Sic Transit Gloria China

  • Shoeshine boy trading club, China chapter

  • There’s an old Wall Street legend about Joseph Kennedy, bootlegger and head of America’s original soap opera political family. At the height of the stock market mania in the ’20s, he received a stock tip from a shoeshine boy. It goes something like this:

    But the boy was not of the timid kind. “Oh yeah,” he yelled back at Kennedy, “well, I got a tip for you too: buy Hindenburg!” Intrigued, Kennedy turned around and walked back. “What did you say?” – “Buy Hindenburg, they are a fine company,” said the boy. “How do you know that?” –- “A guy before you said he was gonna buy a bunch of their stocks, that’s how.” – “I see,” said Kennedy. “That’s a fine tip. I suppose, I was a little harsh on you earlier,” he said, pulling off a glove and reaching in his side pocket for some change. “Here, you’ve earned it.”
    Little did the boy know that Kennedy, a cunning investor, thought to himself: “You know it’s time to sell when shoeshine boys give you stock tips. This bull market is over.”

    This is supposedly how Joe avoided the financial ruin of the crash. He was probably too busy stockpiling whiskey to really care very much, but it does make for a good story.

    We’re reminded of this old saw today with some distant rumblings in the markets. Last week I was wondering what might cause our stock market to break out of its summer doldrums. Over the past few days we may have gotten the answer. While everyone was looking at the Greek crisis, China’s stock market has been crashing.

    The Shanghai Composite Index more than doubled in the last year up until a few weeks ago. All that time it was rising, economic reports indicated the Chinese economy was slowing. Since the peak in mid June, it has dropped over 30%. Last night it was down another 6%, and it would have been more if not for the Chinese government halting trading in most of the stocks. Bloomberg is reporting that Chinese regulators have banned major shareholders, corporate executives and directors from selling stakes in listed companies for six months.

    Investors with stakes exceeding 5 percent must maintain their positions, the China Securities Regulatory Commission said in a statement. The rule is intended to guard capital-market stability amid an “unreasonable plunge” in share prices, the CSRC said.

    This rule sounds like it’s meant to ban bigwigs and fatcats from bailing out on the economy. However, like Kennedy in the ’20s, all the big money already exited and left regular citizens holding the bag. The Chinese always had a high rate of savings, but recently they have been putting more of it into their stock market using margin to to double down on already precarious positions.

    Chinese brokers have extended 2.1 trillion yuan ($339 billion) of margin finance to investors, double the amount at the start of the year. But this often-cited figure is only part of the mountain of debt taken out to finance share purchases. Another 1.7 trillion yuan may have flowed into stock market investment from wealth management products, online lending sites and other sources, according to a Bloomberg survey of analysts.

    This was a good old fashioned bubble, and now it looks like it’s bursting. This will have repercussions all over the world. As of this morning, US stock markets are down over 1%. With the reliance of our industrial and financial industries on the hyper-interconnected global markets, this one probably won’t go down quietly.

    21 thoughts on “Sic Transit Gloria China”

    1. The Ironman comments on China today:
      “China’s Import Recession Continues and Weighs on Stocks”

      Stock markets do not cause recessions. They reflect economic conditions, but most imperfectly. Examples abound. There was a violent US stock market crash in 1987, but no recession until 3 years later. The most recent recession began in December 2007. It was preceded by an all time until then S&P 500 high in September of that year. The index did not begin to crash until March of 2008.

      However, all indications are that the Chinese economy is going into recession. As China is the 3rd largest economy in the world, a recession there will have knock on effects. E.g., resource export oriented economies like Australia and Brazil will be negatively impacted.

      Further the US economy is not in great shape. GDP declined in Q1 2015. It may be positive in Q2, but it won’t be a strong positive (>2.5% agr). Further Europe is weak and in trouble because of the Greek crisis.

      Overall we may be looking at worldwide recession in a context where monetary and fiscal authorities have very little room to maneuver. They are in the coffin corner*. They can’t lower interest rates and they have very little ability to finance higher deficit spending.

      Interesting times.

      *The coffin corner … is the altitude [where an] aircraft’s stall speed is equal to the critical Mach number … Because the stall speed is the minimum speed required to maintain level flight, any reduction in speed will cause the airplane to stall and lose altitude. Because the critical Mach number is the maximum speed at which air can travel over the wings without losing lift due to flow separation and shock waves, any increase in speed will cause the airplane to lose lift, or to pitch heavily nose-down, and lose altitude.

