  Here's another sample for your amusement.  


What does any of the above even mean?  There are 255 pages of this drivel.  "Macroscopic aspect"?  "Unicorn Boom?" "Strictly defined capital expenditures regulations of Group platform?".  This is a publicly held company.  I'm aghast. 

Bear in mind that none of the above is a smoking gun re: a possible fraud, Ponzi Scheme or sham, but all of the signs certainly are there.  As I described in my Follow up thoughts on "I would never say...(Part Deux)....."  post, these shenanigans generally don't become public knowledge until the business can't make payroll. 

The End Game

There are many more goofy businesses like Fosun and AnBang being formed and funded as I type this post.  All of which have an apparent primary government directive to acquire foreign (non-RMB) assets as quickly as possible. The targets seem to be specifically selected to fly under the radar, or at least have a reasonable chance of passing the smell tests of the CFIUS (Committee on Foreign Investment in the United States) process.

So what's going to happen?  The FED, Treasury and the State Department have some of the smartest, most capable analysts, economists and staff ever assembled.  They have access to massive resources, data and economic statistics, much of which is made publicly available and frequently cited by this blog.  In short, they know what they are doing and do it well.  Even though the FED's public policy commentary seems to focus on the usual inflation and employment metrics, essentially conveying to us that they will continue to try to steer our self-driving economic car by looking in the rear view mirror, I'd suggest that they are much wiser than that.  Their public position, predictably of course, is that "all is well".

That said, if I were a betting man, I'd suggest (and hope) that there are nearly round the clock meetings taking place in conference rooms throughout the Eccles building, the topic of each being some derivative of "What the hell are we going to do about this goofy Chinese monopoly-money tsunami?"

Unfortunately, when we look at the big picture, neither the FED nor the Treasury has any authority or tools to prevent a US citizen or company from selling assets to any foreign investor, nor should they. The State Department has limited powers through CFIUS for politically sensitive businesses (Tech, Defense, Infrastructure, Energy, etc.)  but the political pressure applied and the money involved is so great that there's really no viable way to stop it, or even decelerate it.

Unlike the Chinese government, the US Government has no SOEs (State Owned Enterprises) that can be funded and used to acquire assets all over the world.  We rely on the private sector and market forces to, in the words of one of our presidential candidates, "make great deals".

As we've discussed, nothing like this has ever happened before.  This whole adventure began a decade ago when the PBOC started it's unprecedented expansion of China's money supply.  Because of the huge Forex reserves accumulated through their legitimate ascension as a global manufacturing powerhouse the PBOC has been able to prevent the off-shore CNH, despite the press releases, from floating freely. The dual currency system, in concert with mainland price controls on consumer goods (i.e. rent, utilities, food, transportation, ect.) allows the PBOC to manage mainland inflation, while requiring less capital to manage the offshore currency (CNH).  The offshore currency is a relatively small percentage (5% +/-) of China's total money supply.  Moreover, with price, capital and current account controls firmly in place, thus far, the PBOC has been able to defy Krugman’s "Theory of Impossible Trinity" i.e.) It is impossible to simultaneously have full capital mobility, a fixed exchange rate, and an independent monetary policy.  US$ 3 Trillion plus PBOC Forex reserves have become an appropriately sized hammer to implement the logic defying policy.  From a traders perspective, how can you short the off shore RMB (truly subjecting it to market forces) if the PBOC can unilaterally increase the peg and is fully able to deploy enough firepower to support the value and crush your short?

The Bureau of International Settlements, though fully admitting there is little research and precedent for the dual currency phenomenon, published an informative paper in the spring of 2015 analyzing the effectiveness of PBOC monetary policy.  The paper concludes that volatility and differentials between the onshore (CNY) and the less liquid offshore (CNH) markets will persist, due primarily to capital controls, global external conditions and off-shore investor sensitivity and reluctance to participate in the market.  The relationship between the on-shore and off-shore currency will continue to be disjointed as investors will continue to discount information emanating from the less liquid off-shore (CNH) market.

