If the dusk of the empire falls! (Full unabridged version)

Ray said in the book,"Many people believe that economic crises that occurred in different eras and in different countries were caused by different reasons, but I only see the same things happening again and again."

This "same thing" was summarized by Ray into a set of "patterns" for the outbreak of the debt crisis, and introduced to us through this new book. The book also lists 48 economic crises (GDP growth as low as minus 3% or below) that have occurred in the past 100 years, including detailed introductions to three of them (the "hyperinflation" that broke out in Germany in 1921; the "Great Depression" in the United States in 1929; and the 2008 "subprime crisis" that the author personally experienced).

Since China has not had a crisis as defined in the book since modern economic data became available, the book barely mentions the word China. But as a reader, Murph will naturally continue to compare this model with the development history of our country's economy, trying to figure out whether our country will also encounter a crisis?

Hence this article. This is a story about China’s economy. Let’s start from the beginning.

first stage——Prosperity

For a country, capital is an essential factor in economic development. If a country's economy wants to develop, it must invest in education, investment in infrastructure, investment in factories, and investment in machinery. my country's achievements in the first thirty years of reform and opening up were actually nothing more than turning farmers in the fields into workers in factories, and turning an agricultural country into an industrial country. But don’t underestimate this. The machines in the factory cost money. After the products are produced, they need to be transported by roads and ports. The factory requires electricity to run. These things all require a lot of investment.

SoinvestWhere does it come from? fromsavings. For a person, the money we invest comes from savings, and savings comes from our income minus consumption. The same is true for countries, but it is a little more complicated, because the money a country uses for investment can be the savings of its own citizens or the savings of foreigners. In other words, a country can also borrowexternal debtCome invest and develop the economy. But the problem is that the risk of borrowing foreign debt is very high. Later we will use the familiar examples of Brazil and Argentina to illustrate why.

Raghuram Rajan, the author of "Fault Lines" and former governor of the Reserve Bank of India, found through decades of research on economic development in developing countries that the more investment a country has, the faster its economic development will be. However, if the greater the proportion of investment in funding comes from external debt, its growth rate will be slower relative to those countries with less external debt.

in other words,The best way is to invest and develop the economy with one's own national savings., so that there is enough money to invest and avoid borrowing foreign debt. And this is exactly how our country has developed its economy over the past three decades.

The figure shows a comparison of the national savings rates (national savings = government savings + household savings + corporate savings) of various countries. China ranks first. The countries with the fastest economic development, South Korea, India, and Germany, all have high savings rates. It can be said that without a high level of savings rate, China would not have been able to achieve such rapid economic growth.

There are many reasons for China's high savings rate. In addition to its national characteristics, it is also known that the welfare level is low. As shown in the figure above, due to the low welfare level, my country's household savings and government savings are much higher than those of the United States. Speaking of welfare, friends who saw the first picture might think of the country Brazil?

I wrote in a previous article that Brazil’s economy is being dragged down by the country’s unsustainably high welfare policies. In Brazil, for example, the average retirement age is 55. The average pension available after retirement is 70% of pre-retirement salary. The average retirement age in OECD (United States, Germany and other developed countries) countries is 65 years old, and the pension you can receive after retirement is only 50% of your previous salary.

Such a high welfare policy has led to two problems. The first is that the government has no money. In that article, I also wrote that as a country with a land area about the same size as the United States, Brazil does not have a railway network that can handle the task. Even farmers know the truth of "to get rich, build roads first", but the Brazilian government has no money to build roads. The second is that high welfare has led to low savings rates among residents (the pension is too generous, so there is no need to save). The combination of low savings by residents and the government results in Brazil's total savings rate of only 15%, which is the second-to-last position as shown in the figure above.

Because the savings rate of domestic residents is too low, Brazil is forced toHad to borrow a lot of foreign debt(dollar-denominated debt) to invest and grow the economy. But we’ll talk about the story about Brazil later.

Over the past few decades, China has used a large amount of income to save and then convert it into investment, allowing the Chinese economy to modernize at an almost visible speed. But the problem is, if we spend a lot of our income on savings, won’t our spending power become very low? Yes, that's exactly what happened. The ratio of China's household consumption to GDP has always been below 40%, which is not only far lower than the 70% of the United States, but also lower than almost all major countries in the world.

Since consumption capacity is poor and production capacity is strong (economic development is essentially an increase in productivity), we do not have the ability to consume the products we produce. So we can only rely on foreign trade to sell products to foreigners.

As shown in the figure, the ratio of China's total exports to GDP can be seen to have been rising rapidly since the reform and opening up, and after joining the WTO in 2001, it has almost become a straight line.

Since we consume less and produce more,current accountalwayssurplus, that is, more exports and less imports. Under normal circumstances, this will lead to continued appreciation of the RMB, because in the foreign trade market, in order to purchase products produced in China, even if exports are mostly settled in US dollars, exporters will eventually have to convert the US dollars they receive into RMB to pay their wages. Therefore, in the foreign exchange market, the demand for RMB will exceed that of US dollars, causing the RMB to appreciate against the US dollar.

At this time, the government will face two choices. It can either choose to allow the RMB to appreciate, which will continue to erode the international competitiveness of Chinese products (an appreciation of the RMB will make exported products more expensive, while foreign imported products become cheaper), or it can choose to print money to buy U.S. dollars in the market, increasing demand for U.S. dollars to curb this trend.