    2. BTW: the co0mment preview box seems to have disappeared.

      [Jonathan replies: Our comment preview plugin doesn’t work with the latest version of WordPress. I haven’t found an alternative. Anyone who can suggest an alternative or workaround is encouraged to email me at jonathan at chicagoboyz dotnet.]

    3. The US govt benefits from the Greek crisis to the extent there is flight to quality. Over the past couple of weeks our govt bond mkt popped whenever Greek-EU bailout negotiations faltered. The uptrend in US long rates that appears to have begun a few months ago is now on hold. It seems likely to resume eventually. Coffin corner indeed.

      So far Obama’s weak economic recovery and other countries’ ineptitude have kept our govt’s financing costs from blowing up. But there are no free lunches. The tradeoff for low interest rates has been high rates of unemployment and underemployment, less economic dynamism and personal wealth than might have been, stunted lives and massive public corruption.

    4. Andrew, excellent and hilarious use of the indispensable archetype, The Rat. You know when life starts to imitate TV, it’s time to cash in your chips.

    5. “The uptrend in US long rates that appears to have begun a few months ago is now on hold”

      The drop in yields coincided with the stronger dollar also, but I too am skeptical of further moves in that directions. There’s going to be an 11th hour bailout until they prove that there isn’t going to be one. I can’t possibly imagine the communists that rule Greece will ever cut off the spigot of other people’s money, and I don’t see any way Germany would jeopardize their industrial empire.

      “Stock markets do not cause recessions. They reflect economic conditions, but most imperfectly”

      I keep thinking of Japan from 25 years ago. It’s never made it back up there, but it has been on a run lately.

    6. There are other knock on effects. A totalitarian state most fears internal unrest. That sound you hear coming out of Chinese stock markets may be that of the Mandate of Heaven packing its bags for a long absence.

      The quickest way to rally patriotic feeling to support the regime is a foreign enemy. Add to that, the oversupply of military age males; and the sequalae of this may be downright kinetic.

    7. The economic effects of the Chinese and Greek crises are likely to be ephemeral, the political very long lasting.

    8. I had heard the stock tip came from Kennedy’s barber, but the detail on buying Hindenburg adds voracity.

      I moved half my 401k to near-cash Sunday.

      Mr. Bahadur’s observation of the Mandate of Heaven fleeing notes the real issue here – the political stability of the Communist regime in China.

      Interesting that the cyber attacks today seem to be focusing on St. Louis. What is so important to the Chinese and Russian hackers there?

    9. “Interesting that the cyber attacks today seem to be focusing on St. Louis. What is so important to the Chinese and Russian hackers there?”

      I’m not sure, but hopefully it’s a counterattack against the dastardly Cardinals’ cyberwarfare.

      I concur about the adverse political consequences of a collapse of the Chinese economy. That’s why the government has been working so desperately to forestall it, pretty much banning the stock market from going down.

      After reading T. Greer’s excellent work on the Han–Xiongnu Wars and thinking about all the recent developments and alliances between Russia, the Central Asian ‘Stans’, and China, I wonder what the effects will be on the Eurasian Steppe, the implications for Obama’s negotiations with Iran, the implosion of Afghanistan, etc. Things will look a lot different in that part of the world if China continues to deteriorate.

    10. I heard something this morning, that I have not had time to confirm; but if it is true shows the level of desperation of the Chinese government and means the end of any form of market economy in the short to medium term.

      The report was that the government was arresting people for either selling their stock or short-selling their stock. The possibility of going to the Laogai for selling the stock you bought makes that stock a very personal liability and makes ownership of such a very undesirable thing. The best thing you can do is write off everything you have invested as a dead loss, and hope that the second part of the traditional curse [“may you come to the attention of officials”] does not come true.

      If the market collapses, the government is going to seek scapegoats. China has a history of purges from the founding of the Peoples’ Republic to the Cultural Revolution, where what was praised one week became ideological treason the next.

      I commend to your attention an old book, “Escape From Red China” by Robert Loh (Author) and Humphrey Evans (Contributor), if you can find it. Mr. Loh lived through that series of purges and it is instructive on the ability of the Chinese government to whipsaw the people.

    11. I’ve been buying gold since last winter and saw an odd piece in IBD the other day. I can’t find it now but it dismissed gold as a refuge because of the high dollar. Still, it recommended gold stocks. The chart at Monex shows a decline but I still plan to stay in and see what happens.

