If we don’t understand both sides of China’s balance sheet, we understand neither | Michael Pettis

From Michael Pettis’ OpEd in the Wall St Journal:

History suggests that developing countries that have experienced growth “miracles” tend to develop risky financial systems and unstable national balance sheets. The longer the miracle, the greater the tendency. That’s because in periods of rapid growth, riskier institutions do well. Soon balance sheets across the economy incorporate similar types of risk.

….Over time, this means the entire financial system is built around the same set of optimistic expectations. But when growth slows, balance sheets that did well during expansionary phases will now systematically fall short of expectations, and their disappointing performance will further reinforce the economic deceleration. This is when it suddenly becomes costlier to refinance the gap, and the practice of mismatching assets and liabilities causes debt, not profits, to rise.

Read more at If we don’t understand both sides of China’s balance sheet, we understand neither | Michael Pettis’ CHINA FINANCIAL MARKETS

Volatile crude

Crude prices rallied sharply in the last few days, boosted by downward revision of US oil output and hints that OPEC may consider production cuts. October 2015 futures (Nymex Light Crude – CLV2015) tested resistance at $50/barrel before falling just as steeply on weak manufacturing data out of China.

Nymex WTI Light Crude October 2015 Futures

Expect another test of support at $38/barrel. Breach of support would offer a target of $26/barrel*.

*Target: 38 – ( 50 – 38 ) = 26

NYSE Short Sales

NYSE short sales and daily volume are only published 24 hours after the close of trade, but are still a useful indication of where the market is headed. Short sales over 500 million on Monday, remain elevated. Keep an eye out for any increase above 600 million this week — which would warn of rising selling pressure and a likely breach of support.

NYSE Daily Volume & Short Sales

China: It just got worse

S&P 500: Dead cat bounce?

After Friday’s narrow consolidation between 1970 and 1990, S&P 500 September 2015 E-mini futures broke support at 1970, indicating moderate selling pressure.

S&P 500 September 2015 E-mini

Sound domestic economic performance is likely to ensure that the S&P 500 returns to its primary up-trend in the medium- to long-term, but upheaval in international financial markets may have sapped investor confidence in the short- to medium-term. The doji star on the daily chart reflects indecision. A close below 1970 would suggest another test of support at 1870, with respect of resistance at 2000 a bearish sign. A 21-day Twiggs Money Flow peak below zero would also warn of selling pressure. Follow-through above 2000 is less likely, but would indicate light selling and a snappy recovery.

S&P 500

NYSE volumes reflect the increase in activity, starting Friday August 21st, with daily volumes over 2 billion and short sales jumping to 800 million. It will be worth keeping an eye on short sales this week. Recovery above 600 million would warn of rising selling pressure.

NYSE Daily Volume & Short Sales

China’s conundrum: Capital flight or deflation

AND capital flight causes collapsing stock and real estate prices, which could lead to…… deflation.

Self-taught Kenyan wins gold medal in javelin

Julius Yego winner 92.72m WL Men’s Javelin Final | IAAF World Athletics Championships BEIJING 2015

Read more at Quartz

Greece and Its Misguided Champions

From Michael G. Jacobides in Harvard Business Review:

….while some EU policies are punitive or counter-productive, the strength of opinion of pundits long on conviction and short on detail seems to ignore the real root cause of the crisis. This is that the Greek economy has become inward-looking, unproductive, incumbent-favouring, and rife with rent-seeking. They may also underestimate how Grexit would exacerbate many of the Greek pathologies at the root of the crisis.

Greece’s main problem isn’t its currency. Rather, it is that its Byzantine regulations and institutional uncertainties discourage investments and reduce competitive pressures. Grexit would further restrict available capital, shatter the fragile banking sector, and increase the investment gap, which, as McKinsey’s recent study shows, is the key issue.

Read more at Greece and Its Misguided Champions.

Long-term crude prices falling fast

Long-term crude prices are falling fast, with June 2017 futures (Nymex Light Crude – CLM2017) having broken through its medium-term target of $50/barrel*.

Nymex WTI Light Crude June 2017 Futures

* Target calculation: 56 – ( 60 – 54 ) = 50

The August 2015 Report from the International Energy Agency indicates that oversupply is growing. After the latest market turmoil, IEA estimates of global demand are also likely to be revised downward. Maybe that long-term target of $36/barrel** is not so crazy after all.

**Long-term target: 66 – ( 90 – 60 ) = 36

ASX during the 1997 Asian financial crisis

Performance of the All Ordinaries during the 1997 Asian financial crisis and ensuing Russian financial crisis in 1998.

All Ordinaries 1996-1998

The index gained 7.9% in 1997 and 7.5% in 1998 despite the upheaval in Asian markets. Australia is now a lot more reliant on exports to Asia, however, than in 1997/98.