(* Printing money to buy U.S. dollars will not in itself lead to currency flooding, because it can also be adjusted by the deposit reserve ratio. Interested friends can learn about the concept of "money multiplier". Therefore, printing money to buy U.S. dollars to avoid RMB appreciation is obviously a better option.)

The Chinese government chose the latter, printing RMB to buy U.S. dollars and maintaining a stable exchange rate to maintain export competitiveness. The dollars purchased become our foreign exchange reserves.

As shown in the picture, China's foreign exchange reserve balance has soared since China joined the WTO in 2001.

At this point in the story, we find that the Chinese government did almost everything right to create an economic miracle that lasted for more than thirty years. As a Chinese, I not only feel proud, I even feel a little magical.

Of course, our story continues.

second stage——Foam

When a country's economy experiences a boom, it tends to attract investors from around the world. As shown in the figure below, China's foreign direct investment has exceeded US billion every year since 2001. After China announced in 2005 that it would allow the RMB to appreciate, it has exceeded US0 billion every year.

The reason is simple. Economic conditions that are like cooking oil tend to push up asset prices, because houses and stocks have become more valuable, and the currency is appreciating. At this time, investing in China can obtain double benefits - the income from the asset itself plus the income from the appreciation of the renminbi.

Ray writes in the book that during this period, capital from all over the world can be attracted, which often leads to asset bubbles in this country. Everyone is familiar with this, so I won’t go into details and just list the results: According to Huang Qifan, deputy chairman of the Financial and Economic Committee of the National People’s Congress, the current housing price-to-income ratio (that is, how many years a resident can buy a house without eating or drinking) in China’s first-tier cities has reached 40 times; the second-tier cities have also reached 20 times; while New York is only six times and London is only ten times. It can be said that it is already a super big bubble.

In the process of asset price inflation, some people will gradually appear in society who make a fortune by buying houses with loans. Their story quickly spread, attracting more people to invest with debt, and then more people. Anyone who doesn't get in will feel like they've missed out, so the bubble inflates and debt accumulates.

As shown in the figure, the ratio of Chinese residents' debt to GDP has risen rapidly in the past decade along with the real estate bubble.

At this point, the word debt finally appears. Let’s talk about it first. In the previous article, we wrote that the best way for a country to develop its economy is to save, and then convert the savings into investment to develop productivity. The process of converting savings into investment often generates debt. For example, we deposit money in the bank, and then the government borrows it to build roads, or companies borrow it to build factories.

Therefore, debt itself is not good or bad. What is different is the purpose of debt. In Ray's terms,The purpose of the debt needs to generate sufficient economic benefits to repay the debt.We can imagine a student who graduates from high school. He can take out a loan to go to college or to buy a sports car. The difference between the two is obvious.

Of course, it doesn’t necessarily mean going into debt to invest (going to college is an investment). Because the investment itself may not necessarily yield sufficient returns. For example, buying a house is an investment, and most of the debt generated by speculating on buying a house before the subprime mortgage crisis (buying a house not to live in, but to wait for appreciation) is problematic. Because unless house prices can continue to rise, this investment will not be able to generate enough economic benefits to repay the debt, and eventually there will likely be widespread defaults, leading to an economic crisis.

So is there a way to judge whether the debt incurred by a country over a period of time is effective or harmful? Ray's approach is to observeDebt andGDPthanthis number. The reason is that GDP is the country's total income, and debt, as we mentioned earlier, can increase productivity through investment, thereby increasing total income. Therefore, if the ratio of debt to income rises rapidly over a period of time, it means that a large amount of debt has been incurred during this period without a corresponding increase in income. And we all know that borrowing debt that exceeds one's income capacity will lead to default, and for a country, it will lead to an economic crisis.

According to research in a working paper by the International Monetary Fund this year, in the past 43 cases where the ratio of a country's debt to GDP increased by more than 30% within five years, except for five special cases, the remaining 38 cases all resulted in an economic crisis within the following five years.

As shown in the picture, China is green in the upper left corner because there has been no crisis yet. The author says that those five cases are special circumstances because three of them have just emerged from the last economic crisis, and the other two cases were economic crises that broke out five years later. Moreover, the author also emphasizes that all countries where the ratio of debt to GDP was above 100% in the initial state (this is the case in China) had an economic crisis within five years (that is, the five exceptions were all below 100% in the initial state).

U.S. private debt as a share of GDP

The figure shows the ratio of U.S. private debt to GDP. We can see that this ratio increased significantly in the United States in the decade before the subprime mortgage crisis in 2008.

China’s private debt to GDP ratio

The figure shows the ratio of China's private debt to GDP. We can see that during the most prosperous stage of China's economic development, that is, from 2001 to 2008, although the debt itself was growing rapidly, because the economy (income) was also growing very fast, the ratio of debt to GDP had almost no change. According to Ray's criteria, we can say that the debt added in those years was good debt, and it was invested in places that can generate economic benefits.

The ten years after 2008 were different. Comparing the United States, we found that at the same time, the figure in the United States dropped from 170% to 150%, while in China it rose from 120% to 210%. Both the speed of increase and the height reached are almost unprecedented. Except for one country, that is Japan in 1990.

