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Misconceptions About China's Stock Market Crash
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For many U.S. and British economic commentators, recent developments in China have been only slightly less scary than the seemingly endless Greek debt crisis. Supposedly if the Chinese stock meltdown gets much worse, China could be headed for the sort of depression the United States suffered in the 1930s – and perhaps bring the rest of the world with it.

My advice to the commentators is to keep their “Made in China” headgear on. Not only is China not destined for any great depression but, as the top China watcher Pat Choate has pointed out, it can reliably be expected to continue to outperform for many years to come. Moreover, far from being part of the problem, China’s swooning stocks are actually part of the solution.

The commentators may find all this too paradoxical to credit, but then hot-air balloonists were probably similarly nonplussed by reports from Kitty Hawk in 1903. Pace Anglophone conventional wisdom, China does not owe its success to free-market capitalism. Quite the contrary.

China has embraced a powerful new system whose counterintuitive workings often make a mockery of Anglo-American economic dogma. Top Chinese leaders would prefer you did not know all this: the longer Americans remain in the dark about the reality of the Chinese economy’s true workings, the better. Chinese leaders are after all heirs to the tradition of the author Sun Tzu, who famously preached that all warfare was based on deception.

Let’s note at the outset that there are implicit contradictions in Anglophone reporting of the China stock crash.

One version has it that the fundamentals of the Chinese economy are ex-ante badly out of whack and that a Chinese depression is preordained. In this version, stock investors are merely anticipating a real economy disaster.

A second, more widely espoused, version gets the direction of causality the other way around: an economic depression is threatened if the authorities don’t act promptly to prop up the stock market.

The first version can be dismissed out of hand. The idea that the investing public or even some inspired subsection of it can anticipate major economic turning points is bunk. If it were otherwise, the world would be full of billionaires who grew rich through so-called market timing. In reality the number of successful market timers is vanishingly small. Successful investors – Warren Buffett is the quintessential example – generally don’t attempt to predict secular market movements but merely search for individual stocks that look likely to outperform.


As for the second version – that a Chinese stock crash could cause a depression – this is inspired by a widely touted but erroneous belief that the 1930s Great Depression was caused by the Wall Street crash. Supposedly the crash set off a self-feeding process in which a massive loss of consumer confidence induced U.S. industry to slash both jobs and investment. Although this interpretation was authoritatively debunked in 1963 by Milton Friedman, who showed that the real cause was overly restrictive Federal Reserve monetary policies, it remains deeply imbedded in the American press’s consciousness and is clearly a factor in how commentators see the current Chinese stock swoon.

Of course, the press is right about one thing: Chinese stocks are down about 30 percent from their peaks of a few weeks ago. To understand why this is not a problem you need to start with a look at Anglophone ideology. For Anglophones, the key to achieving fast economic growth is to get prices right. By this they mean not least establishing an efficient stock market-based financial system. By contrast, as James Fallows has pointed out, East Asian leaders believe in “getting prices wrong.” What he means is that government officials constantly override the market where this may deliver desirable outcomes such as increasing the flow of savings to industry.

Viewed in this light, Chinese stock markets are easy to understand. Far from aspiring to be pale imitations of the New York or London stock markets, they are run unashamedly as giant casinos in which government functions as the house, and enjoys the benefit of a lucrative house fringe. It is not too difficult to imagine that for the house one profitable maneuver might be to foster pronounced boom-bust stock cycles of the sort that have characterized Chinese stocks for decades (Chinese stocks suffered a far bigger tumble in 2008 than in recent weeks).

At the beginning of the cycle, various Chinese government entities load up on shares at low prices. Then they unload near the top. The victims are ordinary investors who tend to buy near the top and sell close to the bottom. To say the least the government is unsympathetic to such investors, who, of course, are seen as the merest of speculators. Basically they are sheep to be sheered but, for the most superficial of political reasons, the government has been going through the motions of propping up the market.

Underlying all this is a larger system of dirigiste bank-based finance. Not only are all the major banks substantially government-owned but so are all the major corporations.

One final point: while stock market crashes are feared in the Anglophone world in large measure because of fears that they will poleax consumer demand, a shortage of consumer demand is rarely if ever a problem in East Asian-model economies. Quite the contrary. This is because of another fundamental aspect of East Asian economics: consumption is systematically suppressed, a policy that broadly stimulates the propensity to save. At times when consumer demand flags, policymakers can readily ease up on artificial controls on consumption. Consumer credit provides an example. While consumer credit is generally tightly controlled, the controls can be relaxed at short notice, with immediate powerful effects in boosting demand. That said, so far at least New China seems rarely if ever to have had occasion to resort such tactics. As an export-driven economy China has consistently been able to find overseas demand for its goods.