All Ordinaries

Reversal of 13-week Twiggs Money Flow below zero warns of long-term selling pressure. Follow-through of the All Ords below 5000 would confirm a primary down-trend.

S&P 500 during the 1997 Asian financial crisis

Here is the performance of the S&P 500 during the 1997 Asian financial crisis and the ensuing Russian financial crisis in 1998.

S&P 500 1996-1998

The index gained 31% in 1997, and 26.7% in 1998, despite the upheaval in Asian markets. Global markets are nowadays a lot more interconnected, however, than in 1997/98.

S&P 500

All the same, gradual decline on 13-week Twiggs Money Flow suggests medium-term selling pressure — a secondary rather than a primary movement.

Shanghai: Stocks in free-fall

Dow Jones Shanghai Index broke support at 440. Expect more government efforts, near the close, to shore up support. As futile as attempting to hold back the tide. Target for the breakout is 330*.

DJ Shanghai Index

* Target calculation: 440 – ( 550 – 440 ) = 330

Why we should not blame the ECB for low returns on German savings | Bruegel

From Guntram Wolff, originally published in Die Welt:

Real Interest Rates

….what drives this decline in real interest rates? Real rates are determined by a whole set of economic factors, including growth prospects. Ultimately, it is economic performance that drives the return in investments. In a fast growing economy that is still building up its capital stock, real rates should be high as economic growth prospects are high. The opposite is true for an economy in a recessionary environment or an economy with already high capital stocks.

Read more at Why we should not blame the ECB for low returns on German savings | Bruegel.

Australian Dollar during the 1997 Asian financial crisis

Performance of the Australian Dollar during the Asian financial crisis. The falling Dollar acted as a buffer, protecting the Australian economy from the Asian contagion.

AUDUSD 1996-1998

A similar 25% fall from today’s 72 US cents would offer a target of 54 US cents. No science to this. Simply speculation.

A bad case of the ‘nineties

The 1990s featured two significant upheavals in global financial markets. First, 1990 saw the Nikkei collapse from its high of 39000, reaching an eventual low of 7000 in 2008.

Nikkei 225 Index

The collapse followed strong appreciation of the Yen after the September 1985 Plaza Accord and the ensuing October 1987 global stock market crash. The Plaza Accord attempted to curtail long-term currency manipulation by Japan who had built up foreign reserves — mainly through purchases of US Treasuries — to suppress appreciation of the Yen against the Dollar and maintain a current account surplus.

Seven years later, collapsing currencies during the 1997 Asian financial crisis destroyed fast-growing economies — with Thailand, South Korea and Indonesia experiencing 40%, 34% and 83% falls in (1998) GNP respectively — and eventually led to the 1998 Russian default and break up of the Soviet Union. Earlier, rapidly growing exports with currencies pegged to the Dollar brought a flood of offshore investment and easy credit into the Asian tigers. Attempts by the IMF to impose discipline and a string of bankruptcies spooked investors into a stampede for the exits. Falling exchange rates caused by the stampede led to a further spate of bankruptcies as domestic values of dollar-denominated debt skyrocketed. Attempts by central banks to shore up their currencies through raising interest rates failed to stem the outflow and further exacerbated the disaster, causing even more bankruptcies, with borrowers unable to meet higher interest charges.

What we are witnessing is a repeat of the nineties. This time it was China that attempted to ride the dragon, pegging its currency against the Dollar and amassing vast foreign reserves in order to suppress appreciation of the Yuan and boost exports. The Chinese economy benefited enormously from the vast trade surplus with the US, but those who live by the dragon die by the dragon. Restrictions on capital inflows into China may dampen the reaction, compared to the 1997 crisis, but are unlikely to negate it. The market will have its way.

Financial markets in the West are cushioned by floating exchange rates which act as an important shock-absorber against fluctuations in financial markets. The S&P 500 fell 13.5% in 1990 but only 3.5% in October 1997. The ensuing collapse of the ruble and failure of LTCM, however, caused another fall of 9.0% a year later. Not exactly a crisis, but unpleasant all the same.

North America

The domestic US economy slowed in the past few months but increased spending on light motor vehicles and housing suggested that robust employment growth would continue. Upheaval in financial markets (and exports) now appears likely to negate this, leading to a global market down-turn.

The S&P 500 breached primary support at 1980, signaling a primary down-trend. The index has fallen 4.5% from its earlier high and presents a medium-term target of 1830*. Decline of 13-week Twiggs Money Flow below zero would confirm the signal but descent has been gradual, suggesting medium-rather than long-term selling pressure.