      China and India are potential gold buyers but the Chinese government is a wild card.

    12. Mike K Says:
      July 9th, 2015 at 7:03 pm

      May I recommend physical, and possession. Anything someone else holds is not really yours in difficult times.

    13. Joe Kennedy was not a bootlegger; he was a big-time Wall Street operator, with no reason to get involved in explicitly illegal operations run by gangsters. He made a fortune in liquor, but it was by buying the U.S. rights to the most popular Scotch brands for a song during Prohibition. When Prohibition ended he cashed in – quite legally.

      As to the Chinese mess: a 50% decline is pretty ugly, but at the end of it you still have half – you’re not wiped out. Half of what China has now (or had a month ago) is lots more than twenty years ago. If they don’t panic, they can ride it out.

    14. “May I recommend physical, and possession. Anything someone else holds is not really yours in difficult times.”


      “If they don’t panic, they can ride it out.”

      I am hearing rumors of panic. Some stock sellers have been arrested or maybe even shot. The Chinese do not have a strong tradition of law abiding. If some of those “princes” are losing fortunes, the short sellers may be in serious trouble.

    15. It’s true that that there isn’t any evidence of criminal activity related to bootlegging, but to say he had no reason to get involved is untrue. His father owned saloons and imported whiskey from Europe and Canada, and both father and son seem to have hit on lean times after World War I ended with the economy’s severe downturn and prohibition commencing.

      Perhaps we should just believe that Joe made money in booze before prohibition ended and after it ended but did not attempt any deals during it’s duration. Perhaps we should believe that Joe got all his money for his boiler room activities out of thin air.

      What we do know is Papa Joe was an insider trader and market racketeer. He started working on Wall St when Prohibition started and by all accounts was bad at it until he was able to secure and employ duplicitous methods.

      Whether that story about the shoeshine boy is true or not, we can see that Joe’s temperament was to oppose, exploit, and profit from the ambition and industriousness of others.

    16. As to the Chinese mess: a 50% decline is pretty ugly, but at the end of it you still have half – you’re not wiped out. Half of what China has now (or had a month ago) is lots more than twenty years ago. If they don’t panic, they can ride it out.

      They could believe that they still had half right up until the moment the government barred selling your stocks. Keep in mind that China has NO tradition of a rule of law, and millenia of government corruption. From the point of view of the Chinese investor, the government has just stolen everything.

      And they have. Let us say that the markets become real markets again someday. The day that they open, people are going to be trying to get out of the market with whatever they can salvage. And no one is going to be willing to buy any stocks again.

      As I told Mike K about physical and possession. If you can’t get access to your funds when you want/need them, they are not yours.

      Purely anecdotal thought. I am Chinese, and have some knowledge of the mores. You DO NOT want to make an enemy of the family matriarch. If she has been saving, and investing [and the new-fangled stock market was the only legal way to invest] and you rip her off, she will never forgive or forget. Nor will her family. They may not be able to do anything about it now, but we Chinese are a patient [and bloody-minded] people.

      Subotai Bahadur

    17. See Daniel Kahneman’s book Thinking, Fast and Slow about loss aversion.
      The pain of losing a good is greater than the pleasure of obtaining it. People will value declining stocks more at the same price as when they were rising. This is why panic sets in when stocks go down.

    18. “The pain of losing a good is greater than the pleasure of obtaining it.”

      This is probably related to the sunk costs heuristic. I’m thinking about this as I think about a paid-for Greek trip in September,

      Losing your ticket to the movie you have paid for stimulates a sense of loss and behavior that may be more expensive in trying to recoup the loss.

    19. Ref “Subotai Bahadur” at July 9th, 2015 at 3:01 pm

      “… If the market collapses, the government is going to seek scapegoats”

      As demonstrated throughout the 20th century when the Communists’ 5-year plans ended in failure, then failure yet again:
      “Our plans were perfect. Therefore THIS IS SABOTAGE. Find and kill the saboteurs!”

      Over-and-over; millions upon millions of dead “saboteurs” and still –of course– failure. And again, always, “Our plans were PERFECT. Find and kill the saboteurs.”

      = = = =
      Sigh. And now we’ve got every part of Western Civ climbing on the top-down, total-control, “We need EXPERTS running things” bandwagon.

      Six-and-a-half billion may turn out to be Earth’s maximum human population, after all. It might plummet precipitously, sooner than we would wish.

      A bright spot: the Enviro-Nazis will cheer.

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