• Category: Economics, Foreign Policy • Tags: China, Shanghai Stock Exchange 
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  1. Sean says:

    “This is because of another fundamental aspect of East Asian economics: consumption is systematically suppressed, a policy that broadly stimulates the propensity to save. “

    Isn’t saving a characteristic of those populations? Government may well encourage it and seem to be behind it, but I think those populations are not so easily prodded into consumption.

  2. Anonymous • Disclaimer says:

    This passage fundamentally misstates and misunderstands the forward looking quality of public markets as well as basic portfolio theory:

    “The idea that the investing public or even some inspired subsection of it can anticipate major economic turning points is bunk. If it were otherwise, the world would be full of billionaires who grew rich through so-called market timing.”

    The stock market directs financing towards investments with the highest expected return (as expressed within a market-weighted, diversified portfolio). The aggregate movement of market prices is the prediction – no mind (individual, collective or otherwise) of any individual or “the investing public or even some inspired subsection of it” need comprehend or manifest the market’s expectation. The price sits objectively on the trading board and (imperfectly) objectively aggregates the subjective beliefs of its participants and produces prices that predict the future based on all of their information. No billionaires need result from this process (although there are billionaire “quants” who do prosper from market interstices and sophisticated forms of market timing – Jim Simons being a rather spectacular example).

    The collapse of the Chinese stock markets is exactly a harbinger of a deep recession to come. The Chinese government has simply applied cosmetics to the corpse. Believe it.

  3. MarkinLA says:

    If stock movement predicted anything then Apple’s move from 700 to 350 a few years ago would have been an indication of something being wrong with Apple. It was an indication of nothing other than a lot of people were seeing a downward movement in the stock and were trying to get out at a high price and hoping to buy back in later at a lower price.

    When stocks go down people sell for no other reason than that when they go up they buy for no other reason than that. Stocks undershoot their true value on the way down and overshoot their true value on the way up. The movement of stock prices says next to nothing.

    • Replies: @Realist
  4. Anonymous • Disclaimer says:

    Why is stock market price inflation a good thing? We generally hear that inflation is a bad thing. When food prices go up, people generally regard that as a bad thing. Food becomes less affordable for people, hence food price inflation is bad. So why is stock price inflation a good thing when it makes stocks much less affordable?

  5. Anonymous • Disclaimer says:

    Exports are still growing but only slowly. Annual productivity growth in China however is still excellent. I can’t make sense of this article, but I agree China will continue to outperform for years.

  6. Realist says:

    Fox News and the other MSM were just giddy over the ‘news’ that the Chinese stock was going to crash.

  7. Realist says:

    “When stocks go down people sell for no other reason than that when they go up they buy for no other reason than that. ”

    Tesla is a classic example of the latter.

  8. the 2008 financial crisis was preceded by a major crash of the chinese stock market …a few months after china crashed, so did the american stock market.

    • Replies: @MarkinLA
  9. As the growth of China’s GDP for many years seemed to depend on massive construction as a necessary part of the urbanisation which was an inevitable (part cause part effect) aspect of China’s economic modernisation it was of concern to discover that the Chinese government(s) at all levels was rescuing itself and quite a few resource rich countries like Australia by supercharging that source of demand during the global financial crisis. Of concern because, inevitably, building excess capacity is a recipe for trouble, and that’s what did happen apparently. The new story was that China was going to need domestic (presumably consumer) demand to take over.

    If big losses on the stock market were enough to make that needed domestic demand fade away – an empirical question to which I do not claim to have an answer – then it would be consistent with everything known about the Chinese economy that the government, backed by access to huge savings (albeit doubtfully solvent banks and SOEs) would seek to provide and generate demand. But how? Presumably it would not have to go as far as Japan did after 1990 in expenditure on useless projects.

  10. Very interesting to find that I am reading the work of someone who has written much about Japan. Like Eamonn Fingleton I have Japanese in laws (much liked and respected) but I have never lived in Japan and am always keen to be better informed. I discovered the Japan connection when Googling to find out about Mr. Fingleton of whom I had never heard.

