'It's Very Simple': Fata Morgana (Redux)

by: The Heisenberg

- This post is equal parts critique (of the over-democratization of markets), recap (of the bond rally and its reversal) and in-depth analysis (of the mechanics behind recent action).

- The late-March rally in bonds is poorly understood. It was, at least in part, another example of a "false optic".

- Misinterpretation helped fuel last month's "growth scare" narrative.

- And in a testament to how untrustworthy narratives can be, last month's "growth scare" story gave way to this month's "cyclical reflation" tale in the blink of an eye.

Most people familiar with my musings are aware that I harbor grave reservations about the over-democratization of markets.
Plain vanilla index funds that offer investors low-cost, broad-based exposure to benchmark equity indexes are obviously a great thing and balanced funds which pair that exposure with a simple allocation to bonds are even better. They should be the building blocks of any portfolio.
That assessment is more truism than opinion, which is why I long ago ceased responding to anyone who challenged my critiques of democratized markets by extolling the virtues of S&P 500 index funds.
It's never been clear to me, though, why we need a plethora of ETFs that allow retail investors to trade in and out of markets in the blink of an eye and it's even less clear to me why we need ETFs that encourage non-professional investors to day trade things like high yield credit, leveraged loans and emerging market assets.
Before anyone tunes out, let me quickly steer this discussion off the rumble strips and back onto the highway. This isn't a post about liquidity mismatches in credit ETFs or about why I think the epochal active-to-passive shift is pernicious (those two topics are near and dear to me, but they tend to elicit eye-rolls from some readers).
Rather, this is a post designed to make a simple point about the extent to which the over-democratization of markets sets the stage for widespread misinterpretation which can then translate into manifestly false narratives and, ultimately, undesirable outcomes.
I made a similar point in one of the few posts I've written for this platform in 2019 called "Fata Morgana". There, I described how, in Q4, investors suffered from a kind of parallax effect - a confused perspective. In late November, hedging dynamics and the unwind of someone's long WTI/short Nat Gas spread trade accelerated crude's collapse, leading some to believe that oil, which was already plunging, was signaling something particularly dire about the global economy. Shortly thereafter, misunderstandings with regard to the Fed's efforts to normalize policy and misplaced angst about inversions, sparked a panic. Stocks dove, spreads widened and the volatility-liquidity-flows feedback loop kicked in. At the same time, incessant media coverage, tweets from the president and an extremely engaged investor base (from a public interest perspective) perpetuated the spiral.
Some of that, I would argue, stems directly from too much engagement by non-professional investors and (far) too much media coverage which, even when largely accurate and done responsibly, risks lapsing into hyperbole or otherwise pouring gas on the proverbial fire.
Before I bring you the latest example of a market Fata Morgana, allow me to use a (very) recent example to make a point about the over-democratization of markets. On Thursday, the iShares MSCI Turkey ETF (TUR) had its seventh-worst day of 2019, falling more than 2%. To be clear, it's not unusual for that product to fall more than 2% in a single session - there were dozens of such days last year when Turkish assets were besieged by a combination of external and idiosyncratic factors which, by August, conspired to push the lira to the edge of crisis. Additionally, it should be noted that Turkish stocks have had a rough go of it lately. Local elections held late last month stoked uncertainty and, ultimately, the Borsa Istanbul wiped out most of its YTD gains.
That latter bit (about the municipal vote) strikes at the heart of the issue. Clearly, some large investors who use TUR to gain exposure to Turkish equities know what they're doing and as such, are well apprised of local dynamics. But I don't think it would be a stretch to suggest that most "average" (and I don't mean that in a pejorative way) investors who own TUR are largely in the dark about what moves Turkish assets on any given day. And that's to say nothing of the vagaries of Turkish politics, which themselves are inextricably bound up with the fate of the country's markets.
For instance, Thursday's decline in Turkish equities was, for the most part, the result of questions about the country's foreign reserves. Without getting too far into the weeds on this, the Financial Times decided to take a look at the central bank's swaps book and this is what they found:
Why is that a problem? Well, the central bank's borrowings from banks (i.e., those swaps) never rose above $500 million - with an "m" - from January through the end of March. You'll note that the numbers in the chart are in billions - with a "b". The implication is that Turkey is now working pretty hard to inflate its reserves.
Again, the point isn't to get mired in this particular discussion (if you want to, there's more here), but you should also note that one of the worst days in years for TUR came on March 22 (yellow arrow below) when traders couldn't explain a sudden decline in the country's reserve pile.
That selloff coincided with a dastardly day for the currency which, in turn, led to a vicious crackdown the following week, when President Erdogan essentially trapped investors in the lira in a bid to keep the currency stable ahead of the above-mentioned local elections. On March 27, the overnight rate surged above 1,000%.
Ok, so, who cares? Well, anyone who owns TUR, presumably, and that's a problem because it's not entirely clear to me why anyone save emerging market fund managers and seasoned FX traders should have to worry about any of the above. In fact, it is wholly unrealistic to expect "average" investors to sort through what I just outlined, which raises the following simple question: Do we really need a product that allows anybody and everybody to day trade Turkish equities? If such a product (i.e., an ETF from a top-tier sponsor like iShares) is in fact desirable, then shouldn't it be the purview of institutional investors and, perhaps, active EM fund managers who can use it to hedge?
While I don't know the answers to those questions definitively, what I do know is that, anecdotally anyway, it stands to reason that the more democratized the market gets, and the more of these vehicles there are, the easier it is more investors who have no business actively trading certain assets to do just that. The result, I would argue, is a less efficient market as uninformed investors attempt to decipher things they shouldn't have to decode.
It's relatively easy to make that case when it comes to something like Turkish stocks. Given the myriad idiosyncratic factors involved, suggesting it's preferable to leave the decision making to active EM fund managers (or, if you like, to say investors wanting passive exposure should opt for a broader-based EM ETF so as to mitigate the perils associated with any one country) is not a particularly contentious thing to say.
What is contentious, though, is to suggest that most investors probably shouldn't be in the business of trading macro themes with ETFs at all, even when the themes relate to subjects most engaged investors claim to know something about and even when the ETFs and the underlying assets are extraordinarily liquid.
Enter another Fata Morgana.
Late last month, developed market bond yields dove following the March Fed meeting when, against all odds, Jerome Powell and co. managed to deliver yet another "dovish surprise". I say "against all odds" because, generally speaking, the view on the street was that the Fed couldn't possibly get any more dovish without actually cutting rates.