Japan’s private debt as a ratio of GDP

As shown in the figure, Japan also had a skyrocketing debt-to-GDP ratio in the decade before the economic crisis in 1990, as it also experienced a severe real estate bubble. We all know that after the crisis, Japanese house prices fell for nearly thirty years (a drop of more than 65%), and the Japanese economy fell into a lost thirty years.

Japan house prices

This seems terrible. Indeed, the country most similar to China's current economic situation is probably Japan at that time. However, Japan's economy suffered a lost thirty years because it made a series of mistakes after 1990. Based on Japan's past experience, I believe that China will not be able to make these mistakes (for example, the United States did not make these mistakes in 2008), but this does not mean that a crisis will not break out in China. We will discuss this issue at the end of the article.

We found that Japan's debt-to-GDP ratio skyrocketed from 1980 to 1990, the United States from 1998 to 2008, and China from 2008 to 2018. One of the most important reasons is that they all experienced real estate bubbles.

For example, according to data used by Xia Bin, dean of the National Economic Research Institute of Nankai University, in a speech at Tsinghua University in March this year: "At the end of 2016, China's real estate-related loans totaled 26.7 trillion, accounting for 25% of all bank loans. As of now (March this year), loans truly related to housing prices and land prices have reached 70%." In other words,A large amount of newly generated debt has not been turned into investments that can generate economic benefits in the future, but has been turned into housing loans or land loans.

This leads to, according to Ray,The growth rate of income is far less than the growth rate of debt, and the reason why so much debt can be generated now isBecause the price of collateral is very high under asset bubbles, and once a crisis occurs, when asset prices fall and income decreases, a large number of defaults will occur, triggering a more serious economic crisis. Why were American banks willing to provide loans to people who couldn't afford houses at that time? Because they think that even if they can't repay the mortgage, they just need to sell the mortgaged house. And they didn't consider what they would do if house prices also fell? Americans at that time also firmly believed in the myth that "housing prices in first-tier cities will always rise."

The third stage——reverse

The title of this stage is called reversal, but it does not mean that the asset bubble is about to burst, but that the economy begins to change from a raging prosperity to a less prosperous one at this stage. There are two reasons.

First, as mentioned earlier, when a country relies on exports to drive its economy and generates a large trade surplus, its exchange rate will automatically rise (the exchange rate is originally used to adjust the trade balance). At this time, the government has an option, which is to print money to buy U.S. dollars in the foreign exchange market, "manipulate the exchange rate," and forcibly stabilize the RMB exchange rate.

RMB to USD exchange rate

As shown in the figure, the exchange rate of RMB against the US dollar is shown. We find that the RMB was forcibly stabilized at 8.3 by the government in the ten years from 1995 to 2005. But as I wrote in my articles on the trade war, after all, we are not the only player in the international trading system. If we always want to win, then others will stop playing. So we had to start allowing the RMB to appreciate in 2005. The appreciation of the RMB will make export products more expensive.Decline in competitiveness, and imported products have become cheaper, and competition pressure from domestic manufacturers has increased sharply.

Second, in addition to the external factor of exchange rate, there is also an internal factor. Because GDP will grow rapidly during economic prosperity, and GDP means gross national income. Although the proportion of Chinese residents' income in GDP is not as high as that of the United States, which is nearly 80%, it still accounts for 60%. Therefore, the income of Chinese residents will rise along with GDP. The rise in income will also gradually erode domestic export competitiveness (because companies must continue toraise wagesOnly then can we hire people), making the things we produce more expensive. As shown in the picture,

The above two reasons will make China’s economyCompetitiveness declines. thus leading toDomestic investments have become less profitable than before.This is also one of the reasons why the ratio of debt to GDP will expand at an accelerated pace at this stage, because the same investment is unlikely to obtain the same returns as ten years ago. Therefore, China’s current huge debt situation cannot be entirely blamed on real estate.

Therefore, in the reversal stage, due to the continued decline in economic competitiveness, the investment rate of return continues to decline, which will eventually lead tocapital outflow, because at this time, investing in other countries can obtain a higher risk-return ratio (taking smaller risks or obtaining higher returns).

The most intuitive manifestation of capital outflow is the decline of foreign exchange reserves, as shown in the figure:

China’s foreign exchange reserve balance

From 2014 to mid-2016, my country’s foreign exchange reserves dropped sharply by one trillion yuan.capital controlsstrengthened and suppressed.

In addition to declining competitiveness, there is another reason that leads to capital outflows in Ray's model. As mentioned earlier, boom times often generate asset bubbles, and asset bubbles will bring about the "wealth effect" - the appreciation of real estate and stock appreciation will make people feel richer, thus stimulating consumption. Some friends here may question it, thinking that housing loans have trapped everyone’s money, so they should lead to a “consumption downgrade.” In fact, China's current situation is not "consumption downgrade", but "polarization". People who don't own a house may be overwhelmed by their houses, but those who own a house really feel like they've become rich overnight. According to a 2010 report by the White House, the top 10% of income earners in the United States account for more than 60% of the total income. Therefore, of course, this group of people also account for more than 50% of the consumption. In other words, the people who can best determine whether a country's consumption is growing rapidly are these wealthy people. They are all property owners, owning houses and stocks.

As shown in the figure, the ratio of China's private consumption to GDP has increased rapidly since 2010. Since consumption is income minus savings, the savings rate is also falling.