S&P 500 Index

* Target calculation: 1980 + ( 2130 – 1980 ) = 1830

The CBOE Volatility Index (VIX) spiked upwards indicating rising market risk.

S&P 500 VIX

Bellwether transport stock Fedex broke primary support at $164, confirming the primary down-trend signaled by 13-week Twiggs Money Flow reversal below zero. The fall warns of declining economic activity.


Canada’s TSX 60 broke primary support at 800, confirming the earlier bear signal from 13-week Twiggs Momentum reversal below zero. Target for a decline is 700*.

TSX 60 Index

* Target calculation: 800 – ( 900 – 800 ) = 700

Europe selling

Germany’s DAX broke medium-term support at 10700. Expect further medium-term support at 10000 but reversal of 13-week Twiggs Money Flow below zero warns of selling pressure. Breach of 10000 would indicate a test of primary support at 9000.


* Target calculation: 10700 – ( 11800 – 10700 ) = 9600

The Footsie broke 6450, signaling a test of primary support at 6100. Reversal of 13-week Twiggs Money Flow below zero warns of (long-term) selling pressure. Breach of 6100 would offer a target of 5000**.

FTSE 100

* Target calculation: 6450 – ( 6800 – 6450 ) = 6100 **Long-term: 6000 – ( 7000 – 6000 ) = 5000


The Shanghai Composite reflects artificial, state-backed support at 3500. Declining 13-week Twiggs Money Flow warns of long-term selling pressure. Withdrawal of government support is unlikely, but breach of 3400/3500 would cause a nineties-style collapse in stock prices.

Shanghai Composite Index

* Target calculation: 4000 – ( 5000 – 4000 ) = 3000

Japan’s Nikkei 225 appears headed for a test of 19000. Breach would test primary support at 17000 but, given the scale of BOJ easing, respect is as likely and would indicate further consolidation between 19000 and 21000. Gradual decline of 13-week Twiggs Money Flow suggests medium-term selling pressure.

Nikkei 225 Index

* Target calculation: 21000 + ( 21000 – 19000 ) = 23000

India’s Sensex is holding up well, with rising 13-week Twiggs Money Flow signaling medium-term buying pressure. Breakout above 28500 is unlikely but would indicate another test of 30000. Decline below 27000 would warn of a primary down-trend; confirmed if there is follow-through below 26500.



Commodity-rich Australian stocks are exposed to China and emerging markets. The only protection is the floating exchange rate which is likely to adjust downward to absorb the shock — as it did during the 1997 Asian crisis. 13-Week Twiggs Money Flow below zero warns of (long-term) selling pressure on the ASX 200. Breach of support at 5150 is likely and would confirm a primary down-trend. Long-term target for the decline is 4400*. Respect of primary support is unlikely, but would indicate consolidation above the support level rather than a rally.

ASX 200

Public Debt and the Long-Run Neutral Real Interest Rate | Narayana Kocherlakota

Extract from a speech by Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, in Seoul, South Korea on August 19, 2015:

There has been a significant decline in the long-run neutral real interest rate in the United States over the past few years.

10-Year TIPS Yields

This decline in the long-run neutral real interest rate increases the future likelihood that the FOMC will be unable to achieve its objectives because of financial instability or because of a binding lower bound on the nominal interest rate. Plausible economic models imply that the fiscal authority can mitigate this problem by issuing more public debt, although such issuance is not without cost. It is, of course, the province of the fiscal authority to determine whether those costs are worth the benefits that I’ve emphasized…

How we got in this mess

There are two critically important price signals in the economy — the interest rate and the exchange rate. Tampering with them encourages distortions, leading to instability.

  • The Austrians were right: allow market forces of supply and demand to set a neutral interest rate.
  • The main function of regulators should be to ensure that debt growth is consistent with economic (GDP) growth else the banks can distort the supply of money by excessive debt creation.
  • The Austrians are also right about not running consistent fiscal deficits.
  • The other important element is to avoid consistent current account deficits to achieve a fair exchange rate.

None of these (in my view) sensible guidelines have been adhered to for the last half-century. Financial markets are in a real mess and Austrian “hands-off” policies are now insufficient to get us out of it. The only real alternative is to employ “hair of the dog” remedies advocated by Keynes: run fiscal deficits, increase public debt and distort real interest rates. Remember that Keynes published his General Theory in 1936 when financial markets were in an even bigger mess. Even a broken clock is right twice a day (or twice a century in Keynes case).

As for the Monetarists, Market Monetarists present the best opportunity to get us out of this “Keynesian hell” and set us on the path to Austrian (and Monetarist) utopia.

Read more of Narayana Kocherlakota’s speech at Public Debt and the Long-Run Neutral Real Interest Rate | Federal Reserve Bank of Minneapolis.