Two days after the Fed meeting (so, on Friday, March 22) data showed Germany's manufacturing slump deepened in March. The new orders subindex (on the March PMI) fell to 40.1, the lowest since 2009. 10-year German yields pushed below zero for the first time since 2016. The mood, as I put it that morning, was "doom and gloom".
Two days previous, Jerome Powell managed to do what Mario Draghi couldn't earlier in the month:
Deliver a dovish surprise without accidentally "confirming" the market's worst fears about the outlook for growth. One of my favorite analyst quotes of 2019 comes from BofAML's US credit strategist Hans Mikkelsen who, following the March Fed meeting, wrote the following:
Just when you thought the Fed could not possibly deliver another dovish surprise, they did. Of course communicating dovishness is always tricky as there is a delicate balance between the benefit of stimulus and the underlying driver, which is economic weakness.
Mikkelsen probably didn't mean to say anything particularly novel there, and indeed he didn't. The beauty of that passage lies not in profundity, but rather in how concisely Mikkelsen communicates what is perhaps the key quandary of monetary policy in the post-crisis world. There is a fine line between assuaging market fears about the outlook for the economy by indicating policy will be accommodative, and accidentally spooking markets further in the course of justifying a dovish lean.
In a rare misstep, Draghi went too far in March, when the ECB delivered a cut to the euro-area growth outlook dramatic enough to override the good vibes that would have "naturally" accompanied a renewed commitment to accommodation.
Powell, on the other hand, largely succeeded. The March Fed meeting was overtly dovish, but risk assets were not truly spooked. Or at least not until 48 hours later, when the above-mentioned "doom and gloom" narrative took hold. In response to a friend's question about whether the March 22 selloff was an opportunity to buy the proverbial dip, I wrote something called "As Bonds Find ‘Best Friends’, Stocks Grapple With Inversion Freakout", in which I detailed the series of events that helped spark the second-worst day for US stocks of the year after the US 3M-10Y curve inverted.
Here are some quick excerpts:

JGB yields had to play catch up (or, actually, “catch down” is better) to the dovish Fed after a holiday and the Japan CPI miss threw gas on the fire. Then came the grievous German manufacturing data and it didn’t help that France’s composite PMI sank back into contraction territory. Ultimately, the die was cast by the time the US session got going. 
The data from overseas underscored growth concerns and, more importantly, appeared to lend credence to the idea that the Fed’s dovish surprise might have been predicated on the FOMC “knowing something” everyone else doesn’t know.
At that point, the "growth scare" narrative became somewhat entrenched. Predictably, the media and every armchair macro watcher on the planet, rushed to breathlessly opine on i) the US curve inversion, ii) what a return to sub-zero bund yields in Germany was "saying" about the world's fourth-largest economy and iii) what might happen in the event forthcoming activity data out of China were to disappoint.
To be clear, some of that breathless commentary was justified. Growth worries were proliferating and for good reason. 2019 has been a year defined by ominous signs and warnings about the global economy and, after all, there's a reason why central banks felt the need to pivot so sharply.
The problem, though, is that most casual observers were oblivious to the fact that what was going on in US rates wasn't entirely attributable to a "growth scare". Previously moribund rates volatility suddenly woke up during the week of March 25, and by Wednesday of that week, things were getting really interesting to the detriment of risk asset sentiment.
"Global rates [are] again foaming at the mouth with another leg of panicky grab, while conversely [we] see risk assets spooked by the instability seen in the rates-trade", Nomura's Charlie McElligott wrote early on the morning of March 27, adding that the following color:

UST- / swap spread- / front-end- / front-end flattener- 'stop-ins' again 'going off' overnight, with likely exacerbation culprits again being negative convexity types from MBS and systematic short vol strategies. 
That may sound like gibberish to most investors, and indeed, that's the point. What the vast majority of casual market observers were interpreting as a "growth scare", was at least partially the product of convexity flows and hedging following the March Fed.
As noted above, rates volatility suddenly jumped after grinding to record lows earlier in the year.
"This spike in rates vol. is making headlines all over the place today", I remarked, in an e-mail to a friend on March 26. "I guess you've seen that - Bloomberg is running headlines like 'calm goes the way of the dodo'."
"It is very simple", this person responded, adding the following:
Clients were short gamma when rates weren’t moving. The street was long gamma, of course. Since last week, rates have moved a lot, so some of those strangles yield enhancers sold are at the money—they became shorter gamma and started covering. In the meantime, the street became less long, so vol. had to go up.

The next day, Bloomberg ran a feature story called "Here's Why U.S. Bond Yields Plunged So Much Over the Past Week". It contained the following layman's explanation:
Treasuries rallied after the Fed signaled it was done raising interest rates for the moment, driving yields on 10-year notes down to levels last seen in 2017. That forced two sets of traders -- those who had bought mortgage bonds and those who had bet markets would remain calm -- to turn to derivatives markets to tweak their portfolios or stanch their losses. They snapped up positions in interest-rate swaps, pushing Treasury yields down even more.
On March 29, Deutsche Bank's Aleksandar Kocic delivered a characteristically trenchant take on the whole episode, complete with a "seesaw" analogy to illustrate the difference between the way things used to be (when MBS hedging was the dominant market mode) and the way things are now (what he calls the "insurance mode", defined by periods of placidity shattered by episodic vol. spikes). For those interested, I did a lengthy post on that at the time, called "The Gamma See-Saw: Deutsche’s Kocic Explains This Week’s Biggest Market Story".
All of that served to exaggerate moves in US rates and those exaggerated moves were misunderstood and generally misinterpreted by most market participants who assumed that the ferocity of the rally in bonds late last month was solely a function of growth worries. That misinterpretation led many to fearfully point to what's colloquially known as "the jaws" or, more simply, the yawning gap that developed on a simple chart of the S&P (which continued to grind higher) and 10-year yields (which hit their lowest levels since December of 2017 late last month). Here's what the "jaws" looked like on March 30:
"It really depends from which direction the jaws close – through higher rates or via lower equity prices", one client told Goldman a few weeks back.
So, many investors went into April believing the bond market was "saying" something more than it was actually "saying" about growth. Had you not appreciated the role played by convexity flows and hedging dynamics, you might well have gone into the first week of April not realizing that with positions mostly squared and two critical data points on deck (March PMIs from China and US payrolls), the stage was set for a pretty violent snapback in, for instance, the iShares 20+ Year Treasury Bond ETF (TLT) which had its worst single session decline since "long way from neutral" on April 1. Have a look at this chart:
In that yellow-shaded box is the bond rally that played out following the March Fed. On April 1, China reported better-than-expected PMI data, eliciting a huge sigh of relief from those concerned about global growth. With the impact of hedging flows on US rates in the rearview, things reversed in dramatic fashion, leading directly to the selloff in TLT denoted with the yellow arrow and caption in the visual above. A subsequent beat on ISM in the US lent further credence to the idea that the March growth scare was perhaps overdone. On April 3, Nomura's McElligott summed up the situation as follows:
Currently this is simply about the re-pricing of growth expectations which, to me, is partially due to the potentially ‘false optic’ created by the enormity of the convexity hedging impact on Rates over the past two weeks into the rally having caused an ‘overshoot’ of the growth-scare narrative.
There you go - another "false optic". Another confused perspective. More financial parallax.
Another Fata Morgana.
In the three-ish weeks since, the market was pleasantly surprised by, in order, a solid March jobs report in the US (helping to erase the memory of February's debacle), a better-than-expected read on exports out of China, across-the-board beats on Chinese credit growth and, on Wednesday, a blowout set of numbers from Beijing which showed GDP stabilizing in Q1, while retail sales and industrial production surprised markedly to the upside.
The end result: "The jaws" have closed in the "right" direction, with 10-year yields rising some 16bps in April (top pane in the visual). Meanwhile, German bund yields are back in positive territory despite still-dour manufacturing data and Berlin slashing its official outlook for growth to just 0.5% in 2019 (the yellow circle in the bottom panel shows that in March, German bund yields converged with yields on 10-year JGBs, underscoring the "Japanification" story in Europe).
So, what did we learn from all of this? Some readers will invariably say "nothing", but that would be wholly disingenuous. For one thing, anyone who made it through this piece now knows more than they did previously about at least something, whether it's what's going on in Turkey or what accelerated last month's much ballyhooed bond rally.
More importantly, what the above underscores is that in today's markets, over-engagement by average investors (and "average" isn't meant as a comment on ability, but rather to denote anyone for whom investing isn't a profession) and the deafening cacophony of the financial media/blogosphere makes it all too easy for misleading narratives to take the reins. Once that happens, narratives are notoriously stubborn when it comes to ceding control of the carriage, irrespective of evidence. Ask any casual observer of markets what was behind the late-March bond rally and they'll tell you it was a "growth scare". As explained above, they'd be only partially correct.