(* There is a principle in psychology that tells us that people will seriously overestimate the number of people in the same situation as themselves. For example, people who like football will seriously overestimate the proportion of people who also like football in the total population, etc. Therefore, it is normal to deny the existence of the wealth effect based on one's own situation, but it is not correct.)

By studying the economic data of past cases, Ray believes that during the bubble stage, the wealth effect will lead to an increase in consumption. It will not only expand domestic consumption, such as the picture above, but also lead to an increase in imports - the purchase of foreign products and services will also increase accordingly, thus worsening the current account (generating a deficit). The most intuitive manifestation of this is the rapid increase in the number and expenditure of Chinese people traveling and studying abroad.

Of course, even if there is no wealth effect, with the development of China's economy and the substantial increase in per capita income, these two figures will increase, but they may not be so fast.

We have written before that when a country exports more than it imports (current account surplus), it will increase the demand for its own currency in the foreign exchange market (even if the goods are settled in US dollars, manufacturers will still have to convert them into RMB to pay wages), thereby promoting the appreciation of the domestic currency. And if a current account deficit occurs, it will put pressure on the domestic currency to depreciate, thereby triggering capital flight.

Since the wealth effect affects the balance of imports and exports, the most intuitive manifestation is the deterioration of the current account.

As shown in the picture of China's current account, it can be seen that the surplus has indeed dropped significantly since 2008. However, compared with those countries that have experienced crises, China's current account can be said to have no problems at present.

The picture above shows Thailand's current account when the 1997 Asian financial crisis broke out. It was negative for almost ten consecutive years, and exceeded negative 5% for many years. According to Ray's statistics, among the 27 countries that eventually turned from debt crises into currency crises (significant currency depreciation and sharp rise in inflation or inflation), the average current account balance in the year of the crisis was负(deficit) 6%. And China is now正(Surplus) 1.75%, which can be said to be very far from the warning line. Therefore, at present, the contribution of trade issues to China’s capital flight is minimal. But I wrote it down anyway because clearly things are changing —  trade warComing.

Since the United States imports a large amount of Chinese goods every year (0 billion last year), while China only imports a small amount of U.S. goods (0 billion last year), the trade war will definitely seriously damage the price competitiveness of Chinese export companies (tariffs will be added) on the one hand, and on the other hand, it will worsen China's current account due to a decline in exports. These two points will intensify the trend of capital flight and further depreciate the RMB. In fact, the market did react this way. In the past few months, the RMB depreciated against the US dollar by 8.5%.

The trade war is China's biggest challenge and variable when facing the pressure of the debt crisis. It is also the main reason why China's current situation is different from that of all countries that have experienced previous crises, because China needs to consider not only how the policies it applies will affect itself, but also how they will affect the world. We are now the world's second largest economy and largest trading nation. If a crisis breaks out in China, it will surely spread quickly to the whole world, creating another "once-in-a-hundred-year" crisis. So will we have a crisis?

Stage 4——collapse?

Let us not forget what Ray said,"Many people believe that economic crises that occurred in different eras and in different countries were caused by different reasons, but I only see the same things happening again and again."

So, for a country like ours that has followed the template of the debt crisis step by step - experiencing prosperity, bubbles, declining competitiveness, soaring debt and capital flight, there is a high probability that a crisis will occur in the end. At this stage, we will analyze why. However, for investors, we are not only concerned about whether a crisis will occur, but also what will happen after the crisis breaks out.

Let us once again introduce the economic boom and bust cycle in Ray's eyes that I introduced in "World Economy 2017", but this will be explained in more detail.

As shown in the figure, the left side represents debt and the right side represents productivity. First of all, we need to know that in the long run, a country’sThe per capita income level is determined by its productivity. For example, China is richer than India because we have the ability to mass-produce cars, produce mobile phones, and build high-speed rail. However, due to the extremely unfree domestic economic environment (corruption in clearly marked prices, ubiquitous business licenses, and rigid labor markets, etc.), India can only produce an "Ambassador brand car" that was available seventy years ago. Of course, if a country wants to develop its economy, it is not just about saving. It also needs a good economic system, an efficient government and a free business environment. However, these will not be discussed here.

Without debt, economic development (income growth) should be very smooth, as shown on the right, with income growing steadily as productivity increases. But it is obvious that in the real world, a country's economic development is often on the left, with prosperity and recession, forming a cycle. Why? becauseDebt can boost people's incomes in the short term。

As discussed earlier, when the economy is in a boom period, asset bubbles tend to rise, and asset bubbles lead to wealth effects, making the economy even more fiery. At this time, people will misestimate their future income and think that the economy will continue to prosper forever. Fantasy such as "housing prices will rise forever" also begins to appear in people's heads. In addition, I also wrote in "World Economy 2017" that the widening gap between the rich and the poor (asset bubbles widening the gap between the rich and the poor) will cause the poor to rely on debt and borrow money to forcibly improve their living standards in order not to fall significantly behind the rapidly improving quality of life of the rich.

The above three phenomena combined will cause people toRely on debt to significantly increase your consumption in the short term/investment level.Is that so? To give an extreme example, when I thought housing prices would always rise, I would take out loans to buy ten houses. And in economic activities,one person's consumption/Investment is another person’s income. I bought ten houses, and the people who sold them instantly made a lot of money. therefore,When we rely on debt to significantly increase our consumption/When the level of investment increases, our income will also increase significantly, even if productivity does not increase significantly.

