China Is Melting Down

China is melting down but no one knows it or sees it.

The signs are all there. Falling growth (everywhere). Myriad government attempts to pump liquidity and capital into the system. The market still in make believe mode.

Panic has not set in. Commodities have been the canary in the coal mine, but no one seems too concerned. My bet is the property development sector will provide the trigger. Weakness in the Yen has set about the next leg of the global currency wars. Stresses and strains are showing everywhere (Europe, Japan, Latam, Australia).

We are in the calm before the storm. Batten down the hatches.

Playing with fire

From January 1941 through September 1981, per Bernstein's figures, U.S. Treasuries shed 67.3% of their real value.

At a 3% nominal yield and 2.5% long term average inflation…locking in 0.50% real return….if inflation really gets going then all bets are off...and that return doesn't even take account of taxes.

Here is the real risk. Catastrophic risk. I don't think it is deflation. That is because the central banks are already all in on that one. They have already told us in no uncertain terms that they will do everything they can to forestall deflation. Fine. I believe them. If deflation takes place then the CBs are going to combat it. I think the real risk is that they are skating on thin ice. They not only lack credibility (they have used much of it up) but they lack the capacity to expand the monetary base (it is already overextended/on borrowed time). The likely result is things flipping from deflation to hyperinflation as total trust and confidence in the system evaporates. They are skating a fine line right now. If they do manage to get us out of the fire, then they will have been incredibly lucky.

If we don't go into deflation again, then we risk rising inflation and potentially hyperinflation (although that would require a real shock to the system).

We have plastered over the cracks. The system is fragile. Our psyches are fragile. Confidence is fragile (although I think it is very much seeping into the system at the moment and could very easily take us to the next level). But the whole thing is a facade, an emperor with no clothes. No one knows when the music will stop again, but stop it will.

The Achilles Heel of Capitalism

Taleb makes the point that the achilles heel of capitalism is that if you make corporations compete, it is sometimes the one that is most exposed to the negative Black Swan that will appear to be the most fit for survival.

I have made a similar point previously. Basically, those companies that appear to be "best in breed" are oftentimes those that are the rottenest, ie. they are cooking the books (eg. AIG).

The Coming Collapse

Given the path we are on (high levels of debt, unsustainable deficits and the promise of massive unfunded future liabilities), it is not a matter of if, but when, the current structures and institutions that comprise the existing international monetary system (actually that is bit of a misnomer because there is no actual system, but a loose assortment of institutions, rules and accepted norms) collapse under the weight of their own imbalances and corruptions.

2008 was a shot across the bow, but it doesn't look as though we are paying heed to the warning. As such, in the absence of courageous change and honest leadership, we are still on a path to reckoning. You can pay the piper now, or pay the piper later (with interest). That is the choice when you stretch beyond the laws of economics.

But let me be clear. It is not likely to be a collapse in a catastrophic sense. Rather it is likely to be over a long period, punctuated by short periods of crisis, and with the consequent dismantling of whatever structure, institution or norm is ailing us at that particular point in time.

We will awake at some point in the future, and in looking back, will see that all the institutions, structures, rules, and norms that guided us, have been replaced by a new set of rules, structures, and institutions.