A more nuanced argument could well be that because growth concerns prompted the Fed to deliver another dovish surprise and because that dovishness was behind the initial moves which kicked off all the manic hedging activity, "growth scare" was in fact the proximate cause of the bond rally. I'd concede that.
But, in general, my contention is that we'd all be better off if we didn't have a setup where every mom and pop investor on the planet is free to day trade macro themes with ETFs based on a never-ending stream of real-time, broad-strokes commentary pushed out at warp speed by journalists and bloggers all parroting the same theme du jour in a kind of "publish first, ask questions later" fashion. The late November collapse in oil prices (mentioned above) was easily explainable by reference to producer hedges and some soured spread trades. The 2s5s and 3s5s inversions in December begged for nuance, but all anyone cared about was cramming "inversion" into headlines. The ferocity of the late-March bond rally was in part down to convexity flows following the Fed, but it was far easier to churn out dozens of "growth scare" stories first and then call the street's rates desks five days later to see if there was more to the story.
As should be clear from the excerpted conversation I had with a friend on the street last month, there are often "quite simple" explanations for large moves and the people manning the desks are more than happy to elaborate if anyone cares to ask. But that takes effort on the part of the media (to write) and on the part of market participants (to understand). It's far easier to cram a given move into a cookie-cutter narrative.
These narratives have a tendency to become self-fulfilling as we saw in December. Once things get moving in one direction, systematic strategies get roped in, headline-scanning algos are triggered and before long, the nuance becomes irrelevant. Fortunately, the string of upbeat data surprises mentioned above served to short-circuit the "growth scare" story and now, were trading squarely on a "nascent cyclical reflation" theme.

Going forward, that theme will live and die by the prevalence (or not) of more "green shoots".
With central banks now firmly committed to a dovish policy stance, good data can arguably be interpreted as just that - good data. The "good news is bad news because it suggests further stimulus and accommodation isn't necessary" story popped up again vis-à-vis the recent run of positive data out of China, but as far as developed market central banks go, the bar for putting rate hikes and/or normalization back on the table is impossibly high.
In other words, barring a series of "rogue" inflation prints, DM policymakers will be sitting on their hands for the foreseeable future, so we needn't fear good news on the worry it will tempt central banks to lean hawkish again.
That should be a volatility suppressant and, assuming the data hangs in there, we may soon be able to drop the "nascent" adjective from the "nascent reflation" headlines.

