Harsh lessons for China after dramatic week
The Dow lost 588 points on Monday. The rich made money on the way up. Now, they're giving it back – about $250bn-worth in the last two trading days.
Shanghai stocks sank another 8% on Monday, too, and a desperate plea came in from our Beijing office.
"What do we do? Just tell investors to hold on?"
The Chinese are neophytes at investing. Market capitalism was only permitted after 1979. Since then, Chinese investors have only seen the upside. If you wanted to make money in stocks over the last 35 years, all you have to do is to hold on.
In the US, at least, there were always a few old timers who remembered earlier periods – from 1968 to 1982, for example, before the fix was in – when stocks did not always go up. And there was a still a faint residue of doubt as to what was really behind the great boom, and how it might end.
In China, though, almost no one has ever seen a bear market or a recession. The Chinese are all convinced (as near as we can determine) that China will continue to grow – economically and militarily – until it rules the world.
That may still be true. But even so, the Chinese are discovering that even if you're marching uphill, you can still sprain your ankle and scrape your knee.
Meanwhile, back in the USA, the boom came in stages. The first stage began in '82 and was healthy and reasonable. It lasted until 1987. Interest rates and inflation fell, stocks rose.
Then came the Crash of '87, in which the stockmarket registered its biggest drop ever – down 22% in a single day. In the aftermath, Alan 'Bubbles' Greenspan made it clear that the Fed would no longer play the role of honest custodian of the nation's money and indifferent observer of its capital markets. Henceforth, the Fed was in Wall Street's pocket, and Wall Street was in everybody else's pockets. After '87, the Fed made EZ money available, by lowering its key rate. The EZ money passed through the banking sector, which took a substantial cut, and raised capital asset prices, which benefitted the rich. One of the richest of the rich is Donald Trump, said (by himself) to be worth $10bn, and now candidate for president.
Monetary stimulus was supposed to be balanced by monetary tightening, but the Fed was soon stimulating far more than it was tightening. This was the second stage of the boom. The most dramatic event of this stage was the crash of the Nasdaq in 2000. Many of the highest flying dotcoms went out of business and the Nasdaq itself fell more than 70%. But the Dow and the S&P were soon on the rise again.
It was in this period that the economy began to look as though it should wear a bag over its head. In the popular jargon, it was 'financialised'. Retail sales increased as households spent money they didn't have on things they couldn't afford and didn't need. Much of this money was made by 'taking out' equity from their houses.
Mortgage finance boomed, as lending practices in the housing industry loosed up. Malls and housing developments were built all over the country. Companies, notably GE, changed their business models to take advantage of easy credit. And the great houses of Long Island changed hands – from the tycoons of commerce and the titans of industry they passed to bankers and hedge fund managers.
This second stage ended in 2008, when the housing bubble blew up. Then began an even more grotesque phase. In Stage III the river of EZ credit flowing into the US became a tidal wave, lifting US stocks up to 300% of what they had been at the bottom of the crash and causing even more rot in the economy. More people went on 'disability' than got new jobs. Household income went down. And the main buyer of US corporate stock became US corporations themselves!
This was when the Fed gave up all pretense of operating a balanced, sensible monetary policy. Instead, it dropped its key rate to near zero and kept it there for six years.
This phase is not over, but the end must be coming. When? Well, we never know.
Friday's 530-point break was just a warning. Most likely, we will see some dilly-dallying around, a bounce and nervousness, but no panic. The talking heads will explain that there is nothing to worry about, we've seen these 'corrections' before, the best thing to do is to buy and hold. That always worked in the past. It will work again, etc, etc.
And then, suddenly, we'll get a few days when the Dow will close down 1,000-points. That will be the end of this third phase.
What then? Well, that's when Saint Janet will ride to the rescue. We can almost see the Time magazine cover already. Saint Joan on a white horse, with the reins in her left hand and a banner in her right.
But wait. This time it won't be so easy. Rates are already at zero; what's she going to do? Drop them below zero? Loosen margin requirements? Prohibit us from making 'negative' comments? Give Americans a tax credit so they can spend money? Introduce QE4, wherein the Fed not only buys bonds, but stocks too!
For now, it is cash, cash, cash. Cash is king. But that will change when the Fed swings into action. That will be the fourth and final stage of the great boom – when the zombies and cronies counterattack, with a massive barrage of inflation. Hang on to your hats!
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