Whether it's a fake "Paradise on Earth" video clip, fake financial statements, fake NBS statistics, fake currency or fake products listed on an e-commerce website, I think we can establish, at lease the genesis of a pattern here.  For all of the above reasons, It's in the Chinese government's best interest to manage the supply and keep the exchange rate for the offshore currency bubble-iscious and as disconnected from the "real" struggling, debt laden economy and currency (CNY) as possible. It's an incredible chess game taking place between the world's financial Super Powers.  If average citizens like you and I can figure this out, we can be rest assured that that the FED, Treasury and State Department are all well aware of it and are working tirelessly on a few moves that would preserve our financial system and eventually put the PBOC in Checkmate......just like they were "all over" the housing crisis.


Additional Reading:

Silicon Valley Fraud - Interestingly, it's fraud usually doesn't happen until the perpetrator has a problem making the payroll.
http://www.nytimes.com/2016/09/01/technology/a-silicon-valley-dream-collapses-in-allegations-of-fraud.html?smid=tw-share

Wells Fargo Fraud - 5,300 employees - 2 million fake accounts - Huffington Post
http://www.huffingtonpost.com/rj-eskow/al-capone-meet-wells-farg_b_11992610.html

Susan Rice - MSNBC Video
http://www.mediaite.com/online/u-s-chinese-officials-get-into-a-spat-on-tarmac-after-obamas-plane-lands/

Forbes - G20 - What the World knows about Hangzhou
http://www.forbes.com/sites/ywang/2016/09/02/what-we-know-about-chinas-g20-summit-host-city-hangzhou/#755899cf1da6

Fosun - Financial Statements
http://ir.fosun.com/phoenix.zhtml?c=194273&p=irol-IRHome

NYT - Anbang's Global Shopping Spree
http://www.nytimes.com/2016/09/02/business/dealbook/anbang-global-shopping-spree-china-mystery-ownership.html?emc=edit_ta_20160901&nlid=70198410&ref=cta&_r=0

Forbes - China's Largest Companies -Ranking
http://www.forbes.com/pictures/hfek45ehi/industrial-and-commercia/#230305446ffd

Bloomberg - ICBC - NPL's
http://www.bloomberg.com/news/articles/2016-08-30/icbc-posts-1-gain-in-second-quarter-profit-from-year-earlier

Bloomberg - Zombie Barrowers
http://www.bloomberg.com/news/articles/2016-08-18/china-s-secret-lists-of-zombie-borrowers-leave-banks-in-the-dark

ICBC- Financial Statements
http://www.icbc-ltd.com/ICBCLtd/Investor%20Relations/Financial%20Information/Financial%20Reports/default-PageList-2.htm

ABC - Financial Statements
http://www.abchina.com/en/investor-relations/performance-reports/annual-reports/

China Breaks into Song over G20
http://blogs.wsj.com/chinarealtime/2016/08/31/china-breaks-into-song-over-the-g-20/

Worlds Largest Banks - 2000
http://www.scaruffi.com/politics/banks.html

Balance Sheet Assets 2000 - JPM - 332; CITI 327; GS 290; WF 263; BAC 572

Mario Draghi pleads for higher wages
http://fortune.com/2016/09/08/draghi-pleads-again-for-help-as-ecb-stands-pat/

Forbes - Largest Chinese Companies
http://www.forbes.com/pictures/hfek45ehi/chinese-banking-dominate/#1e0bbc5b72b5

Forbes - Largest US Companies
http://www.forbes.com/sites/steveschaefer/2016/05/25/the-largest-u-s-companies-2016-berkshire-banks-and-apple/#666e05fd4701

Forbes - Worlds Biggest Public Companies
http://www.forbes.com/global2000/#/tab:overall

2010 Fosun Financials - Related Transactions  Note 50 pg 177 - 4.5B RMB loans
http://media.corporate-ir.net/media_files/irol/19/194273/20110411/Annual%20Report_e.PDF
87B RMB total assets 12/31/09 -  p 65

2015 Fosun Financials -
http://www.fosun.com/wp-content/themes/fuxing/document/report-2015-yr-en.pdf
406B RMB total assets 12/31/15 -

Vincent Price Diabolical Laugh
https://youtu.be/1iHkqgKMBDc

Hank Paulson - 2006 - sells $500 million of GS Stock Tax Free
http://www.marketwatch.com/story/paulson-files-to-sell-500-mln-in-goldman-stock