So here is the picture:

As shown in the figure, the gray line represents the trajectory of economic development (income growth) without debt, and the black line represents the trajectory of economic development (income growth) with debt. This gave rise to the “economic cycle” that we are familiar with.

Even more interestingly, we now know that since one person's consumption/investment is another person's income, rapid income growth during booms and bubbles - where the black line exceeds the gray line - is itself unsustainable (since debt cannot grow indefinitely). But often at this time, as mentioned earlier, the ratio of debt to income (GDP) will increase even more significantly.

U.S. private debt as a share of GDP

For example, what happened in the United States before the subprime mortgage crisis was that this ratio increased significantly. One can imagine how dangerous the entire economy has become in this process. Sooner or later, peopleThe ability to borrow debt will reach its limit，Creditors will realize that the income capacity of the person who borrows money is actually not enough to afford the debt; and debtors will also feel afraid that they have too much debt.

When this day comes, the debtor will stop lending, either passively (because the creditor is afraid) or actively (because he is afraid), and the whole process begins to reverse.Debt reduction leads to consumption/Investment decreases while one's consumption/Investment is another person's income, which in turn leads to a reduction in income. A reduction in income will make debtors less able to borrow money, or less qualified to borrow money.What's worse,As incomes fall, asset prices tend to collapse at the same time,Because how can people afford such expensive assets after the prospect of huge income increases is dashed?When asset prices and income fall simultaneously, massive defaults occur.而Defaults led to the auction of mortgaged assets, which exacerbated the decline in asset prices.This created a vicious cycle and an economic crisis broke out.

It is conceivable that the situation described above is very terrible, so when it happens, governments around the world will try their best tobailout, or ratherBefore the crisis actually breaks out, money printing and other means are used to prevent the outbreak of the crisis.

When it comes to bailing out the market, everyone will definitely think of "four trillion". In fact, it is not the only bailout by the Chinese government in the past ten years. Next, we have to find out what happened in China in the past few years, but we must first look at what happened in the United States in 2001.

In 2001, the United States suffered the collapse of the Internet bubble (the Nasdaq index plummeted 78%) and 9-11, and a crisis was imminent. In response to the crisis, then-Federal Reserve Chairman Alan Greenspan beganLower interest rates (print money)。

US interest rates

As shown in the figure, it dropped from 6.5% in 2000 to 1% in 2003. This move was successfulReduces the cost of borrowing for society as a whole, so people can continue to rely on debt for consumption/invest.

Let's take a look at this picture again,

U.S. private debt as a share of GDP

The result is that although the United States still suffered a recession in 2001 (the gray part - two consecutive quarters of negative GDP growth), the debt did not decline, but continued to surge.

U.S. house prices

As shown in the picture, we can see that from 1996 to 2001, housing prices in the United States have been rising rapidly together with debt. As you can imagine,if in2001If the Fed did not print money (lower interest rates) to rescue the market,The U.S. would have suffered a more prolonged recession, but probably would have avoided the disaster of the subprime mortgage crisis it later encountered in 2008 (because the bubble had become bigger and the debt had become more massive).

Although it is correct to think this way, the problem is that through research on all countries that have experienced crises in the past, Ray found thatNo government will fail to rescue the market. No one would agree to stand by while a crisis breaks out on their watch.

Therefore, the model we mentioned before becomes like this:

As shown in the figure, within a large debt cycle, there will be many small debt cycles. Whenever a small debt cycle begins to reverse,The government will come to the rescue (by printing money to lower interest rates) and start the next mini-debt cycle.In the process, as the United States experienced in 2001, each mini-debt cycle makes the total amount of debt larger than the previous cycle.

But unfortunately, debt cannot eventually rise to the sky.

US interest rates

The picture still shows U.S. interest rates. During the subprime mortgage crisis, the Federal Reserve lowered interest rates more quickly, even to zero.

U.S. private debt as a share of GDP

However, as shown in the figure, the ratio of U.S. debt to GDP is still declining rapidly. In other words, it failed to stop the vicious cycle we explained before.

U.S. house prices

Therefore, as shown in the figure, U.S. home prices are also falling sharply.

Moreover, the Fed not only lowered interest rates, but also directly printed money to buy real estate mortgage-backed securities. In other words, it encouraged people to buy houses by directly lowering mortgage interest rates. This is the “quantitative easing” policy we are familiar with.

U.S. 30-year mortgage interest rates

The picture shows the thirty-year mortgage interest rate in the United States. Our focus is the period in the red box. During that time, the Federal Reserve lowered mortgage interest rates from 6% to 3% through quantitative easing. And the reason why I want to cut off so much data is to show everyone that it has never been lower than 5% in history.

The picture shows the balance sheet of the Federal Reserve. Legally speaking, every banknote printed by the Federal Reserve is its liability, so we can look at how much banknote the Federal Reserve printed to save the subprime mortgage crisis! But it is obvious that such crazy money printing still failed to prevent the spread of the crisis.

While the United States is doing relatively well, Japan is even worse.

As shown in the picture, interest rates in Japan have been almost 0% since the crisis broke out in 1990.

Japan's private debt-to-GDP ratio has been declining.

