It Comes From The East (And Soon)

The title is, indeed, a bit hyperbolic, but the substance of the article is correct…. and it’s in Forbes.

On Friday, Chinese state media reported that China Credit Trust Co. warned investors that they may not be repaid when one of its wealth management products matures on January 31, the first day of the Year of the Horse.

The Industrial and Commercial Bank of China sold the China Credit Trust product to its customers in inland Shanxi province. This bank, the world’s largest by assets, on Thursday suggested it will not compensate investors, stating in a phone interview with Reuters that “a situation completely does not exist in which ICBC will assume the main responsibility.”

Why does all this matter?  Because this “investment” was “offered” under terms that were essentially impossible to fulfill at the outset.

They included a 10% annual return to investors, or three times bank deposit rates in China.  This means that the company had to be paying more than that (since nobody lends intentionally at a loss.)

Obviously the firm that did the borrowing was desperate.  The Forbes article details some of the probable reasons, but it doesn’t matter why.  What matters is that this is an instance of a facially-fraudulent scheme if looked at with any sort of diligence at all.

That’s very much like our so-called “pension plans” that promise 8% returns in their portfolios, all of which are scams because there is no possibility of ever earning that return except by stealing it over very long periods of time.  A person’s work-life is about 45 years (20-65), and thus if we were to assume such a pension plan had a ~40 year time horizon the first dollar put in would have to have expanded by 21.7x over that 40 years.  For that to be sustainable the economy would have to expand by 21.7x over the same 40 year period.

Let’s look back 40 years, to 1974.  GDP was 1.548 trillion.  It would have to be 33.6 trillion today for that “estimate” to have worked, and we’re fully 50% short of that aren’t we?

How about now?  We’re at $16.9 trillion today.  GDP would have to be $366.7 trillion 40 years hence for that 8% return to “work.”

The only other means for it to “work” is if you steal fully half of the return in your fund from someone else, assuming our so-called “expansion” matches the last 40 years.  But it won’t, because of this:

That is, what we’ve done over that last period, most-particularly from 1980 forward, is expand credit and therefore have people borrow more and more money to “produce” a lesser expansion in GDP.  And that’s exactly what we’ve gotten — the blue line is over the red line.  Further, continuing this charade requires ever-looser credit standards and ever-lower interest rates.

There are two problems with this: First, zero is an effective lower barrier on interest rates.  But more to the point, as rates approach and reach zero there is no reason for someone who has capital to lend it at all, since they earn nothing from doing so.

This in turn destroys the incentives to form capital, and that in turn chokes off GDP.  As I have previously commented the impact from this sort of policy is not felt instantly, which is why people like Ben Bernanke and Janet Yellen thought they could get away with it originally — that it would be short-lived and therefore the impacts hidden in what would otherwise be a “recovery.”

Unfortunately for them the recovery never came, because the credit bubble was (as are all credit bubbles) expressions of fraud.  By suborning fraud one becomes a part of the fraud. Now the Fed is trying to slowly back away from that which theyknew wouldn’t work over an extended period (despite Bernanke’s words) in the first place.  How did they know this?  Arithmetic never changes.

Frauds cannot exist forever.  You choose either to expose and prosecute them, letting the consequences fall on the people who commit them, or you compound them and make them worse.  Those are your options.

China has done the latter, but the important point here is that we have as well.

Yes, I expect China will try to cover this one up.  And in the grand scheme of things the dollar amount of this scheme isn’t all that large.  But that’s not the point either; all collapses of large-scale fraudulent edifices do not happen when the final “wall” is hit.  They happen long before, when the critical person sticks up their hand and calls bullshit on what they are being told and sold.

Exactly who the critical person is and when the event happens is impossible to determine in advance.  But that this event will happen, because from an arithmetic perspective it must, is simply not subject to debate.

The Market Ticker

Go to responses (registration required to post)