 Hank Paulson
http://www.paulsoninstitute.org/wp-content/uploads/2016/09/PPI_Demystifying-Chinese-Investment_Paulson_English.pdf

Paulson - Views on the August 2015 RMB devaluation
https://www.youtube.com/watch?v=O0f17SexBWg

Paulson - China's Economy is Running Out of Gas
https://www.youtube.com/watch?v=4nfQeyGLtQo

FED - Largest Banks in the US > $300 Million (1,792 Banks)
https://www.federalreserve.gov/releases/lbr/current/

Forbes - McDonalds and KFC Selling Chinese Assets
http://www.forbes.com/sites/ywang/2016/09/09/why-mcdonalds-kfc-are-turning-to-local-investors-to-survive-in-china/?utm_source=followingweekly&utm_medium=email&utm_campaign=20160912

Fosun - Ironshore IPO
http://www.businessinsurance.com/article/20160609/NEWS06/160609773

Ironshore - AM Best
http://www3.ambest.com/ambv/bestnews/presscontent.aspx?altsrc=9&refnum=24104

BIS - CNH/CNY Differential - Fundamentals, Contagion and Policy
http://www.bis.org/publ/work492.pdf

Mizuho Bank - CNY vs CNH
http://www.mizuhobank.com/service/global/cndb/rmb/pdf/double.pdf

ERI - PBOC Monetary Policy White paper 2014
https://www.hindawi.com/journals/ecri/2014/509643/

Friday, August 19, 2016

The Theory of Financial Relativity

The best thing about being a blogger is that I have the latitude to write about whatever piques my curiosity, without concern that some ham-handed editor might ban my musings or worse try to distill them to 140 characters or less, in a misguided effort to maximize "eyeballs" or advertising revenue.  Many of the topics I like to explore are simply too complex to discuss in a few paragraphs.  For example, for this post, to really understand this topic, it's important to take a trip back in time to revisit the work of French Chemist and Physicist, Antoine Laurent Lavoisier, circa 1785.

I'm hopeful I didn't lose too many of you with that introduction, but I believe it's an important preamble to set the stage for what we're going to talk about today.  For those of you unfamiliar, Lavoisier developed/discovered what is now commonly known as the Law of Conservation of Mass (i.e. Matter can neither be created nor destroyed.) This was groundbreaking work and his experiments and methods became a road map for for the modern science to follow.  Unfortunately, for his unique perspective and conflicting political views during the French Revolution, Lavoisier was eventually guillotined in 1794, presumably without recognition, understanding or appreciation of the historic importance of his work.  I'm of course hopeful that my work re: the Theory of Financial Relativity will result is a much less brutal consequence for my efforts.  I've never been one to contemplate giving my life, literally, to science. Thankfully, I need not frame my work to deal with the politics of an impending revolution, nor do I have a guillotine-wielding Robespierre to consider, at least that I'm aware of.

As Lavoisier's theory generally states, in a closed system, Matter/mass can neither be created nor destroyed. It simply changes form.  Mass/Matter is fungible, flowing seamlessly from one state to another when energy is applied.  Matter is Matter.  For example, in economic terms an iPhone and the proverbial "steaming turd on a hot August sidewalk" have roughly the same mass, yet the perceived economic value is vastly different.

This post explores the human experience re: the mechanics of how our global economic systems place a value on various forms of Matter.   Here's a silly little chart to get us started.



Let's say for example, hypothetically of course, that there are only two things on this planet, "Matter" and "money".  Matter is defined as "everything" and "money" is defined as our perceived value of same.  Since Matter is a constant (it can't be created nor destroyed), simple math tells us that the relationship between the price people are willing to pay for Matter (at least on this planet....a closed system) and the amount of money available, is linear.  As our singular, omnipotent, all powerful imaginary central bank increases/decreases the money supply, the price that people are willing to pay for Matter increases/decreases proportionately.

So...Why does the Price of Matter actually matter?

