Trumped! A Nation on the Brink of Ruin... And How to Bring It Back

by David Stockman

  But the Red suzerains of Beijing are already proving in spades that when the music of credit expansion finally must stop, they will have no clue about what to do or capacity to execute if they did. In that respect, it now appears that in the first quarter China’s banking system generated new credit at an annual rate of nearly 40% of GDP.

  In turn, China’s so-called “iron rooster” was given a new lease on life as a result of even more artificial demand for capital investment and infrastructure that is already massively overbuilt. Accordingly, during March, China’s steel production hit an all-time high, causing prices to temporarily rise and closed mills to reopen.

  So much for the credit restraint promised by China’s central bank and for the 150 million tons of capacity closures announced by the apparatchiks in Beijing a few months back. In latching itself to Mr. Deng’s printing presses, the Chinese Communist Party made a pact with the financial devil. But now it is far too late to stop the Ponzi, meaning that another central bank–driven debt implosion is fully scheduled and waiting to happen.

  GAMBLING LIKE NEVER BEFORE IN THE RED CASINO—ITS BALEFUL GLOBAL IMPLICATIONS

  In the heyday of its incredible credit and construction boom, China was building two world-scale utility plants each week and opening up a new airport every day. Economic-fiction writers like Goldman’s Jim O’Neill, chief propagator of the BRICs myth, declared the Red Ponzi to be the very Second Coming of capitalism.

  Now, by contrast, a Chinese billionaire goes missing practically every day, as a recent Washington Post article explained:

  That’s what happened last year when China’s richest man—at least on paper—lost half of his wealth in less than half an hour. It turned out that his company Hanergy may well just be Enron with Chinese characteristics: Its stock could only go up as long as it was borrowing money, and it could only borrow money as long as its stock was going up. Those kind of things work until they don’t.

  The gentleman in question, Li Hejun, has had quite the financial spill. About 500 days ago in April 2015, according to Forbes, he was worth $32.7 billion. Then on May 20 last year, when the stock of Hanergy Thin Film Power Group (HTF), in which he had a 81% stake, plunged by 47%, $14 billion of that disappeared in minutes. And since then, all the rest of it has vaporized as well.

  Our purpose here is not to jitterbug on the corpse of another riches-to-rags story from the Red Ponzi. The fact is, Li Hejun and his Hanergy caper is China writ large.

  Like Hanergy, China is an incendiary cauldron of financial madness that is destined to have a spectacular demise. And it will take the global economy and the gambling dens of Wall Street, London, Tokyo and the rest down with it.

  Yet the punters continue to frolic in the shallow waters of the market’s daily chart-driven undulations, as if oblivious to the great Red Shark fast approaching. Then again, having missed Fannie Mae, Freddie Mac, Lehman and AIG there is apparently no sign obvious enough to empty the financial beaches in a world of central bank–driven Bubble Finance.

  Still, consider a little more detail about the Hanergy caper because it represents not an extreme outlier, but the actual central tendency of the Red Ponzi. The Washington Post account summarizes the pure madness as well as can be done whilst keeping a straight face:

  The first thing to know about Hanergy is that it’s really two companies. There’s the privately owned parent corporation Hanergy Group, and the publicly traded subsidiary Hanergy Thin Film Power (HTF). The latter, believe it or not, started out as a toymaker, somehow switched over to manufacturing solar panel parts, and was then bought by Hanergy Chairman Li Hejun. And that’s when things really got strange. The majority of HTF’s sales, you see, were to its now-parent company Hanergy—and supposedly at a 50 percent net profit margin!—but it wasn’t actually getting paid, you know, money for them. It was just racking up receivables. Why? Well, the question answers itself. Hanergy must not have had the cash to pay HTF. Its factories were supposed to be putting solar panels together out of the parts it was getting from HTF, but they were barely running—if at all. Hedge-fund manager John Hempton didn’t see anything going on at the one he paid a surprise visit to last year. It’s hard to make money if you’re not making things to sell.

