JW: Let’s turn from Greece to China, where there’s been some measure of recovery from the stock market collapse. We were all following it with great interest, but how serious was this collapse? It looked huge on the charts, but after all, the fall in values was only to levels seen as recently as March of this year. Is the bigger story perhaps the zealous interventions of the Chinese authorities?
JR: I think both stories are big. Let’s take them separately. First of all, I would not refer to this crash in the past tense. It’s actually just starting. I was on television last fall looking at the Shanghai Composite Stock Index and said, “This is a bubble that’s going to crash.” To me, it was very apparent. Bubbles are not that difficult to spot.
When it did crash, I called attention to that and said, “Hey, I was out there a while ago saying this was a bubble that was going to crash.” Somebody immediately came back and pointed out that the level at which I made that forecast was actually below where it was after the so-called crash. In other words, if you had ignored me and bought stocks, you would still have made money.
I’m not in the business of picking tops and bottoms or picking exact turning points. I am in the business of analyzing system dynamics and trying to understand where those dynamics are going so that we can stay ahead of the curve and not be surprised by these things, whether it’s Greece or the Chinese stock market and so forth.
Yes, it is correct that it was off the top and crashed pretty hard – about 30% – but even at the 30% level, it ran up so much that even after going down 30%, it was still above the level where it was at the beginning of the year. But it’s not over. When bubbles break, they don’t go straight down to the bottom. They go down, bounce up, down again, and then they bounce up a little bit. We hear people saying, “Buy the dips.” They buy the dips, it goes up, it goes down again, and some people say, “There’s another dip. Buy the dip,” etc. It’s a process of denial, a process of stages, an irregular process. It doesn’t go straight down.
I suggest that analysts or investors take two stock charts that actually look very alike, the Dow Jones Industrial Index from 1927 to 1933 or the NASDAQ stock market from 1996 to 2001. Either one of them will do fine. Then just normalize it and overlay it on top of the Shanghai Composite. What you’ll see is that the run up looks quite similar. It gets strong, it gets momentum, and then it goes hyperbolic. Then it goes straight up, it gaps up, and then it breaks. You’ll see is that Shanghai is nowhere near a bottom.
Everybody remembers October 21, 1929, when the U.S. stock market went down almost 25% over a two-day period. That was just the beginning. The market didn’t hit bottom until 1933. It took four years to grind its way down and was down 90% by the time it was done, not 20% or 30%.
It was the same thing with NASDAQ when it broke in January 2000. It found its way back not to the old high, but it went up a little bit and ground down a little bit. Then it broke sharply and ended up down 80%. So if you look at those stock charts and look at what’s going on in Shanghai, I would say that this crash has just begun.
Coming to your second point, the Chinese government has used extraordinary measures that are fairly well-known. They did a whole host of things to basically stop the fall. They banned short selling which seems to be the first thing everybody does. Then they told institutions they were not allowed to sell at all. Then they limited margin accounts. They also came up with a $19 billion investment fund. So they got all the brokers to buy stocks, they told the institutions they were not allowed to sell stocks, they eliminated short selling, and they did a number of other things. Who knows what they did that we don’t know about?
It was an extraordinary effort, but it hasn’t really worked. It stopped that crash dynamic and put a floor under it, but it hasn’t caused it to rally very much. I wouldn’t expect it to. This process is just beginning, so yes, it is very serious.
By the way, this doesn’t mean that the Chinese economy is falling apart. Growth has slowed down a lot, and that’s a big deal for the world because they are about 10% of global GDP, but the economy hasn’t ground to a halt. This is a stock market crash and a capital markets problem. A lot of individual investors are getting wiped out, and it could be a social problem for the Communist Party and the authority of the Communist Party.
I expect it to go down a lot more, but I would watch very closely. It’s far from over. It has that dynamic to it where it could to go down another 50% from here, go up and down a little bit, and fluctuate. This is really just beginning, and it’s a serious problem for people who threw money into it.
Meanwhile, the elites – the princelings, senior Communist party members, CEOs, owners of state-owned enterprises, and other mega-wealthy in China – are getting their money out as fast as they can. They have been for years as I covered in Chapter 4 of The Death of Money.