Let's think this through.  If our imaginary money supply stays constant, the aggregate value of all global Matter also remains the constant.   There's a certain level of stability.  There's an expectation of equilibrium.  If the price of one type of matter goes up....another must go down.   People, who ironically are also made of Matter, have an easier time making rational decisions, determining value and allocating their money.

In an economic system, people convert matter to other types of matter through production, construction, marketing, hype, fraud and any conceivable method to create a higher perceived value, and hopefully, create some personal wealth for their efforts along the way. Perhaps they take wood, land, plastic and cement and create luxury real estate, or maybe throw together some aluminum, steel and engineering talent and Eureka! we have a jumbo jet!  In any case the perceived value of the end product should be much higher than the aggregate value of the components, providing of course, in this example, that there is enough "money" available, and people can afford the luxury Real Estate and/or the jumbo jets can actually stay in the air. As all of this activity takes place, it would be prudent for our singular, omnipotent, all powerful imaginary Central Bank to gradually increase the money supply to match the perceived value of what's being created.  Unless there's  a reasonable expansion of the money supply, as people perceive more value in a jumbo jet and they are willing to pay more for travel, compared to say, food or clothes, the relative perceived value (and price) of food and clothing would have to decline without said monetary expansion.  i.e.) There's only enough money to go around.

Here's where it gets complicated 

The above simple example describes the price/value relationship between one (1) currency and one (1) constant, universal economic good/service (Matter).  Today, our wonderful, big blue marble has more than seven billion people engaged in some sort of economic activity (production or consumption).  There are millions of businesses, all attempting to manage a perceived value of tens of billions of SKUs, barters, trades, goods and services. There are hundreds of governments trying to regulate the aforementioned activities for various, and usually conflicting political reasons.  There are 200+ Central Banks and currencies out there, thousands of financial institutions, and hundreds of trillions of dollars worth of "money", financial assets, stocks, bonds, derivatives, off the books IOU's, guarantees and god knows what else, all having their "perceived values" adjusted by Mr. Market nearly every millisecond.

All of this complexity and speed, of course, creates the possibility for mistakes and errors in judgment.  Dr. Richard Thaler, if you are familiar with his work on Choice Architecture, often cites the difference between humans and "Econs".  Humans, of course, are you and I. We make choices based on our own personal biases and limited knowledge, often failing to make the best choices. Econs, as Thaler describes, are people who have no biases, perfect knowledge and an aptitude to always make the best decision in any scenario.  Econ's, of course don't exist....so it looks like you and I (and seven billion of our neighbors) are relegated to the life of a human, muddling through with limited or incorrect information, inappropriate biases and an insufficient ability to analyze most of our daily conundrums.

Central Bank Coordination

Financial globalization has lead us to an unprecedented time in Central Bank history.  Like never before, the FED, PBOC, ECB, and the BOJ (the combined monetary engine for roughly 75% of the planet's economic activity) seem to be operating in a carefully choreographed stimulus dance, with each trying to take the lead and pick up the tempo at the expense of the others.  This waltz began with the BOJ's movement toward  Near-ZIRP in the late 1990's and was further validated by the FED's rate cuts, TARP and stimulus during the financial crisis.  Once the FED opened the door, albeit necessarily, to recapitalize the US Banking system, Central Bankers around the globe had an epiphany....they were born again,  They began implementing policy, which, under the guise of economic stimulus, did little more than support and inflate already bubble-ized asset prices.  It stands to reason that the Central Bankers will reach (if they haven't already) the point of no return.  It would appear that we are on an inevitable, accelerating pace to negative interest rates in every corner of the globe.  (Sweden, Denmark, Japan, Switzerland, etc. are already paving the way)  There is always some "crisis" on the horizon preventing the Central Bankers from "going up" that pesky quarter-point. This phenomenon was unthinkable a decade ago.

The FED Charts below illustrate the odd behavior of US Broad Money (M2) over the last few years.  M2 has nearly doubled in the last decade yet the velocity (defined as the ratio of the number of times one dollar is spent per quarter) continues to decline.