    What I have just read provoked special interest when I discovered the same line about Japan as about China, namely that those clever people were engaging in strategies that Americans didn’t understand, and of which American ignorance was fostered by the cunning Japanese. (Think Confucius and Sun Tzu, supra).

    I suppose one shouldn’t put too much store on what Mr. Fingleton did after putting on jacket and tie and delivering his copy to the New York Times but the non MSM in the shape of Spiked had some rather rude things to say about almost everything he wrote about Japan’s economy (somehow working the word “paranoid” in too) and this heckling of our esteemed columnist can be found here

    Now I don’t know Mr. Fingleton and have nothing against him. I could imagine listening happily to his charming Irish voice in a Dublin pub with sehr gemütlich spirit all round (sorry I feel some gesture to his multi country sophistication is owed but have too few exotic languages, not even my ancestral Irish Gaelic, and have to improvise). I happen to be sanguine about the effect of the Shanghai stock market volatility on the rest of us, as he is, but let’s not accept him as the great non-MSM contrarian. He mostly proves that journalists have to try ever harder to find a line that grabs attention. Well done him, for managing to do quite an efficient recycling job from Japan to China.

    • Replies: @Eamonn Fingleton
  11. The Chinese stock market is basically a casino, Chinese corporations don’t rely on it for funding, and it has very little relation to its economy at large. Triples, goes down by 50%, doesn’t really matter.

  12. @Anonymous

    Jim Simons’ record provides little support for your argument. He is a hedge-fund manager whose reputation, in common with that of most other successful hedge-fund managers, crucially depends on an early bout of above average success which he does not seem to have been matched in subsequent years. In the late 1980s and early 1990s he outperformed spectacularly with one fund – the Medallion fund. He then closed it to new investment, which has meant that no information is available on its subsequent performance and as a practical matter such performance is reportedly a closely guarded secret. It is a reasonable inference that if the Medallion fund had continued seriously to outperform there would be little need for secrecy.

    More generally, if it were really true that stock market investors can anticipate major economic turning points, movements in stock market averages would be remarkably smoother than they actually are. As the investment author Benjamin Graham pointed out in his famous Mr. Market allegory, stock markets are notably manic-depressive – wildly optimistic one day and wildly pessimistic the next. Trying to predict the movements of the overall averages is largely a game of chance.

  13. MarkinLA says:
    @leftist conservative

    The boom-bust cycles of emerging market stock markets is nothing new. If there was any time that the US stock market did not predict a problem in the economy, it was the stock run up prior to 2008 so any other stock market tanking was just a coincidence, like when the Asian Tigers had their economic problems.

    Emerging markets are especially susceptible to wishful thinking by the populace. Average people have “discovered” the way to get rich without working for the first time in the countries existence. The insiders (brokerage people and corporate execs) have found a way to get rich without working by relieving the average people of their money. As the average people see the market going up, more and more people want in and push prices higher.

    What these people don’t understand is the illusion of wealth that the stock market creates. 1000 shares of Apple trade 5 dollars higher and everybody who has one of those billions of shares thinks his shares are worth 5 dollars more too. This works in the opposite direction.

    The reality is that the stock market is actually a legalized version of a pyramid scam but since it is connected with financing a business it is legal. A pyramid scam disappears when the marks have been fleeced. However, the stock market is perpetual and the insiders can continue to run their scam forever and in both directions. The vast majority of shares traded have nothing to do with financing a business. It is just people speculating on the movement of the price of the stock.

    • Replies: @dead_rat_reporter
  14. Realist says:

    “As an export-driven economy China has consistently been able to find overseas demand for its goods.”

    The fact that China’s economy is dependent on western economies is problematic. The west is due for a big butt kicking.

  15. Kiza says:

    I am of two minds about the author’s arguments.

    On one hand, I am not a believer in one economic model, the perfect model, the universal Western model. Such thinking triggers the “Group Think” impulse in me and a dismissal of its supporters.

    On the other hand, calling the Chinese smart and oh so different reads like a bit of a mind stretch.

    The conclusion is the old safe: only time will tell.

    But, Nancy Morris and other critics appear way off mark.

