China's Crash In Context

This is a follow-up to a post I made a few months ago, US Strength in the Upcoming Monetary Shift. In that previous post, I challenged the notion that the United States would be entering future negotiations for a new monetary system from a position of weakness. It outlined some of the weaknesses of other world powers and some of the strengths of the United States. It was not to say that the US would sit at the head of the table, though I certainly don’t rule that out, only that it would not be absent, left in a pile of rubble. The US will likely have substantial influence. Many in the alternative financial media take it for granted that the US is going to become a third world nation due to its financial, monetary, and fiscal profligacy, with the Russians and Chinese teaching the Yanks a lesson. The reckless actions of the US will have repercussions, but they will be market driven from simple economic laws, not at the hands of other nations. I believe picking foreign powers as the ‘good guys’ is related to a need for retribution for what is perceived, with good reason, as arrogant and atrocious stewardship as a world power. While understandable I think that is more a gut reaction than proper research and analysis. The remainder of this post with focus on China.

China’s recent market troubles support the view that they will have difficulty supplanting the US as a world economic leader, at least over the next decade, during which time I think we are going to observe a monetary overhaul.

Many believe that China’s success is the result of superior long term planning by their government. When the truth is, China’s success is simply the result of a shift from communism, which doesn’t work, to fascism which incorporates just enough capitalism to be successful. Sure once in a while they do things that appear to be a good idea, but so too did the soviets.

Their rise has been goosed by a simple credit created boom allowed by a debt-based monetary system, no different than the flawed system used in the United States and the rest of the world. There is not a significant difference between a credit created boom due to government borrowing and private borrowing. You may get some more useful production from the private sector, but there is still rampant misallocation of resources, mal-investment resulting in bubbles, and speculation. When all this unwinds the damage done to market psychology will be irreversible as evidenced by the tears running down the faces of newly created stock traders watching their virtual wealth disappear.

And it is unwinding as I type, with the Shanghai Composite Index shockingly falling over 30% in one month, over 5% today alone, 7/8/15. The Chinese are reacting to this drop in nearly the same manner as the United States did in 1929, with the same result, failure. Though not as dramatic (barring the perhaps the bond market bubble) the US certainly has its fair share of asset bubbles due to central bank intervention. The difference thus far has been the US markets have remained oddly buoyant in the face of both the Greek crisis and Chinese market crash. This suggests the US Plunge Protection Teams ability to manipulate markets to drive market participant sentiment appears more fit for the task than their Chinese counterpart. These apparent abilities will not prevent the eventual reversion of the markets from their lofty heights, but may allow it to be more controlled, preventing some psychological damage. This is likely due to the experienced gained over a much longer run with financial markets, and crashes, than the Chinese.

One of the reactions from those who see China as the heir apparent, or dare I say savior of the world economy is their possible gold hoard. There are rumors, with admittedly convincing research, indicating China could have 10 or even 20 thousand tons of gold. They reason if the credit created bubble collapsed they could simply back the yuan with that gold. This certainly may be an option, but the question is whether the Chinese Government would be willing to give up control of the monetary system, and be restricted by a gold standard. Shifting to a gold standard would be, as Mises said, a voluntary abandonment of further credit expansion, and would allow the crash to play out.

China has a historically fickle population that is quick to protest and revolt. This is always a primary fear of the government which has used the credit created boom to placate the masses. A gold standard would put the power in the hands of the population, not the government, and while I would love to see that transition, I doubt the Chinese government would. If this is the route taken, the struggle for the Chinese government to maintain power could leave the economy and society in turmoil for decades.

On a side note; if this market turmoil is associated with cyber-warfare as suggested on Zerohedge, who knows who will win the war, but the battle, as measured by market reaction, is being won by the United States.