One would think that this relationship would be unlikely, if not, impossible.  Logically, circulation should increase (rather than decline) as the money supply increases.  For an answer to this paradox we need to look to Dr. Thaler's work in Behavioral Economics.  Since the financial crisis, all of this liquidity has been poured into the banking system.  Since the bankers are the gate keepers, deciding who gets a piece of all of this stimulus, we can only conclude that the lions share of this money has been "stuck" in the banking system and financial assets, i.e.) the often discussed "decoupling" of the financial system from the "real" economy. Simply put, the money isn't actually making its way to individuals and businesses which hire workers, spend money, increase consumption and therefore, velocity.  The money is being used to bid up the price of financial assets.  If we think about it for a minute, it makes perfect sense.  Most of us (bankers included) make the best choices available.  If we don't believe that we can expand our businesses profitably, we don't do it.  The folks at the top of the food chain would rather keep the money in financial assets, retirement accounts and savings.  (because they are generating a heck of a return)  They/we/us have no need to consume. Our consumption habits don't change all that much when we have a good year.  On the other hand, working folks, scrimping by on two part time jobs would most likely consume/spend every nickle they could if the money ever made it down to them.  Unfortunately for all of us, it doesn't.   So consumption, prices and wages don't increase....and we can't grow our businesses comfortably/profitably.  So we all hunker down.



Debt continues to grow.  As we can see by the chart below, Non-Financial (Core) and Public (Government) debt has increased significantly (US$ 23 Trillion) since 2010 with no appreciable accretion in GDP. Simply put, businesses and governments are borrowing to spur growth with comparatively little to show for it. Moreover, with China's NBS continuing to report dubious GDP/Growth/Production, and nearly all of the below described debt increase ($20 Billion) is attributable to the Chinese economy, the proliferation of non-productive, low quality (non-performing) debt may be accelerating at a much quicker rate than the traditional ratios might indicate. In other words, despite all of this stimulus, global GDP might actually be declining.      



Here's another chart (below) showing US GDP growth.......bumping along at a half -% or so per quarter.  It looks kind of pathetic when we think about the amount of money that's been deployed to generate this paltry growth.  You'd think that the GDP would be skyrocketing.  Again, the value of Matter that really matters... Matter that's "transformed" and "consumed" (GDP)..... has been flat. 



The FED is starting to rethink what's happening in this "New Economic Era".  Presumably they'll be working toward an increased focus on fiscal policy (which unfortunately is out of the FEDs control) in an effort to get more of the money they print into the hands of people who will actually spend it.   (see Williams - New Orthodoxy)

So What's the Problem?

Central banks can continue to ease, provide credit, roll over bad loans, absorb and recapitalize businesses, and keep money losing, zombie enterprises afloat indefinitely.  With a coordinated effort Central Bankers can support the price of bad Matter, continually breathing new life into an an economy chocked full of steaming financial turds.  So as the Central Banker's dance continues, the global money supply and related debt levels spiral upward.  As an economist, you might ask: Where is the inflation going?  Well, of course the disposition of inflation is government/economy specific.  The perceived value of Matter everywhere is being re-evaluated.  In the US we know inflation isn't going into wages or raw materials.  We've learned long ago that trickle down economics doesn't always trickle.  Sometimes the trickle gets diverted by Mr. Market.  I've postulated for a while now that we shouldn't be seeing a doubling in US equity prices (since 2009) with an anemic (2% +/-) annual growth in GDP, but that's where the inflation is hiding.  The US Stock Indexes just keep busting through record high after record high.  In China the inflation is "stuck" in vacant real estate and excess capacity.  I'm sure we can look at every economy participating in the global money supply expansion and make a "Where's Waldo" guess as to where they are storing their inflation.  As an aside, for those of us who work for a living, there doesn't seem to be much inflation showing up in our paychecks anywhere on the planet.  Yet, the retirement (income) assets we're hoping to buy with our savings are continually priced higher. The yield declines, until we will all eventually pay a fee  to save (negative rates).  This math, for a Central Banker, is apparently a fair trade for the avoidance of a systemic default

The Theory of Financial Relativity:

The cornerstone of the theory is:

"Central Bankers, acting in concert, expanding the money supply, funding, guaranteeing and recapitalizing debt, regardless of quality, can prevent the decline of the perceived value of the planet's aggregate Matter."