    Here are a few points which I consider to be beyond doubt:
    1) The Western Markets are very often irrational, they resemble a cattle stampede of a Western movie (no bears, only bulls in both direction).
    2) Consistent Market-Timing is a pure myth (I cannot believe that any serious person from finance would believe it possible).
    3) The markets are primarily the places of liquidity, their price-setting function is way overblown into a dogma by theorists.
    4) There has been a consistent and pathetic stream of schadenfreude from the Western MSM about the Chinese economy over the last 20 years, only a total fool would rely on MSM Financial “news” about China. I wish I had a dime for every time I read that China is unsustainable.
    5) Even in the Western markets, the influence of the stock-market prices on the Main Street economy is only through psychology, such as the subjective feeling of consumers=stock-holders of being rich or poor and the investment intentions by the managers (optimism and pessimism), not through any hard and direct link or economic law.

    Therefore, why would a stock-price crash all the way in China be spelling a forthcoming, certain disaster for the Chinese economy, when most investment decisions there are made by technocrats who have no reason to base their decisions on how rich or poor they personally feel?

    As long as someone buys the Chinese goods, overseas or in China, the Chinese economy will be fine, thanks very much.

    • Replies: @Ron Unz
  16. @MarkinLA

    A precise analysis. Fingleton characterizes the Chinese stock market as a sheep shearing enterprise. I think that has long been the ultimate function of public traded stock markets — the transfer of wealth from the gullible masses to the plutocrats. Hence, the current US market still searches for its top, while media analysts lament how the retail investor has missed out on its run-up. Yet should the “widows and orphans” ever pile into it, the insiders will immediately initiate a steep sell-off, and walk away with the pot. Remember the fable of old Joe Kennedy and the shoeshine boy.
    But then, I am too cynical to grasp the subtleties of economics.

  17. @Wizard of Oz

    A reply to Wizard of Oz:

    As I pointed out in an article in the New York Times Sunday News Review a few years ago (see link below), Japan has been doing fine in recent decades. The impression otherwise is just an urban myth that top Japanese officials have been glad to perpetuate. As they know full well from tensions with Washington in the 1980s, the stronger the Japanese economy appears the more pressure Tokyo faces to open Japan’s still closed markets. Japan’s all important export machine is today stronger than ever, and this despite the fact that its workforce has dropped by one-tenth due to an aging population. Did you know that the Japanese auto industry, for instance, has doubled its unit output since the 1980s — and greatly improved the quality of its products to boot? Countless other examples of little noted Japanese industrial success could mentioned, particularly in the most advanced areas of manufacturing such as in capital equipment, advanced materials, and key components. They may be invisible to the American press but they are fully apparent in Japan’s ever buoyant trade performance. Meanwhile America’s once superlative advanced manufacturing industries have collapsed, with devastating results for the U.S. current account deficit.–

    • Replies: @MarkinLA
    , @MarkinLA
  18. Ron Unz says:

    As long as someone buys the Chinese goods, overseas or in China, the Chinese economy will be fine, thanks very much.

    Well, I totally agree with that and I actually discussed some of underlying reality in a major article I published a couple of years ago. Here’s a graph it included, showing the relative changes in the per capita incomes of China and America over the last few decades:

    The interesting thing is that despite all the endless recent MSM headlines about “China’s Economic Slowdown” and “America’s Economic Recovery,” when I get around to finally spending five minutes updating the graph from 2010 to the present, it will look almost *exactly* like a direct extrapolation of the 1980-2010 numbers.

    These days, we’re living in the USSA and reading American Pravda…

    • Replies: @Realist
  19. Biff says:

    I’m personally no economist, but my wife is Chinese, and the difference micro-economically between east and west is this: My wife, and her family and her extended family don’t do debt. At all. As in none. Notta. Zilch. They treat it like the plague. If they were Superman, debt would be kryptonite. The house we live in is completely paid for, along with the restaurant my wife owns. No debt.

    When I was in college I lived in a crappy little apartment building, and right above me lived a Chinese family of four living in a one room apartment. The oldest daughter was just in high school when they finally saved enough cash($175,000) to buy a house.

    It’s simply how they roll.

    • Replies: @Kiza
  20. Sam Shama says:

    Very Interesting article which compares the dichotomous nature of the Western/US vs the Chinese economic models.

    On a PPP basis, the per capita trajectories of the levels of gdp/output look like the following (I am using St. Louis Fed data). I hope the link works:

    Naturally, the base from which the the growth is calculated, will entirely determine the rates over the past 30 or 50 years. If such growth rates can be sustained, especially when an economy enters the “middle-income” category (or certainly if it becomes a “high-income”) is open to speculation/debate. Many unforeseen things can happen over 50 years.

  21. Realist says:
    @Ron Unz

    “These days, we’re living in the USSA and reading American Pravda…”

    This is absolutely true. The western media is terrible. They have lost all credibility with people who think for themselves.