So house prices have become like this, falling for nearly 30 consecutive years. As for why the U.S. economy finally resumed growth and Japan became like this, it is a hotly debated topic in the economic circles. We will mention some of it later, but it is not the subject of this article. Here we only need to see one fact clearly, that isDebt cannot rise to the sky. When the debt reaches the limit, the debtor will clearly know that he can no longer afford more debt (or feel afraid of taking on a large amount of debt), and the creditor will also clearly realize that the debtor is actually unable to repay the loan. At this time, no matter how the government rescues the market, prints money, or adopts policies, it cannot prevent the crisis from breaking out.

Of course, even so, if the United States had not taken actions to rescue the market during the subprime mortgage crisis, it is likely that the world would have experienced the "Great Depression" again. Therefore, Ray calls the United States' experience in the subprime mortgage crisis "beautiful deleveraging."

Now we can understand what China has experienced from 2008 to the present. Let’s look at this picture again:

A large cycle from debt boom to debt crisis will contain many small cycles in the middle. Until the debt reaches its limit, the economy begins to inevitably deleverage and reduce consumption/investment. And because one person's consumption/investment is another person's income, income plummets, forcing people to cut more consumption/investment, forming a vicious circle and detonating a serious economic crisis. It is difficult for any government rescue measures to produce good results.

China has experienced two small cycles in the past decade. The picture shows the changes in China’s interest rates:

The first time was the subprime mortgage crisis in 2008. No problem, the government bailed out the market with a "four trillion yuan" package, the stock market soared, and real estate soared.

The second time was in 2015. Although there was no external crisis, the economic growth rate declined significantly due to increasing debt risks and weaker economic competitiveness. The government once again stepped in to rescue the market. As shown in the picture above, it continued to cut interest rates and reserve requirements (print money).

The picture shows the increase in housing prices in China. In fact, we saw that housing prices had already begun to fall at the beginning of 2015 (a small cycle began to decline), but the government's bailout caused it to rise sharply in 2016. I think China's 2015 bailout was very similar to the United States' 2001. The myth that "house prices will always rise" also started from that time, because isn't it, the government really bailed out the market? If the government isn't willing to let real estate fall, how can it fall?

In fact, we have seen from the examples of the United States and Japan thatThere is no government that does not rescue the market. The reason why it was successful before was only because the debt had not reached the limit.If the debt is increased to the limit, there will be no rescue. Unless the government can declare,“We don’t have to repay the previous mortgage, let’s get a loan to buy a new house, right?”

(* If this is really done, it will probably be the most generative redistribution of wealth in history. The people will be very happy, but I am afraid that no one will invest in China from now on. Of course, no country will do this.)

So how do we judge whether China has reached the limit of debt? Unfortunately, it's hard to tell. We can only compare with past history.

As we mentioned earlier, China's private debt-to-GDP ratio is currently the highest in the world - more than 210%, exceeding the 170% of the United States in 2007, and second only to Japan's 220% in 1990. The latter two respectively led to the two most serious economic crises since the Great Depression.

Private debt also includes corporate debt and household debt.

China's corporate debt ranks first in the world.

However, household debt is not particularly high. But the problem is that the income ratio of Chinese residents to GDP is also very low. So if we calculate household debt anddisposable incomeThe ratio between them, according to calculations by Jiang Chao, chief economist of Haitong Securities, has reached 90%, as shown below,

In the United States, this figure reached 120% in 2007, and in Japan in 1990, it reached 100%. Therefore, if residents’ debt has not reached its limit yet, it should soon. Moreover, we must also consider that our country’s social welfare is not as good as that of the United States and Japan, so residents will have more concerns when borrowing debt.

Of course, in addition to the private sector, there are also government sectors, as shown below,

It can be seen that China’s government debt (central + local) is still very low. It should be noted that we know that local governments have many financing platforms, and these debts are included in corporate debts, not local governments. Therefore, local government debts are underestimated and corporate debts are overestimated.

butGovernment debt is not our concern, because no matter what happens, the government will definitely bail out the market during a crisis, and the government will definitely increase debt. But we already know that the cause of the crisis is that private debt has reached its limit, so no matter what the government does, it will be difficult for the private sector whose debt has reached its limit to start accumulating debt again.

The most obvious example is Japan. As shown in the figure above, we find that the debt of the Japanese government sector is the largest in the world, which was accumulated in the process of continuous bailouts after 1990 (tried everything from building bridges, building roads, directly injecting capital into banks, etc.). However, Japan's housing prices and the ratio of private debt to GDP have still fallen for nearly three decades.

As shown in the figure, Japanese government debt soared after 1990.

Therefore, to sum up, it can be said that China's current debt is probably very close to the limit. So what happens if a crisis breaks out in China?

If you have read the article "The Big Short Film Review - The Tenth Anniversary of the Subprime Crisis", it really helped me a lot. In that article, I wrote that in mid-2004, due to the surge in international oil prices caused by the U.S. invasion of Iraq and the currency glut caused by the long-term low interest rate policy, Greenspan, then chairman of the Federal Reserve, began to raise interest rates toCope with inflation, as shown in the figure, raised from 1% to 5%. Real estate prices in the United States also began to fall in 2006.

U.S. federal funds rate

The U.S. inflation rate rose from 1.1% in 2002 to 4.6% in 2005, causing the Federal Reserve to continuously raise interest rates to curb inflation during the same period.

It can be seen that the real estate bubble in the United States was actually punctured by itself. It was the high interest rate policy in the United States that turned the high housing prices at that time into an increasingly unaffordable asset. It is conceivable that if Greenspan did not suddenly and significantly raise interest rates, the U.S. real estate bubble might have persisted for a few more years. Although it will eventually break.