Everything is indeed..."Relative".  The proposed Theory, to be tested over time (Like most Macro-Economic Experiments there is unfortunately no test-lab available) is comprised of Five Underlying Banking/Accounting Rules (FUBAR):

  1. The aggregate value of Matter has a linear relationship with the supply of money.
  2. Prices of individual components of Matter(assets) will fluctuate based on their perceived value.
  3. Central Banks, acting in concert, can manage the perceived value of classes of Matter (assets) within a relative range through open market operations. i.e.) Purchasing anything their hearts desire with money hot off the press.
  4. Nominal prices are irrelevant as long as perceived value relationships remain constant within a relative range. 
  5. If classes of Matter (assets) never decline in value or default, Economic stability is guaranteed.

Of course, the key question is:  Does the world really have a theoretical debt ceiling?....if so...what is it?  The Theory of Financial Relativity would conclude that there is none.

It's a given that individual businesses, economies and governments all have a theoretical "debt limit". They borrow money and  reach their debt ceiling when their creditors believe, through complex analysis, there is a possibility that they might not be paid back.  At that point, lenders have their lawyers draft a carefully worded letter that says.  (Dick Fuld Banker-Speak-Translator "BST" Translation:):  "NO MORE %$&#!! MONEY FOR YOU!....YOU LOSER!....GIVE ME MY MONEY BACK NOW!".   These letters are of course, generally ineffective (the money is gone/spent), but they feel good to write and legally absolve the author from any responsibility to shareholders or regulators for making the bad loans in the first place. As a nugget of trivia, I believe the Mafia coined the term "debt ceiling"....or was that "cement overshoes".....but I digress.

Let's consider the possibility (and it seems to be happening), that if all of the Central Banks on the planet are on the same page and collude to prevent any and all defaults, they will all keep printing money at a coordinated rate, maintain stable currency relationships and allow borrowers to keep paying debt service with cheaper and cheaper currency.  If Central Bankers continually increase the outstanding global debt and money supply (i.e. nobody demands their money back, similar to how the PBOC is operating today) the cycle could conceivably continue on forever.  Central Bankers, when they work as a team, can simply keep printing money, preventing anyone from having to send out those nasty "GIVE ME MY MONEY BACK!" letters.  Like in China today, everyone gets a participation trophy.  The world is sunshine lollipops and rainbows in perpetuity.

Carlo Reiter, an analyst at JCAP estimates that the Chinese Central Bank (PBOC) spends RMB 570 to 600 Billion (US$ 85 to 90 Billion) per month rolling over bad loans that would otherwise be considered non-performing (NPLs).  One series of actions which might indicate that the FED, ECB and BOJ are acting in concert with the PBOC would be a continued, coordinated easing to assist the PBOC in an orderly depreciation of the RMB.  Carlo expects this roll-over-funding to continue and the RMB could decline by up to 15% within the year.  If Carlo is correct, for this to be a truly orderly adjustment, the PBOC will absolutely need a little help from their friends.  If the Theory of Financial Relativity is genuinely being implemented, we can expect this stealth refunding and expansion of Open Market Operations to accelerate, softening the blow when perceived value shifts, if and when Central Banks around the globe deem it necessary to step in.

Naturally, Central Bank Balance sheets continue to expand. (Yardeni)  Combined assets (FED, PBOC, BOJ & ECB) have increased nearly US$ 2 Trillion, to roughly US$ 17.3 Trillion this year. This increase would most likely be even greater had the PBOC not been required to spend "a few hundred billion" of its FOREX reserves defending an over-valued RMB.  (Remember my post a year and half ago.....China's Dream?)  Of note, this increase, of course wasn't a liquidity driven TARP-like-free-for-all yard sale where the Central Banks were forced to buy every orphan, unwanted security on the street in order to keep financial markets from freezing up.  The bulk of this expansion, as far as we can tell, has been voluntary.  Global, pre-crisis balance sheet levels were roughly US$ 6 Trillion and rose to about US$9 Trillion once liquidity was safely restored.  Today, Central Bank Assets have nearly doubled from that level.  As you might suspect, it's apparently lots of fun to print money and buy stuff!    