  22. Anonymous • Disclaimer says:

    Don’t forget there are also great internal demands within China. China can be seen as a group of 23 countries.

    Collective action is always better than individual and self-interest oriented action. Chinese can fasten their belt and eat less but not the Westerners.

    We should do some studies if it is the right way to judge the situation or the consequences from the Western point of view.

    The Westernrs should get a better understanding of the Oriental cultures, including the Chinese and the Japanese cultures, in order to get a better understanding through communication.

  23. Kiza says:

    Hello Ron, nice to see you took a moment off work.
    A great observation Biff, however it leads to another point. It is not only the difference in people’s attitudes between the East and the West. If you do not have debt in the West, you are paying to people who do have debt, in other words, you are a fool. Since all markets are manipulated and the tax system is set in favor of the “investors” (read speculators), then those who are debt free, the savers, are paying for the indebted. BTW, when I write “speculators” I do not mean those who do arbitrage and other economically useful market functions, I mean: the manipulators, the fixers, the insiders.

    Ok, since all Western markets are now fixed and the power of “the market forces” only exists in the imagination of economists and in the words of the MSM talking heads, the question is when and how can the current situation return to a true free market? (I am not convinced that a truly free market can exist, but what we have now in the West is just becoming totally opposite to it).

    Personally, as someone with training in natural sciences I am inclined to believe in the immutable laws of nature, such as the entropy (leveling). The Western economic system appears to be surviving thanks to a huge expenditure of resources to prop it up, including printing of money, wars and gradually increasing social repression (e.g. surveillance). This is like a spring being depressed, until one day it springs back with a huge energy.

    Regarding the Chinese economic and market system, it is different but it may not be different enough from the Western system. To me, the Chinese system looks like a good old financial pyramid scheme, but at least it is not based on other people’s money (debt) as much as the Western financial pyramid is. Once, I discussed with Mike Whitney (who I respect immensely) that all “finance” throughout human civilization has been based on:
    1) some form of pyramid scheme, and/or
    2) some form of other people’s money.
    The whole history of finance is the history of repackaging these two principles and selling such product to the gullible, a flim-flam.

    Sorry to the author, but the difference between the Western markets and the Chinese markets is only in the quantity, not in the nature. It is the same old, same old.

    • Replies: @Biff
    , @Wizard of Oz
  24. map says:

    China is a house of cards. While Fingleton is right not to put much stock in China’s capital markets, he is wrong to imagine that anything else in China is anything better.

    China, for example, has no system of property rights. This extends to stock ownership. When you buy shares in a Chinese company, you effectively own nothing. In fact, you don’t own anything you buy in China outside of what you can carry on your person. How do you sustain any kind of economy if you essentially own nothing? No wonder the Chinese are parking money outside of China.

    Fingleton seems to make a big deal out of “export driven” economies, but does he not realize that for one country to run a trade surplus another country must run a trade deficit? That export-led growth depends on a specific act of government policy in which your sales are dependent on the political whims of the country to which you export? Or, does he imagine that every nation can essentially run a mercantilist policy of focusing on exports while restricting imports?

  25. MarkinLA says:
    @Eamonn Fingleton

    You forgot the number one reason why Japanese success has to be disregarded. The Japanese are supposedly undergoing a demographic death spiral. They desperately need immigrants to save them. If we in the US don’t have our immigrants we will be just like those Zombie Japanese in a few years.

  26. MarkinLA says:
    @Eamonn Fingleton

    collapsed or outsourced?

    St Jude Medical used to make all it’s pacemakers and ICDs in Sweden and the US. These are fairly sophisticated devices using unpackaged ICs on a hybrid substrate with tiny gold wires welded from the IC pads to the hybrid traces. It is basically a significantly shrunken printed circuit board. People cannot do this work. The only thing they do is shuffle assemblies from one robot or testing station to another until the final product is ready to be sealed and disinfected.

    They opened a factory to make hybrid assemblies in Arizona to get cheaper wages and state tax incentives (soon to be closed). Then they opened a plant in Puerto Rico to get tax incentives. Then they closed the plant in Sweden since they no longer needed it to export to Europe favorably. Then they started reducing the number of shifts in California where they had been working 24/7 due to the demand. Then they opened a plant in Malaysia where they are having teething problems. It is rumored that the California plant has only 5 more years to exist once the Malaysia plant is fully functional.