  But it’s a lot easier to borrow money and pretend that you’re making it. At least as long as you have the collateral to do so—which Hanergy did when HTF’s stock was shooting up. Indeed, it increased 20-fold from the start of 2013 to the middle of 2015.

  And then it came crashing back to earth on May 20 when the ruse got exposed. That is, its market cap had gone from $5 billion to $42 billion in about five months, and then it was all given back in five minutes.

  In fact, the company presently has no market cap at all. It has been “suspended” from trading since last summer.

  Nevertheless, it is not just the the phony 8X gain at the beginning of 2015 that reveals the incendiary underside of the Red Ponzi. The more fantastic side of the story is how this stock was levitated by upward of $35 billion in such a brief span of time.

  As the Washington Post story further explained, it all happened in the last 10 minutes of trading every day!

  Suppose you’d bought $1,000 of HTF stock every morning at 9 a.m. and sold it every afternoon at 3:30 p.m. from the beginning of 2013 to 2015. How much would you have made? Well, according to the Financial Times, the answer is nothing. You would have lost $365. If you’d waited until 3:50 p.m. to sell, though, that would have turned into a $285 gain. And if you’d been a little more patient and held on to the stock till the 4 p.m. close, you would have come out $7,430 ahead. (Those numbers don’t include the stock’s overnight changes).

  That’s some pattern. And there’s almost no way it could have been the result of chance. The most reasonable explanation is that someone was deliberately moving the stock up and up so that he could borrow more and more against it. Nobody knows who was behind it—at least not yet, but it’s clear who benefited from high share prices the most: Hanergy Chairman Li Hejun.

  It turns out that China’s very richest man at the time was posting his HTF shares as collateral for loans from the giant state-owned banks and shadow-banking lenders.

  He did some of it through offshore subsidiaries, but when even that loan gravy train ran out there was no place to hide. Lenders were forced to sell the company’s shares that had been pledged for the loans, and in a matter of minutes the stock crashed and was subsequently suspended.

  As the Post finally explained,

  there isn’t much of a company left. HTF has lost four times as much money as it’s taken in over the past year, it can’t even pay the rent for all of its offices, let alone its bonds, and Li just unloaded some of his shares on the private market for 97 percent less than they were worth at their peak.

  We have contended that China’s so-called banking system is just an extension of the Beijing-based state command-and-control machinery. It has virtually nothing to do with legitimate banking, and, in fact, is just a giant financial waterfall through which fiat credit is sluiced into the economy on a top-down basis.

  Surely, the billions that were being pumped into the Hanergy Ponzi—in the face of what even a lending-officer trainee could see was a stock-rigging operation—leaves no other conclusion.

  In fact, the parallel surge of the Shanghai stock market during approximately the same period was funded in exactly the same manner. During the period between July 2014 and June 2015, when the Shanghai index soared by 150%, margin lending exploded from $100 billion to $500 billion.

  Relatively to China’s ostensible GDP, that was in the same ballpark as the eruption of margin lending that preceded the 1929 stock crash in New York.

  Indeed, at the peak of the stock frenzy last June, Chinese gamblers had opened 389 million stock-trading accounts—one for every man, woman and child in America with 60 million left over. And on top of conventional broker margin loans, the number of online P2P-lending operations had surged, as discussed above, from 10
0 in 2013 to upward of 2,500 by last year.

  The point is, after $30 trillion of debt issuance in less than two decades China has turned itself into a giant mob of speculators and gamblers.

  The place is dangerous, and not because it bought a rusted-out used aircraft carrier from the Ukraine a few years back, and not because it cheats in world trade, as The Donald so loudly and correctly insists.

  The Red Ponzi threatens the world by virtue of a printing press that is so white hot that an implosion that will shake the global financial system is only a matter of when, not if.

  CHAPTER 19

  The Apotheosis of Bubble Finance—the Coming Crash of Tesla and the FANGs

  THE INEXORABLE EFFECT OF CONTEMPORARY CENTRAL BANKING IS SERIAL financial booms and busts. With that comes increasing levels of systemic financial instability and a growing dissipation of real economic resources in misallocations and malinvestment.