Moreover, the "Theory of Financial Relativity" provides that, as long as the perceived value relationships remain constant, the nominal value of assets (Matter) is irrelevant.  Asset prices might be increasing at the speed of light but it feels like we are standing still.  There is no debt ceiling and there can never be an actual default.  The deck chairs are simply reshuffled.  Sadly, there is also no real economic growth.  Like Major League Baseball during the steroid era, all of the historic ratios become meaningless. Wages and commodity prices will always decline in real terms since new money must be used to roll-over bad debt, stave off defaults and pay the negligible debt service due to BZIRP.  (Below-Zero-Interest-Rate-Policy....like the Frozen theme song....just "let it go"...) Interest rates must remain negative forever. Yet, the world remains in equilibrium.

So, you might ask, what happens if one of the major players won't/can't participate in the choreography? What happens if  some political shock appears on the horizon that a coordinated Central Bank effort can't handle?  What if the currency/valuation relationships are disrupted?  What if Central Bankers just can't seem to get along, or god forbid, disagree?  Isn't there a good chance that the rogue economy/Central Bank might be sucked into a financial black hole, taking anything near its' perimeter (counter-party) with it?  Well, yes, of course, that probability exists, just as it always has, but I might suggest that there is also a point where, once the giant ball of global debt reaches a critical mass, the consequences for not playing along would be so severe that no banker or politician would dare tempt fate.  The safe political path would always be to continue pumping stimulus into zombie banks, paying paltry debt service on loans that will never be paid back in a mad scramble to an undefinable, infinite bottom.

Central Bankers behavior would resemble a financial arms race reminiscent of the cold war. Remember MAD? "Mutually Assured Destruction"?.  (Authors Note: When I typed that phrase I had a chilling flashback of the days when my classmates and I would huddle under our kindergarten desks when the Nuclear drill alarm went off.)   The deterrent of MAD relied on the belief that the consequences of launching a missile were so dire that it was thought no rational leader would ever consider doing it.  Central Bankers may be nearing a monetary MAD, but instead of ICBM's, today we use junk bonds, derivatives, "dog-shit-wrapped-in-cat-shit"CDO's and the discount rate.  Today, no rational Central Banker would dare tighten unilaterally.  When they press the button they would risk destroying the global financial equilibrium and their own country's economy....along with everyone elses.  What Central Banker worth his/her salt would want his/her picture to pop up after a Wikipedia search entitled: "Dude responsible for the Global Financial Armageddon"?

Interestingly, there may also be, in this author's opinion, a moral hazard attached to all of this acceleration.  The money we've earned and managed to save from back in the 80's & 90's, when treated like any other commodity, declines in value rapidly.   When the supply of dollars/currency increases geometrically, every one of those original '80's & '90's dollars is now worth a fraction of what it was worth when we earned/saved it, in terms of purchasing power.  The value of our savings is destroyed.  As a "saver" choices become limited.  Our life savings is the validation of our hard work and good decisions over the last few decades.  Today, as Investors, we can either 1.) "Invest" in risk assets that should either increase dramatically in nominal terms if the Central Bankers stay the course..... or could go away overnight if the choreography of the Central Bankers is somehow violently disrupted; or 2.) hold cash and watch its purchasing power silently devalue over time.  Risk averse savers on fixed incomes (our Mom's & Dad's and eventually you and I) will slowly go broke.  Sadly, those are really our only two (2) options today.

Therefore, if the Theory of Financial Relativity is correct, and Central Bankers will never permit risk asset prices (in aggregate) to decline, we should all throw caution to the wind and trust our Central Bankers.  We should pile our savings into risk assets (stocks & derivatives tied to stock performance) forever. Jeremy Siegel was right!  We're all going to be filthy rich (in nominal terms) without doing a blessed thing!  Participation trophies all around!


The Only (Painless) Way Out.....

Now, let's say that, perhaps, just for the sake of argument, that the Theory of Financial Relativity (what's happening now) might be.....well.....and I shudder to think it......dead wrong.   I'm not talking about an Ooops...I bounced a check or forgot to renew my license plates kind of "wrong".  I'm talking about something more like a "the world is flat...this ship is unsinkable.....those O-rings should work just fine... and I'm positive Saddam has Weapons of Mass Destruction" fire and brimstone kind of "wrong".  As a scientist (particularly an Economist), I feel it's my duty, and only prudent, to speculate about the ramifications of being catastrophically wrong.  It's just part of the job.