  27. Biff says:

    If you do not have debt in the West, you are paying to people who do have debt, in other words, you are a fool.

    You should further explain this, but my guess is the tax code. Interest can be written off(a form of welfare). If that is your idea of being what a fool is, I might remind you that expanding your business, and/or purchasing business related items can take the place of interest deductions. In fact there is an endless array of opportunities for tax deductions outside of the interest trap that is constantly sold to the public by the banking cartels(via trained accountants) and their minions in political offices.

    • Replies: @Wizard of Oz
    , @Kiza
  28. @Kiza

    Attitudes to and consequent action wrt debt are compounded of very practical considerations; e.g. the absence of a welfare safety net and state old age pension, affordable health care etc. or being thrown into prison for debt as in 18th century England or perhaps the Gulf States today and what might broadly be called cultural factors. Experience of the Great Depression and lack of early experience of inflation and the political factors contributing to it after opportunists had taken up conveniently oversimplified Keynesianism is what I have in mind. Confirmed by my first boss telling me that he concluded in 1946 that politicians were going to rob people (he was referring to inflation not taxation) I built on a first degree grasp of economics post-Keynes to be more than 100 per cent invested all my adult life in assets which might appreciate in value and/or produce increasing income streams. But I constantly found myself aware of the mindset of older people who had deposits in a savings bank earning 1.5 per cent when inflation was 3 per cent. It was interesting to observe the extent to which such conservative innumeracy or economic illiteracy was reflected at much higher levels than the careful responsible working class. It took till 1981 for Australia’s highest court to recognise inflation with great éclat in determining that awards of damages should presume a 1 per cent earning rate on funds to provide for future needs. Of course the slightest advertence to economic history after the 1694 founding of the Bank of England and the beginning of the era of modern (lower) interest rates would have known that real interest rates from 1694 to 1914 didn’t fluctuate far from 2.5 to 3 per cent for gilts. (4 per cent was the traditional well secured first mortgage rate and rent for agricultural land). Sure enough real interest rates rebounded by the mid 80s.

    In Australia, not uniquely, the inflation expectations which had quite early intruded into wage fixing and finally reached the mind of the average punter, eventually were quelled by the flow on effects of Paul Volker’s heroic efforts and so the question might now be asked as to why borrowing to invest is so popular. (I have no understanding of what causes Australian’s high levels of household debt – but perhaps it reflects borrowing for housing more than for consumption). The simple answer would appear to be tax advantages even in a world of inflation below 3 per cent.

    But what of China? The abhorrence of debt well known to our Western ancestors quite recently is not the whole story. While it was only recently, I understand, that the first SOE was allowed to fail it seems that there are large numbers of corporations and local government entities which are basically insolvent, all the more since the spending spree of the global financial crisis years. China hasn’t needed to be taught QE.

    I think btw that you overestimate the extent and significance of manipulation or even attempted manipulation. At least for investors on rich countries’ stock exchanges the scams and manipulations are just flotsam on the great wave of retirement savings being professionally managed and, far from anything smart being done with it, suffering from self-interested risk aversion by the managers. (Mind you far to much is paid for the delusion that “all shall have prizes” and that all can enjoy “outperformance”).

  29. @Biff

    How can expanding your business take the place of interest for tax deductions? I infer from your expression “interest trap” that you think it is a bad idea for businesses to use loan capital on which they pay interest and that they are gulled into it by the banks and other sources of loan funds.
    By contrast many analysts will regard a failure to use its strong balance sheet to gear up as a failure by a company’s management though, obviously, mining and other cyclical businesses should have a lower debt to equity ratio than, say, owners of premium office buildings in London or New York.

  30. Kiza says:

    Hello Biff,
    There are at least three simple mechanisms for wealth transfer from the savers to the borrowers in the current system:
    1) the interest paid is tax deductable,
    2) the interest received from the bank is usually not (in most tax tax jurisdictions),
    3) the official inflation rate is a lie and capital gain indexation based on it is a joke.

    I am sure that there are more. Debt oriented economic set up was probably a good idea when the West was growing its manufacturing base, but it is disastrous now that the manufacturing base is declining and is being replaced by the less capital intensive service industries. In other words, debt orientation has always been a doubtful idea, but there was a time when the benefit outweighed the damage, now it is pure damage. The majority of the Western debt now is the unproductive (but tax deductable) marginal debt, which only feeds the stock market pyramid scheme without contributing to the capitalization of the enterprises.