I travel around the world quite a bit. Go to Vancouver, British Columbia or Melbourne, Australia or Istanbul, Turkey or London or Paris – I was just in London and Paris last week – and you hear the exact same story. High-end condos are going through the roof. They’re being bought up by mostly Chinese money among others – maybe some Russian oligarchs and South American drug lords as well.
You have to be connected to get your money out of China. You may be upper middle class – perhaps you own five McDonald’s restaurants in Wuhan or a chain of 7-Elevens in Chongqing or a car dealership in Shanghai — you’re not poor but you’re not mega-wealthy. You may have a few million dollars saved up, but you still cannot get your money out of China very easily. If you are mega-wealthy worth $100 million or $500 million or $1 billion as many of these Chinese princelings are, there are a lot of ways to get money out of the country either through corruption, the ability to have offshore companies, transfer pricing, rigging fake losses in a casino, etc.
What does it tell you if the smartest, richest, most connected people in China are getting their money out? How much confidence do they have in their own economy? The stock market is a problem, but it’s not the only problem. There is a lot of rot in that society. You could be looking at social unrest down the road.
As I said, I think their stock market has a long way go down, so I wouldn’t invest a nickel in China. There are other reasons for that. For example, if you’re a large business, they steal your intellectual property. China is a fascinating story. It’s an old culture, a strong economy, and an important player in the international monetary system. I watch it from the global macro international monetary perspective, but it has so many problems and so much opaqueness that I wouldn’t recommend anyone investing in it.
JW: Is the implication then that this collapse is a very special case? Or is there anything to draw from it in a larger sense about stock market investment and what can happen from an investor’s point of view?
JR: It’s a special case in the sense that China’s stock market is collapsing. This is not happening elsewhere in the world. The European stock industries are doing okay, and Europe’s growth seems to be a little bit better.
The U.S. looks like it peaked last November – not literally peaked, but it’s reached a few new highs since then although not very much higher than it was last fall. The U.S. stock market is going sideways in what I call ‘non-directional volatility.’ There are days when it’s up 200 points, down 150 points, up 90, and down 80. Looking at a chart of the S&P and the Dow Jones, they’re wiggling sideways with a lot of volatility. Job creation seems to have slowed down as have a lot of things, so it looks like the U.S. is not quite in a recession, but we’re close to one. Growth really hit a wall as to the stock market late last year.
I don’t see the bubble crash dynamic in other major stock markets that I do in China. China seems to be unique in that case. I look at the interconnectedness, what I call density function or the potential for either what’s called contagion or what the IMF calls spillover effects. What are the odds that a crisis in one country spills over and causes a crisis in another country? That’s always a potential problem and something I look at very closely.
The Greece thing seems to have been contained to Europe so far and not too much damage was done to capital markets. Obviously, this is extremely painful for the people of Greece as they have to sacrifice: their pensions are being cut, their unit labor costs are going down, wages are going down, and unemployment is going up. There are a lot of problems inside Greece, although that could bottom and turn around pretty quickly once banks reopen, they get access to capital, and maybe some Chinese capital comes in. You might look for a turnaround in Greece, but there was no real contagion, although I think there would have been if Greece had left the euro.
The China thing does seem to be unique to China. Looking back a week ago Wednesday when we had that awful sequence of events, it looked like Greece was collapsing, China was collapsing, and the New York Stock Exchange was closed for some software problems all at the same time. Two of those things are behind us – the Greece thing and New York Stock Exchange closing – and regarding China, I think markets have absorbed that.
These don’t look like the kinds of things that will set the world on fire, if you will, or start global contagion, but they are warnings of how unstable a lot of things are.I always say that the thing that will cause a global panic is the thing we don’t expect. We could see the Chinese event coming. I talked about it on television last year in 2014. I may have been early – that’s fine – but we could see it coming a mile away. And we’ve been talking about Greece for five years, so as dangerous as those things were, neither one of them were unexpected.
One reason to own gold, one reason to be prepared and not wait for a crisis, is that when the crisis comes, it will be something we don’t expect and there won’t be time to get ready. The time to get ready is now.