The Eternally Optimistic IMF

The International Monetary Fund believes that ringing alarm bells on global economic growth is not its job, especially with many observers spotting signs of improvement in the past few weeks. But with economic conditions set to worsen before they improve, complacency is likely to have a high cost.

Ashoka Mody

mody24_MANDEL NGANAFPGetty Images_imf

PRINCETON – In April 2018, the International Monetary Fund projected that the world economy would grow robustly, at just above 3.9% that year and into 2019. The global upswing, the Fund said, had become “broader and stronger.” That view quickly proved too rosy. In 2018, the world economy grew only by 3.6%. And in its just released update, the IMF recognizes that the ongoing slowdown will push global growth down to only 3.3% in 2019.

As always, the Fund blames the lower-than-forecast growth on temporary factors, the latest culprits being US-China trade tensions and Brexit-related uncertainties. So, the message is that growth will rebound to 3.6% next year. As Deutsche Bank points out, IMF forecasts imply that fewer countries will be in recession in 2020 than at any time in recent decades.

But the forces causing deceleration are still in place. Global growth this year will be closer to 3%, with rising financial tensions in Europe.

The IMF keeps getting forecasts wrong because it misses the big picture. The economically advanced countries – which still produce about three-fifths of global output – have been experiencing a long-term slowdown since about 1970. The reason, Northwestern University’s Robert Gordon says, is that despite the promise of modern technologies, ever-slower productivity growth has dragged down the growth potential of these rich economies.

As a result, China has come to play a dominant role in determining the pace of global growth. Besides its large size, the Chinese economy has extensive trade links that transmit its growth to the rest of the world. When China grows, it sucks in imports from other countries, giving the global economy a big boost. Rapid Chinese growth revved up the world economy between 2004 and 2006, in 2009-10, and in 2017.

But China’s once-heady growth rates have necessarily fallen as the country has become richer. By historical standards, an economy as rich as China today should be growing at 3-5% a year, rather than the 6% or more that the Chinese authorities are trying to achieve through fiscal and credit stimulus.

Pushing too hard for extra growth has increased China’s financial vulnerabilities to worrying levels. By standard measures of credit growth and asset-price inflation, the country should have had a financial crisis by now. The Chinese authorities have therefore played yin and yang, stimulating growth to prevent a rapid slowdown, but reining in the stimulus to contain financial risks.

The latest cycle has been no different. In 2017, Chinese policy stimulus spread through the world, leading to the celebration of a “synchronous upsurge.” The most significant beneficiary was Europe, which depends heavily on trade. European Central Bank president Mario Draghi patted himself on his back for deft “monetary policy measures,” which he said had supported “broad-based” momentum.

When China withdrew its stimulus in early 2018, the IMF, the ECB and other forecasters blissfully continued to project high growth rates, even as the global economy slowed rapidly. Soon enough, Europe swooned, sending Italy into a technical recession and Germany to the threshold of one. (Oddly, the United Kingdom’s economy, for all its Brexit-related troubles, is doing marginally better than both.)

In the past few months, China’s leaders, concerned about their economy’s slowdown, began a new round of stimulus. Although data are not yet available, world trade growth appears to have risen slightly since then. European growth rates have ticked up, although only enough to alleviate immediate recessionary risks.

For the world economy, the continuing problem is the short-lived nature of Chinese stimulus. The OECD has already warned that the latest stimulus will drive up the worryingly high volume of corporate debt, and that over-indebted local governments will borrow more to finance wasteful infrastructure. Faced with the choice of financial crisis or slower growth, the Chinese authorities – and the rest of the world – will once again prefer slower growth. Thus, China’s deceleration will resume in the coming months, dampening world growth yet again. For now, no other country is in a position to take China’s place.

Darkening the global outlook further, the US economy is coming off the “sugar high” of fiscal stimulus and corporate cash repatriation from overseas. In addition, Germany’s slowdown in 2018 and early 2019 may not only reflect its sensitivity to slower world trade growth. Its economy may be finally descending from its high pedestal as its vaunted diesel-engine-based car industry struggles to meet pollution standards and growing competition from electric cars.