    The problem of the Western (and to a lesser extent the Chinese) financial system is compounded by the fractional banking, which permits money printing by the banks. This creates a planet of uncovered liabilities, or rather another inverted pyramid with its ever-expanding base in the cloudy future.

    The current, possibly terminal phase, of the financial system is when both the government and the banks can print money, or when as in the US, the Federal Reserve, a private banking cartel, makes the Government dependent on the banks for capitalization. This is when the banks effectively get the government, that is its police and its military, to work for them instead of the population. Voila, you have the current US.

    • Replies: @Kiza
  31. these China is god and all powerful articles are getting really really old.

    reminder: China printed more money since 2008 than the FED the ECB and the BOJ COMBINED!!!

    explain that?

    • Replies: @Realist
  32. Kiza says:

    Sorry, I had a short-circuit in my brain, the three reasons are:
    1) the interest paid is tax deductable,
    2) the interest received from banks is not indexable for inflation (in most tax jurisdictions),
    3) the official inflation rate is a lie and the capital gain indexation based on it is a joke.

    In the past, the official inflation rate was typically 1/2 of even the most optimistic real inflation rate, but the size of the lie is increasing as money printing increases. Ask John Williams of

    • Replies: @Kiza
    , @Biff
  33. Kiza says:

    Finally, if you need a wickedly good laugh at the end of a bad working week here is a piece of news from the US: “All These Other Bitches Get To Print Money So I Can Too”

  34. Realist says:

    “eminder: China printed more money since 2008 than the FED the ECB and the BOJ COMBINED!!!

    explain that?”

    You explain it….citation?

  35. Biff says:

    First, I completely suck at macro-economics, but I’m trying to figure out what you are saying, and I get it to a certain extent. There is no doubt that handing out debt is a bankers way to rule the world – debt = money and money = debt

    There are at least three simple mechanisms for wealth transfer from the savers to the borrowers in the current system:
    1) the interest paid is tax deductable,
    2) the interest received from banks is not indexable for inflation (in most tax jurisdictions),
    3) the official inflation rate is a lie and the capital gain indexation based on it is a joke.

    I get the first one – none borrowers get taxed more.

    #2 and #3 I’m a bit lost.

    • Replies: @Kiza
    , @Kiza
  36. Kiza says:

    There is many more people in this world who think they understand when they mostly do not. I could be one of those, so please do not take my words as the final say, please remain critical about anything you read and make up your own mind. Having written this disclaimer, here is my explanation.

    The interest received from banks is not indexable for inflation means that when a bank pays interest to you on your savings, this interest is not reduced for the rate of inflation. Thus, let us assume a 3% inflation and a 5% bank interest on some term deposit. This is impossible to find right now, because the term deposits pay 0.5% and the official (joke of an) inflation rate is 2-3%. What would be the right is that you pay tax on 5%-3%=2%, or 40% of all the interest you earned from the bank. Therefore, if you earned $1,000 in interest in a FY, you should pay tax only on $400, because the rest ($600) was how much the inflation eat into your saving sitting in the bank. But, you have to pay tax on the full $1000. To makes things worse, when the bank lends your money to an “investment borrower” who may pay 10% interest to the bank, the borrower can deduct this whole 10% interest as a business expense. If the borrower borrowed this money to buy rising stocks on a stock market, this is not really a productive investment but the interest is still fully tax deductable.

    I hope you can see now how a naive money saver is thus subsidizing both some stock market gambler and the government (through tax paid).

    In my next post I will explain the capital gains indexation or why governments must lie about the inflation rate.

  37. Kiza says:

    Ok, capital gains indexation.

    When you invest money into something which produces a profit and/or increases in value (e.g. you buy a house as an investment), you have to pay tax on both dividend (say you bought a rental property for cash and you get rent – this rent is your investment dividend) and on the increased value of the house when you sell it – that is on the capital gain. The Capital Gain is calculated by adjusting the value by the official inflation rate. Capital Gains Tax makes a huge part of Government’s income, in “good times” up to 10%. Here is where the vested interest of the government comes into play – to minimize the official inflation rate and thus increase the tax revenue. The governments do not have a single reason to increase the official inflation rate, whilst they have many strong reasons (their own income) to decrease the official inflation rate (to pretend to be the good housekeepers etc). This is why the official inflation rate, as a general rule, is about half of the real inflation rate (again see

    Let me cut this long story shorter. The Western system is set up to favor the debtors and the government and at the expense of the savers. The savers lose all the time, the debtors lose only on sudden increases of interest rates, when they have to fire-sell their indebted assets because they cannot service the debt.

