Editor’s Note: Brutal economic numbers continue to pour in from around the world. They indicate further malaise ahead. So this week, we’ve turned back to PBRG founder and editor of The Palm Beach Letter, Tom Dyson, for more critical insight. Tom shares his unique perspective on China, currency controls, and more, below…
J. Reeves, editor, The Palm Beach Daily: Reports show China has trillions of dollars in bad loans floating around its economy. What’s the story? How dangerous is it?
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Tom Dyson, founder, Palm Beach Research Group: I’ve read the reports. One recent report came from major Asian brokerage house CLSA. CLSA estimates Chinese banks’ bad debts ratio could be as high 8.1%.
That’s six times higher than the official 1.5% nonperforming loan (NPL) level reported by China’s banking regulator!
[A nonperforming loan is money a borrower hasn’t made a scheduled payment on for at least 90 days. Once a loan is considered nonperforming, the odds of it being repaid in full are low.]
Other reports say bad loans in Chinese banks have doubled in 2015… and there’s a trillion-dollar “hole” in the banking system.
Anecdotal evidence supports this. Bridges to nowhere. Empty skyscrapers. Ghost cities. How do you pay the bank loan on an empty skyscraper? You can’t.
So yes, this is a huge problem. It reflects years of malinvestment. Wait… malinvestment is too kind. More like idiotic investment.
China’s about to have its own Lehman Brothers moment. Chinese banks loaned out billions of dollars in “dumb” loans. And they’re about to take the hit.
There’s a loose network of traders and fund managers who always profit from these sorts of things… George Soros, Kyle Bass, etc.
They’re all heavily shorting China’s currency right now.
It’s the new “Big Short.” I expect these guys will make enormous profits. And in retrospect, everyone else will wonder how they didn’t see it coming…
J.R.: Central banks will fight deflation to the death. They can’t force people to take out loans… but they can print money. Could we see a global stagflation (low economic growth plus high unemployment and inflation)?
Tom: It’s unlikely.
Look, they’ve already turned the dial to “10.” They’re at maximum on the central bank stimulus gauge. Could they print money, Venezuela-style? Or drop it from helicopters? I don’t think so. Seems far-fetched.
I hope they don’t prove me wrong…
Besides, the banks need asset inflation. They need to prop up the stock and bond markets… to get the economy growing.
Dropping money from helicopters would only lead to price inflation. There’d be an outcry. It just doesn’t seem politically acceptable.
This isn’t a problem a central bank can fix. It’s just not. Malinvestment has built up for decades and decades. We need a “spring cleaning.” That’s all it is. It’s a simple case of letting gravity do its work.
All this central bank intervention is just smoke and mirrors. The only solution is real economic growth.
A growing economy creates opportunity… to invest, to produce, to capitalize, and to improve. But the economy can’t grow until we’ve cleaned out all the bad loans, bad investments, and unnecessary capacity.
But the economy cannot grow. There are no opportunities left.
New York University recently surveyed 42,000 companies. In more than half the companies, they found any dollar invested in new growth would return a loss of about 3.3% a year on capital invested.
We must clean house. It’s the only way. If it were up to me, I’d cease all stimulus immediately and let the market set interest rates.
We’d sort out our problems in no time.
J.R.: Let’s talk about currency controls. As governments grow more desperate, we could see more laws and regulations forcing citizens to keep money in the country. What will these new regulations look like?
Tom: I was just in Venezuela. They regulate currency by controlling exchange rates. They set the exchange rate at a level where it doesn’t make any sense for foreigners to trade currency with locals. So the locals are stuck in their local currency.
It creates a black market in illegal currency exchange, of course. This deters some people, especially in a brutal police state.
Governments can also impose tariffs. In Cuba, I saw there’s a 10% fee for converting Cuban money (pesos) into dollars. And the government has the monopoly on foreign currency exchange stores.
China uses currency controls to support the value of their currency, the yuan.
But currency controls never work. The market always prevails in the end.
The only question is how much humiliation does the government (and the people) suffer along the way… and how much money does it waste?
Now, I could see some of this stuff happening in Third World countries. But we won’t see capital controls in America… at least not anytime soon.
That’s because American currency is too strong. And there’s too much capital flowing IN. The Federal Reserve wants to grease the wheels… not bung them up with sand.
If anything, I see America blocking capital from coming here. For example, preventing foreigners from buying American property.
J.R.: Why are you recommending any stocks in this environment? Even good businesses will see their share prices suffer in a bear market. Aren’t you better off keeping your money in cash?
Tom: Yes—cash is the horse that wins the race. As long as you keep it somewhere safe. Banks aren’t safe. (That’s a long story for another time.)
Stocks will do badly in general. But some stocks will do less badly than others. Bank stocks will be among the worst.
High-quality consumer stocks—like tobacco, diapers, or food—will do much better. But they still won’t do as well as cash.
We’re not recommending many stocks in The Palm Beach Letter. And the ones we are recommending either have recession-proof business models or tons of cash.
We’ll also be looking to buy high-quality companies at very attractive prices as “The Great Unwinding”—a massive sea change happening in global markets—progresses.
This market isn’t good for most buy-and-hold approaches. But it’s a trader’s market. Nimble investors who can trade sentiment will do well.