The real risk, however, lies in Italy. Running down the checklist of crisis indicators, all of Italy’s are flashing red. The economy has zero – possibly negative – productivity growth, which makes it impossible to generate internal momentum to pull out of recession. The ECB has no room to help. Italy’s debt-to-GDP ratio is above 130%, and the European Union’s absurd budget rules, in any event, make fiscal stimulus nearly impossible. Tremors along the Italian fault line will spread quickly to France, which has only slightly better indicators and also little scope for an effective policy response to a serious downturn.

The IMF, always reluctant to ring alarm bells on the global economy, is especially unwilling to counter the recent upbeat sentiment. But with economic conditions set to worsen, complacency is likely to have a high cost.

Ashoka Mody is Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs at Princeton University. He is a former mission chief for Germany and Ireland at the International Monetary Fund. He is the author of EuroTragedy: A Drama in Nine Acts.

Trump, Tariffs and China Spell Trouble for American Steel

The vanishing levies on Canada and Mexico could be just the beginning of the industry’s problems

By Nathaniel Taplin

It was all just a fleeting, pleasant dream.

U.S. steelmakers woke last week to the brutal reality of evaporating tariffs on Canadian and Mexican steel. But an even greater problem is waiting in the wings: China may soon be tempted to ship more of its unwanted steel to foreign shores.

President Trump said Friday that the 25% tariffs he imposed on Canada and Mexico in mid-2018 would be lifted and that both countries would drop retaliatory levies. That removes a major hurdle to congressional approval for Mr. Trump’s revamped Nafta, the U.S.-Mexico-Canada Agreement.

U.S. steel companies will certainly take a hit, given that the tariffs boosted U.S. prices significantly above the global average for most of 2018, at the expense of steel-consuming industries like oil and autos. Even with the 25% tariff, imports of Canadian and Mexican hot-rolled coil steel are roughly 5% cheaper, according to Moody’s.

           Bad news is coming down the pipe for U.S. steelmakers. Photo: staff/Reuters

Meanwhile, Chinese steelmakers are raising output nearly as fast as property investment, the main source of steel demand, is growing. If that trend continues and Chinese mills send their excess production abroad as they did in 2014, it could sink global steel markets.

The big global steel rally that began in 2016 was made in China. The country’s stimulus pushed property investment sharply higher, while Chinese President Xi Jinping’s signature campaign to reduce excess factory capacity and pollution, launched in 2017, gave steel output a hard knock. Close to 10% annual growth in real-estate investment, paired with falling steel output, sent China’s monthly net steel product exports sliding about 60% between late 2015—when they ran to nearly 10 million metric tons—and late 2017.

Unfortunately, nothing lasts forever. Weakening economic growth in 2018 led to weaker controls on production. Property investment is still growing at about a 10% clip, but now steel output is too. Margins have narrowed, and net exports have begun to creep higher.

One cause for optimism is that regulators appear to be aware of the problem. China’s two biggest steel cities will extend seasonal winter production restrictions into June, Reuters has reported.

This is helpful, but it also puts the global steel market once again at the mercy of Chinese officials. April industrial growth was bad. If May doesn’t show a significant bump, or the Chinese job market keeps worsening, pollution restrictions might be watered down again.

Beijing doesn’t want domestic steel prices to collapse. Given the strained state of trade relations with Washington, sending more steel abroad look tempting. The U.S. steel industry needs to prepare for a bad day.

China’s Fake Numbers And The Risk They Pose For The Rest Of The World

Not so long ago, London Telegraph’s Ambrose Evans-Pritchard was one of the handful of must-read financial journalists. He probably still is, but since he disappeared behind the Telegraph’s pay wall his work is invisible to non-subscribers, only emerging when a free outlet runs one of his stories.

That happened this morning when the Sydney Morning Herald carried his analysis of the financial Ponzi scheme that is China.

After taking on more debt in a single decade than any other country ever — in the process helping to pull the US and Europe out of the Great Recession — China recently shifted into an even higher gear, creating a world record amount of credit in the most recent reporting month.

And – more important for headline writers and money managers – it reported exactly the right amount of GDP growth.

This brings to mind a long-ago interview in which economist Nouriel Roubini asserted that China just makes its numbers up, frequently reporting GDP immediately after the end of the period being measured, something that even the US can’t do.

But it’s one thing to for the rest of us to suspect and/or assert that China is just giving the markets what they want to hear, and another thing to understand the implications and explain them coherently. Evans-Pritchard does this in his latest article.