The first way out, of course, is the aforementioned valuation reset and a Global Financial Armageddon, which hopefully no Central Banker would be in favor of.

The second path, and perhaps, the only painless way out of this spiral might be a carefully choreographed, cooperative, global Central Bank tightening? Central Banks would/could/should meticulously coordinate a slow march back up to "normal" interest rates, hopefully in a cooperative, joint effort, limiting market disruption, restoring the perceived value of savings and salvaging the future for the generations to come. Or, in the nearly immortal words of the globally respected economist, Dr. Tom Petty:  "Hey ....Baby....there ain't no easy way out.....You can stand me up at the gates of hell....but I won't back down..."

Success, of course would demand that Central Bankers lay all of their cards on the table and come clean, describing, in great detail, all of the skeletons in their collective closets and own up to all of the politically motivated misrepresentations and accounting gimmicks they've cooked up over the last decade.  Agendas, ideologies and self-interest would be put aside.  Peace and harmony would flood the streets.  Central Bankers would march arm in arm, shoulder to shoulder on Washington, Frankfurt, Beijing and Tokyo, armed with the truth, demanding monetary responsibility and a new, cooperative world order.  No Banker left behind....No Justice!....No Peace!.....Power to the People!.....They would rise up in stalwart unity, forever Facebook friends, dedicated to the proposition that they will no longer facilitate financial weapons of mass destruction fueled by cheap money and irresponsible, steaming financial turd proliferation.   As has been aptly demonstrated on the interest rate spiral down, Central Bankers are a brilliant, cooperative, benevolent, politically savvy group, deeply concerned about the common good and the welfare of all mankind.. and.....hey stop laughing!....it could happen!.....

Armageddon here we come.....


Additional Reading:

April 21st Yahoo! Finance Interview
http://finance.yahoo.com/news/ecbs-draghi-havent-talked-helicopter-124843859.html

Negative Interest Rates
http://www.bloomberg.com/quicktake/negative-interest-rates

People are starting to look.....Anne Stevenson Yang at Grant's re: RMB
http://www.valuewalk.com/2016/04/alibaba-group-holding-ltd-baba-jcap/

Gordon Chang - China's Credit growing 4x GDP
http://www.forbes.com/sites/gordonchang/2016/04/17/china-credit-growing-four-times-faster-than-gdp/#190b9108256c

Interest Rates
http://www.global-rates.com/interest-rates/central-banks/central-bank-america/fed-interest-rate.aspx
http://www.global-rates.com/interest-rates/central-banks/central-bank-china/pbc-interest-rate.aspx
http://www.global-rates.com/interest-rates/central-banks/european-central-bank/ecb-interest-rate.aspx
http://www.global-rates.com/interest-rates/central-banks/central-bank-japan/boj-interest-rate.aspx

CIA Factbook - Total Stock of Domestic Credit
https://www.cia.gov/library/publications/resources/the-world-factbook/rankorder/2211rank.html

World Bank - Domestic Credit
http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS?locations=US
http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS?locations=CN

BIS - Debt Statistics
http://www.bis.org/statistics/totcredit/tables_f.pdf

Trading Economics - US, EU, China, JPN Stats
http://www.tradingeconomics.com/country-list/government-debt-to-gdp

MAD Flashback
https://www.youtube.com/watch?v=sTJ0GB1ltAQ

John Williams - SF Fed President - Take on ZIRP
http://www.bloomberg.com/news/articles/2016-08-15/williams-calls-for-rethink-of-fed-orthodoxy-in-new-economic-era

Bloomberg - Monetary Policy
http://www.bloomberg.com/news/videos/2016-08-17/trennert-monetary-policy-has-become-actually-harmful?cmpid=yhoo.headline&yptr=yahoo

Yardini - Central Bank Balance Sheets
http://www.yardeni.com/pub/PEACOCKFEDECBASSETS.pdf