    But, principally, the system is set up to always favor banks. A single, historically relatively recent invention called the fractional banking is probably the single biggest mechanisms for the wealth transfer from the general population to the banks. This is what I called the “pyramid scheme with its base in the distant future”. Here is how this works.

    A bank, any bank (this is why it is called a bank), creates money out of thin air upon two things happening: someone deposits $1,000 into a bank account, someone else takes a loan of $50,000. You probably will not believe this but the bank actually does create $49,000 out of thin air, because the law of the land permits it to do so (this is what having a banking licence means). This is because the bank is obliged by law to keep only 2% of its assets in its reserves (vault). Ok, so where do the $49,000 then come from? This is your future labor which the bank has put its paws on. This is why I call this a pyramid scheme with its base in a cloudy future.

    It is very important to understand that banks are not landing money because they have savers’ capital to place, then because this is how they lay claim on the future production of a society. Banks must create loans because this is how they create wealth out of thin air, by laying claim on the future wealth of the society – a wonderful, wonderful institutionalized pyramid scheme.

  38. Kiza says:

    I do admit to being a proponent of the so called Austrian School of Economics, which teaches almost opposite econo-financial organization of the society to the currently rulling organization. Their principal premise is the so called “sound money”. But this school is hated by the rulling class, because their ownership of the society would not be viable under the principles of the Austrian School of Economics.

    The simple challenge is – will the society fail due to the rulling macro-economic model and when? In other words, when will this current systemic pyramid scheme become exhausted?

    For further reading, please visit

    • Replies: @Kiza
  39. Kiza says:

    Sorry, one more comment.

    What has been common to all pyramid schemes throughout history is that everything looks hunky-dory until it gets exhausted. It works, it works and then, one morning, it does not. The scheme’s proponents always point at the past as the predictor of the future.

    Perhaps “pyramid scheme” may be too nice a name for the current system. Anybody who has training in physics could think of the current financial organization of the society as a chain reaction: every unencumbered dollar of the society’s production (your labor) knocks off 49 dollars of the future production into the bankers’ hot little hands (through the principle of fractional banking). Then you may appreciate what awaits such society at some point of the chain reaction.

    To make things even worse, fractional banking is not the only one. There are a few other financial pyramid schemes at work.

    • Replies: @Biff
  40. Biff says:

    Thanks. Some of that I kind of intrinsically knew, but never really could explain. Personally I never keep savings in a bank at all. Most gets invested in gold backed securities/currencies, and if you’re a saver, the inflation rate alone will have you in the losing category. OTOH I consider debt(as in acquiring it) to be lethal if your business is on the skids. One can easily be “owned” with debt(which is why the IMF is handing out debt to Ukraine).

    • Replies: @Kiza
  41. Kiza says:

    Biff I do similar as you. When SHTF, then only gold will be worth anything – we need to disregard the current situations of the gold market. I have exactly the same attitude to debt because my risk profile is skewed towards the minimum of risk (for a minimum of return), especially in my own business.

    Even keeping money in the bank or in the proverbial mattress and being a fool is better than being a debt slave. But it is good to have the right perspective on things – the Western financial and tax system is pro-debt.

    • Replies: @Kiza
  42. Kiza says:

    One more thing, please keep in mind that gold backed securities are not worth the paper they are written on. There is at least 20 times more paper gold in this world then real gold. If the system crashes, then only the gold you hold in your hands is worth anything, most paper will disappear in a puff of smoke (Cyprus, Greece). Even deposit boxes get raided. If SHTF at the end of the chain reaction, then the prepers will turn out to be right and the rest of us will be wrong: only gold, food and weapons will be worth anything. I do not want to be paranoid and become a preper, but I would never make fun of the prepers as some people inside the system do. Let us see who has the last laugh.

  43. Mark Caplan says: • Website

    True, the Shanghai index is well off its recent high but it is currently up 77 percent from a year ago.

  44. Anonymous • Disclaimer says:

    @Eamonn Fingleton,

    it’s not quite true that Jim Simons closed the Medallion fund to new investment and would necessarily tout high returns if they existed.

    Rather, Simons *returned outside investors’ money* some years ago. The Medallion fund has, since that time, operated as a private fund for Simons and his employees to manage their wealth. They have no need to publish returns statistics because they don’t sell any investment product to any investors.

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