Maximum vulnerability: China (and the world) are still in big trouble
China’s majestic and elegantly-stable GDP figures are best seen as an instrument of political combat. 
Donald Trump says “trade wars are good and easy to win” if your foes depend on your market and you can break them under pressure. 
He proclaimed victory when the Shanghai equity index went into a swoon over the winter. This is Trumpian gamesmanship. 
It is in China’s urgent interest to puncture such claims as trade talks come to a head. Xi Jinping had to beat expectations with a crowd-pleaser in the first quarter. The number was duly produced: 6.4 per cent. Let us all sing the March of the Volunteers.
“Could it really be true?” asked Caixin magazine. This was a brave question in Uncle Xi’s evermore totalitarian regime. 
Of course it is not true. Japan’s manufacturing exports to China fell by 9.4 per cent in March (year on year). Singapore’s shipments dropped by 8.7 per cent to China, 22 per cent to Indonesia, and 27 per cent to Taiwan. Korea’s exports are down 8.2 per cent. 
The greater China sphere of east Asia is in the midst of an industrial recession. Nomura’s forward-looking index still points to a deepening downturn. “Those expecting a strong rebound in Asian export growth in coming months could be in for disappointment,” said the bank. 
China’s rebound is hard to square with its own internal data. Simon Ward from Janus Henderson said nominal GDP growth – trickier to manipulate – is still falling. It dropped to 7.4 per cent from 8.1 per cent in the last quarter on 2018. 
Household demand deposits fell by 1.1 per cent last month. This means that the growth rate of “true” M1 money is still at slump levels. It has ticked up a fraction but this is nothing like previous episodes of Chinese stimulus. It points towards stagnation into late 2019. “Hold the champagne,” he said. A paper last month by Wei Chen and Chang-Tai Tsieh for the Brookings Institution – “A Forensic Examination of China’s National Accounts” – concluded that GDP growth has been overstated by 1.7 per cent a year on average since 2006. They used satellite data to track night lights in manufacturing zones, railway cargo volume, and so forth. 
“Local officials are rewarded for meeting growth and investment targets,” they said.  
“Therefore, it is not surprising that local governments also have an incentive to skew the statistics.” 
Liaoning – a Spain-sized province in the north – recently corrected its figures after an anti-corruption crackdown exposed grotesque abuses. Estimated GDP was cut by 22 per cent. You get the picture. 
Bear in mind that if China’s economy is a fifth or a quarter smaller than claimed it implies that the total debt ratio is not 300 per cent of GDP (IIF data) but closer to 400 per cent. If China’s growth rate is 1.7 per cent lower – and falling every year – the country is less able to rely on nominal GDP expansion whittling away the liabilities. 
Debt dynamics take an ugly turn – just at a time when the working-age population is contracting by two million a year. The International Monetary Fund says China needs (true) growth of 5 per cent to prevent a rising ratio of bad loans in the banking system. 
China bulls in the West do not dispute most of this. But they say that what matters is the “direction” of the data, and this is looking better. Stimulus is flowing through. It gained traction in March with an 8.5 per cent bounce in industrial output – though sceptics suspect that VAT changes led to front-loading. Suddenly the words “green shoots” are on everybody’s lips. 
The thinking is that China will rescue Europe. Optimists are doubling down on another burst of global growth, clinched by the capitulation of the US Federal Reserve. It will be a repeat of the post-2016 recovery cycle. 
Personally, I don’t believe this happy narrative. But what I do respect after observing late-cycle psychology over four decades – and having turned bearish too early during the dotcom boom – is that investors latch onto good news with alacrity during the final phase of a long expansion. A filtering bias creeps in. 
So sticking my neck out, let me hazard that heady optimism will lead to a rally on asset markets until the economic damage below the waterline becomes clear. 
Let us concede that Beijing has opened its fiscal floodgates to some degree over recent weeks. Broad credit grew by $US430 billion ($601 billion) in March alone. Business tax cuts were another $US300 billion. Bond issuance by local governments was pulled forward for extra impact. But once you strip out the offsets, it is far from clear that the picture for 2019 has changed. 
Nor is it clear what can be achieved with more credit. The IMF said in its Fiscal Monitor that the country now needs 4.1 yuan of extra credit to generate one yuan of GDP growth, compared to 3.5 in 2015, and 2.5 in 2009. The “credit intensity ratio” has worsened dramatically. 
I stick to my view that the US will slump to stall speed before China recovers. Europe is on the thinnest of ice. It has a broken banking system. It is chronically incapable of generating its own internal growth or taking meaningful measures in self-defence. 
Momentum has fizzled out in all three blocs of the international system. We are entering the window of maximum vulnerability.