Therefore, although China also has debt and real estate bubbles, they may not burst immediately because there is no obvious trigger yet. But one person thinks a trigger may be coming soon.

The picture shows the interest rates in the United States. After a long period of zero interest rate policy, the U.S. economy finally began to recover, and the Federal Reserve also began to raise interest rates in 2016. In 2017 and 2018, it will increase by 1% each year.

As shown in the chart, the yield on the U.S. ten-year Treasury note has just exceeded 3% again. When we discussed capital flight before, we discussed that it is due to the decline in China's economic competitiveness, which in turn leads capital to seek assets overseas that can bring higher risk-return ratios. U.S. Treasury bonds are considered a zero-risk asset in the financial market. When their yields get higher and higher, they will continue to attract capital from all over the world.

Many of the past cases of currency crises caused by debt crises were triggered by the Federal Reserve's continuous interest rate hikes. For example, the "tequila crisis" that broke out in Latin America in 1994, the Argentine crisis in 2000, etc.

What’s interesting is that Michael Hartnett, chief investment strategist at Bank of America, recently made a chart telling us that every past Fed rate hike cycle has led to an economic crisis somewhere in the world.

Since China has also faced the pressure of capital flight in recent years (foreign exchange reserves have dropped by one trillion), (my favorite) Jiang Chao, chief macro analyst of Haitong Securities, made the conclusion of "protecting exchange rate or housing prices." This means that when the Federal Reserve continues to raise interest rates, if we choose to follow the interest rate hikes to curb capital flight, it will burst the real estate bubble, because the already debt-laden real estate market cannot bear too high interest rates, just like the United States in 2006.

Jiang Chao believes that we will choose to follow the interest rate hike because the exchange rate is more important than housing prices, so he also wrote articles such as "2016 or the Biggest Peak in China's Real Estate History".

Although I like Jiang Chao very much (because he is very concerned about people's livelihood issues) and often forward his articles, my views on this issue are completely different. my point is“The exchange rate will not be protected, but housing prices will eventually fall sharply, no matter how the government rescues the market.”

Everyone must be very clear about the latter point by now. If the debt reaches its limit, house prices will still fall when the crisis comes, no matter how the government rescues the market. And why does Jiang Chao think we should protect the exchange rate? Perhaps it is because China is afraid of experiencing an inflationary crisis caused by a sharp depreciation of its currency like Thailand in 1997?No.

Ray said in the book that when a country's debt reaches its limit and reaches the stage of collapse,There will be two consequences.The first is like Japan and the United States, where housing prices plummet and the economy declines, but the exchange rate will not be a problem; the second is like Thailand, where housing prices plummet, the economy declines, and the exchange rate collapses (a sharp depreciation of more than 50% against the U.S. dollar), which in turn causes import prices to rise, triggers severe inflation, and national wealth shrinks significantly.

What’s interesting is that in all past cases, house prices couldn’t be saved no matter what happened because the debt had reached its limit. There is only one situation in which housing prices will rise, and that is the outbreak of a "hyper-inflation crisis." In a hyperinflationary crisis, when a currency depreciates to the point of being worthless, all assets that are not paper currency will rise in price wildly. It is impossible for this to happen in China.

So what is the difference between the above two consequences? Ray gave many standards, andChina does not comply with any of them.Let’s talk about the most important one first—— external debt. Ray believes that when a country has an economic crisis,Since the government cannot print money to repay foreign debt (it can print Thai baht but cannot print dollars), a large amount of foreign debt will make investors very panic.They will desperately exchange for dollars, thereby devaluing their own currency.After the domestic currency depreciates, foreign debt becomes even more unaffordable, so investors become more panicked and the currency depreciates faster.Therefore, when a debt crisis breaks out, countries with large amounts of foreign debt often encounter the crisis of sharp currency depreciation, and sharp currency depreciation will cause import prices to rise sharply, triggering severe inflation. Therefore, Ray calls the debt crisis encountered by such countries an "inflationary debt crisis".

We mentioned at the beginning of the article that when domestic savings are seriously insufficient, a country can only meet investment needs by borrowing foreign debt. For example, Brazil, a country with a savings rate of only 15%, certainly has a very high external debt. Compared with China's 13%, Brazil's foreign debt-to-GDP ratio was 32% in 2017 (it has been above 30% for more than ten years). Let's take a look at what has happened in Brazil over the past few years.

The picture shows the trend chart of Brazilian Real against the US dollar.

In 2014, due to the political crisis, combined with the financial and financial constraints of hosting the World Cup and the Olympic Games, Brazil suffered an economic recession, and Real fell nearly 50% against the US dollar. Since January this year, due to the uncertainty of the election (populists may come to power), Real has fallen sharply again by 25%.

The picture below shows the inflation rate in Brazil.

It rose sharply by more than 10% in 2014 and started to rise again this year. And if we look at the inflation that Brazil has experienced over the years, we can imagine how poorly this country's economy has been managed.

The chart below shows the size of Argentina’s foreign debt.

As shown in the figure, it can be found that Argentina's foreign debt has not been low in the past few decades, reaching as high as 35% in 2016. Therefore, when the subprime mortgage crisis hit, Argentina immediately experienced panic.