  At length, the world becomes poorer.

  Why? Because gains in real output and wealth depend upon efficient pricing of capital and savings, but the modus operandi of today’s central banking is to deliberately distort and relentlessly falsify financial prices.

  As we have seen, the essence of ZIRP and NIRP is to drive interest rates below their natural market-clearing levels so as to induce more borrowing and spending by business and consumers.

  It’s also the inherent result of massive QE bond buying where central banks finance their purchases with credits conjured from thin air. Consequently, the central banks’ big fat thumb on the bond market’s supply/demand scale results in far higher bond prices (and lower yields) than real savers would accept in an honest free market.

  The same is true of the hoary doctrine of “wealth effects” stimulus. After being initiated by Alan Greenspan 15 years ago, it has been embraced ever more eagerly by his successors at the Fed and elsewhere ever since.

  Here, the monetary transmission channel is through the top 1% that own 40% of the financial assets and the top 10% that own upward of 85%. To wit, stock prices are intentionally driven to artificially high levels by means of “financial easing.” The latter is a euphemism for cheap or even free finance for carry-trade gamblers and implicitly subsidized hedging insurance for fast-money speculators.

  As the stock averages rise and their Fed-subsidized portfolios attain ever-higher “marks,” the wealth-effects operators supposedly feel, well, wealthier. They are thereby motivated to spend and invest more than otherwise, and to actually double down on these paper-wealth gains by using them as collateral to obtain even more cheap funding for even more speculations.

  The trouble is, financial prices cannot be falsified indefinitely. At length, they become the subject of a pure confidence game and face the risk of shocks and black swans that even the central banks are unable to offset. Then the day of reckoning arrives in traumatic and violent aspect.

  Exactly that kind of Lehman-scale crisis is now descending on global markets. In fact, it’s even worse. Speculative excesses that are even more fantastic than during the dot-com era mania have now infested the technology and social media stocks.

  So once again the end result of today’s massive central bank intrusion in financial markets will be yet another thundering crash of the highfliers and a resulting financial crisis of unprecedented extent.

  THE FOLLY OF THE FANGS

  Needless to say, there have been some spectacular rocket ships in the market’s melt-up during the last several years. But if history is any guide this is exactly the kind of action that always precedes a thundering bust.

  To wit, the market has narrowed down to essentially four explosively rising stocks—the FANG quartet of Facebook, Amazon, Netflix and Google—that are sucking up most of the oxygen left in the casino.

  At the beginning of 2015, the FANG stocks had a combined market cap of $740 billion and combined 2014 earnings of $17.5 billion. So a valuation multiple of 42X might not seem entirely outlandish for this team of racehorses, but what has happened since then surely is.

  At the end of August 2016, the FANG stocks were valued at $1.3 trillion, meaning they have gained $570 billion of market cap or nearly 80% during the previous 19 months. Not only has their combined PE multiple escalated further to 50X, but even that’s almost entirely owing to Google’s far more sober PE at 30X.

  By contrast, at the end of August 2016, Netflix was valued at 300X its meager net income of $140 million, while Amazon was valued at 190X and Facebook at 60X.

  In a word, the gamblers are piling on to the last trains out of the station. And that means, look out below!

  An old Wall Street adage holds that market tops are a process, not an event. A peak under the hood of the S&P 500 index, in fact, reveals exactly that.

  On the day after Christmas 2014, the total market cap of the S&P 500 including the FANG stocks was $18.4 trillion. By contrast, it closed at $19.0 trillion in August, reflecting a tepid 4% gain during a 19-month period when the stock averages were spurting to an all-time high.

  Needless to say, if you subtract the FANGs from the S&P 500 market-cap total, there has been virtually no gain in value at all; it was still $17.7 trillion.

  So there you have it—a classic blow-off market top in which 100% of the gain over the last 19 months was owing to just four companies.