Lots of good data here – something notably lacking in most reporting on China’s “miracle.”

But the best — and scariest — single stat is the dramatic decline in the marginal productivity of debt.

China, like the US, is getting progressively less bang for each newly-borrowed buck. There’s a point at which new borrowing doesn’t just product less wealth but actually destroys it. The US and China are heading that way fast, while Europe might be there already.

As Evans-Pritchard, notes, the result is “maximum vulnerability.”

Britain is once again the sick man of Europe

If treachery becomes part of the debate, there can only be total victory or total defeat

Martin Wolf

David Cameron, the 'essay crisis' prime minister, resigns after losing the EU referendum in 2016 © Getty

When I was young, in the 1960s, the UK was known as the “sick man of Europe”, for its prolonged economic weakness. But after Margaret Thatcher’s time as prime minister, this grim epithet no longer seemed applicable. Yet now, once again, as I go abroad — and especially in continental Europe — people ask me, with a mixture of bewilderment, pity and Schadenfreude, “What is wrong with Britain?” I do not pretend to know the answer (or answers). But I can describe the symptoms: the UK is undergoing six crises at the same time.

The first and most important crisis is economic. The starting point was the shock of the 2008 financial crisis. But, today, the most important aspect of this is the stagnation in productivity. According to the Conference Board, output per hour in the UK rose by just 3.5 per cent between 2008 and 2018. Of all significant high-income countries, only Italy’s grew less. Yet that is not because the UK’s productivity is already high. On the contrary, output per hour in the UK lags behind that of Ireland, Belgium, the US, Denmark, Netherlands, Germany, France, Switzerland, Singapore, Sweden, Austria, Australia, Finland and Canada. High employment and low unemployment are good news. But stagnant productivity means stagnant real incomes per head. This means that one group can only get better off if another does worse. This does not make for happy politics. A long period of fiscal tightening has made it unhappier.

The second crisis is over whether national identity has to be exclusive. That question soon turns into one about loyalty. Many are comfortable with multiple identities. Others insist there must only be one. One way of looking at this division is as one between “people from somewhere” and “people from anywhere”, as David Goodhart defines it in his book, The Road to Somewhere. But, once politicised, this becomes far more bitter and divisive. It has been, in Brexit.

The third crisis, Brexit, has weaponised identity, turning those differences into accusations of treason. Normal democratic politics are subsumed within (and managed by) appeals to a higher shared loyalty. Once the idea of “treachery” becomes part of political debate, only total victory or total defeat are possible. Such perspectives are incompatible with the normal give-and-take of democratic life. And so, in fact, it has proved. The country is so evenly divided, and emotions are so intense, that resolution is at present impossible.

The fourth crisis is political. The existing parties, based historically on class divisions, do not fit the current identity divisions between those who are gladly both British and European and those who insist that being the former excludes the latter (at least if by “European” one means “citizen of the EU”). Both main parties are being destroyed in the process, but a new political configuration is yet to emerge.

The fifth crisis is constitutional (by which I mean that it relates to the rules of the political game). Membership of the EU is a constitutional question. Use of referendums as the device to resolve such constitutional questions is itself a constitutional question. If referendums should decide such things, what must be the role of parliament in interpreting and implementing that decision? What, for that matter, is a sensible decision-rule for a constitutional referendum? Should it be a simple majority or a supermajority? Why did we stumble into this mess, without asking ourselves any of these questions?

The sixth and perhaps most important crisis of all is of leadership. The UK has stumbled from the “essay crises” of David Cameron to the mulish obstinacy of Theresa May. Now it can see before it the prospect of a general election, with a Conservative party led by Boris Johnson confronting a Labour party led by Jeremy Corbyn. These two men do not have much in common. But they seem to me the least qualified potential prime ministers even in a country that is, after all, still a permanent member of the UN Security Council. One is an inveterate buffoon and the pied piper of Brexit. The other is a hardline socialist and a life-long supporter of leftwing despots. With such leaders, the mess can only worsen — and it surely will.

Why so many crises have befallen the country at the same time and how they all relate to one another are really important questions. Poor economic outcomes, in terms of real income growth, are surely related to the rise of national identity as a salient issue, though there are other factors, notably immigration. What matters, however, is not what caused all this, but that it is going to take a long time to sort all this out. The UK will, alas, remain sick for a while.