As shown in the picture, the exchange rate of the US dollar against the Argentine peso can be found. Since the beginning of the subprime mortgage crisis, the Argentine peso has been depreciating (the picture shows the US dollar is appreciating), and the cumulative amount has exceeded 90%!

As shown in the picture, Argentina's inflation rate has never been lower than 10%, and has reached 40% in recent years. A friend from Argentina told me that this country is now in such chaos that no one dares to go out with good things. If you drive a good car out, it is very likely that it will be snatched away on the street.

The picture above shows some data compiled by Ray on all cases where currency crises have occurred and led to inflation. I have circled the three most important ones, namelyExternal debt accounts forGDPthan ——The average is 46%, China is 13%;current account(Is trade surplus or deficit) - the average is negative 6%, and China is positive 1.75%;foreign exchange reservesRatio of GDP - the average is 10%, and China is as high as 23%.

Not to mention that China is still implementingcapital controls(To a certain extent, it limits the speed of capital flight, at least it will not reach a large scale and cause panic in a short period of time). So China isThere will be no currency crisis.

Why won’t China encounter a currency crisis (currency depreciation of more than 50%)? Because the foreign debt is very small and the foreign exchange reserves are sufficient, there will be no panic when the RMB depreciates. andChina is a big exporting country, and the depreciation of the RMB will stimulate domestic economic development., making the Chinese economy more competitive and Chinese assets cheaper. These conditions will attract new investment. Therefore, when the RMB depreciates to a certain extent, even if the government does not care, there will be market forces to prevent it from continuing to fall. What's more, the government cannot ignore it. That's why in Ray's cases, although each country experienced currency devaluation during the crisis, there was no cause for collapse.

Therefore, under ideal conditions, it is impossible for the government to protect the exchange rate.Letting it fall would do China a lot of good. Ray also wrote in the book,In all cases of debt crises, the government ends up printing money, borrowing money to invest, and devaluing the currency. Countries that move faster will recover faster.

Because if the government continues to raise interest rates during a debt crisis, it will only cause asset prices to fall faster, debts to shrink faster, and incomes to fall faster, forming a more vicious cycle.Therefore, no matter what the government initially thinks, including those countries that want to protect their exchange rates, they will eventually give up because raising interest rates and tightening the economy is too painful for the people.

Let’s look at a country that made serious mistakes, Japan.

As shown in the figure, the red line is Japan's stock index, and the blue line is Japan's interest rate. We can find that after Japan's "Heisei Bubble" burst in January 1990, it took the Japanese a full six years (1990 ~ 1996) to lower interest rates to zero. When the subprime mortgage crisis broke out in the United States, it took less than a year to complete this action, as shown below:

So what do the Japanese think? In fact, they are protecting the exchange rate.

The picture shows the exchange rate of the Japanese yen. Because the Japanese yen is so cheap, we can only look at it backwards - in terms of US dollars against Japanese yen. We found that since Japan signed the Plaza Accord in 1985, the yen began to appreciate from 1:250 to about 1:150. The Heisei bubble burst in 1990, and the Japanese were reluctant to quickly lower interest rates, which led to domestic disinflation—— Inflation rate fallsphenomenon (as shown below). So when a serious crisis broke out in the country, the yen actually appreciated! As shown above, the value has appreciated from 1:150 in 1990 to less than 1:100.

The picture above shows Japan's inflation rate, which fell from 4% in 1990 to negative values ​​in 1996. In the economy, this type of falling inflation rate (not one that falls from more than ten percent but starts from a low point) is much scarier than rising inflation, because falling inflation means that the selling prices of goods fall, which in turn means reduced corporate income, and reduced corporate revenue means companies have to cut spending and lay off employees, which in turn leads to a reduction in residents' income and makes them less able to afford goods. The selling prices of goods fall even further, which turns into a vicious cycle and plunges the economy into a severe recession. Japan undoubtedly experienced this painful lesson during those years.

Strange, doesn’t anyone in Japan understand economics? Why was such a policy developed? In "The Great Recession" by Koo Chaoming, which may be Japan's most famous economics book, the author wrote, "Japan was one of the largest exporters in the world at the time, and we were not so easy to devalue the currency (print money to save the market).This will arouse strong dissatisfaction among trading partners. "

Considering that Japan at that time had just signed the Plaza Accord with the United States in 1985 because it could not withstand the pressure from the U.S. trade war (which allowed currencies such as the Japanese yen and the German mark to appreciate against the U.S. dollar), such concerns may not be unreasonable.

So we can go back to China again. Today, China is the world's largest trading nation and has a far greater impact on the world than Japan did back then. Don’t believe it? As shown below:

The picture shows the U.S. S&P 500 stock index. On August 11, 2015, the Chinese government announced "exchange reform" and prepared to devalue the RMB. As a result, the U.S. S&P 500 Index plummeted by more than 10% within a few days, frightening Americans. The reason we have mentioned many times is that the depreciation of the RMB will stimulate the Chinese economy, but will make American goods more expensive and affect American employment.

So we now seem to be facing a very similar situation to what Japan was back then, with debt reaching its limit and then a trade war. So this trade war has really cast a heavy shadow on the already very fragile global economy. It's really hard to predict what will happen in the future. But the good news is, I will always be with you.

This article comes from Murph丒Xuan Weibo https://weibo.com/ttarticle/p/show?id=2309404288058957667162