  Actually, there is growing deterioration down below and for good reason. Notwithstanding the FOMC’s stick save at nearly every meeting during the past two years, each near miss on a rate hike reminded even Wall Street’s most inveterate easy-money crybabies that the jig is up on rates.

  Sooner or later the Fed will just plain run out of excuses for ZIRP, and now, after 93 straight months on the zero bound, it clearly has.

  And at the most inopportune time. As we demonstrated earlier, the world economy is visibly drifting into stall speed or worse, and corporate earnings are already in an undeniable downswing. As we have also indicated, reported earnings per share for the S&P 500 during the LTM ended in June 2016 came in at $87 per share, or 18% below the $106 per share reported in September 2014.

  So the truth is, the smart money has been lightening the load during much of the last two years, selling into the mini-rips while climbing on board the FANG momentum train with trigger finger at the ready.

  CHASING THE LAST MOMO STOCKS STANDING—AN OLD WALL STREET STORY

  Needless to say, this narrowing process is an old story. It famously occurred in the bull market of 1972–73 when the impending market collapse was obscured by the spectacular gains of the so-called Nifty Fifty. And it happened in spades in the spring of 2000 when the Four Horsemen of Microsoft, Dell, Cisco and Intel obfuscated a cratering market under the banner of “this time is different.”

  But it wasn’t. It was more like the same old delusion that trees grow to the sky. At its peak in late March 2000, for example, Cisco was valued at $540 billion, representing a $340 billion, or 170%, gain from prior year.

  Since it had earned $2.6 billion of net income in the most recent 12-month period, its lofty market cap represented a valuation multiple of 210X. And Cisco was no rocket ship startup at that point, either, having been public for a decade and posting $15 billion of revenue during the prior year.

  Nevertheless, the bullish chorus at the time claimed that Cisco was the monster of the midway when it came to networking gear for the explosively growing internet, and that no one should be troubled by its absurdly high PE multiple.

  The same story was told about the other three members of the group. During the previous 24 months, Microsoft’s market cap had exploded from $200 billion to $550 billion, where it traded at 62X reported earnings. In even less time, Intel’s market cap had soared from $200 billion to $440 billion, where it traded at 76X. And Dell’s market cap had nearly tripled during this period, and it was trading at 70X.

  Altogether, the Four Horsemen had levitated the stock market by the stunning sum of $800 billion in the approximately 12 months before the 2000 peak.

 
That’s right. In a manner not dissimilar to the FANG quartet during the past year, the Four Horsemen’s market cap had soared from $850 billion, where it was already generously valued, to $1.65 trillion, or by 94%, at the time of the dotcom bubble peak.

  There was absolutely no reason for this market-cap explosion except that in the final phases of the technology and dot-com bull market, speculators had piled onto the last momentum trains leaving the station.

  But it was a short and unpleasant ride. By September 2002, the combined market cap of the Four Horsemen had crashed to just $450 billion. Exactly $1.0 trillion of bottled air had come rushing out of the casino.

  Needless to say, the absurdly inflated values of the Four Horsemen in the spring of 2000 looked exactly like the FANG quartet today. The ridiculously bloated valuation multiples of Facebook, Amazon and Netflix speak for themselves, but even Google’s massive $550 billion market cap is a sign of the top.

  Despite its overflowing creativity and competitive prowess, Google is not a technology company that has invented a rocket ship product with years yet to run. Nearly 90% of its $82 billion in LTM revenues came from advertising.

  But the current $575 billion worldwide advertising spending is a 5% growth market in good times, and one that will slide back into negative territory when the next recession hits. Even the rapidly growing digital-ad subsector is heading for single-digit land; and that’s according to industry optimists whose projections assume that the business cycle and recessions have been outlawed.

  The fact is, Google has more than half of this market already. Like the case of the Four Horsemen at the turn of the century, there is no known math that will allow it to sustain double-digit earnings growth for years into the future and therefore its 30X PE multiple.