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China Tries to Teach the USA Free-Market Capitalism

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The irony of ironies unfolds for the world to see.

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Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

China rallied 6% off its overnight low; that's the good news. The bad news is that it was down more than that when the rally began. The Shanghai Composite finished the session pretty in pink, remaining in bear market territory.

All the while, the Chinese government is standing firm on their agenda. They're trying to administer the medicine necessary to cure the debt disease rather than provide drugs that mask the symptoms, like so many other central banks around the world have done. Only time will tell how they fare, but extending that analogy, we're sure to see signs of withdrawal, which can be violent at times.

I read a Bloomberg article last night that brought me back to 2007, which is the period this juncture most reminds me of.

It spoke of how the cash crunch in China has, among other things, put the China GDP goal in jeopardy for the first time since 1998. (I traded through the Asian contagion; let me tell you, it wasn't fun.)

Liu Li-Gang, formerly of the World Bank, offered, "If they (China) fail to achieve 7.5% (GDP target), they will lose credibility with the markets, provincial leadership and financial institutions... that means that in the future, whenever they say something, the market may interpret it differently, and the credibility issue is something very critical for them to consider."

Flash back to August 2007 when it was clear to anyone who paid attention that the wheels were falling off the stateside financial wagon. In The Credit Card, which spoke specifically to this topic, I shared the following fare, which is seemingly apt in our current day. And I quote:
As we listen to the vernacular from the powers that be around the world, the onus is on us to assimilate the cumulative dynamic that has evolved over the last five years. The Federal Reserve attempted to buy time on the back of the tech bubble with fiscal and monetary stimuli that encouraged risk-taking, reward-chasing behavior. It was a grand experiment of sorts and it continues to brew.

While debt is front and center, credit of a different breed -- credibility -- has emerged as the issue at hand for markets at large. If and when investors begin to perceive that central banks are no longer larger than the markets -- and this, in my opinion, is simply a matter of time -- a crisis in confidence will ensue.

That's a troubling thought considering the current angst in the context of global indices that remain higher for the year. I'm not smart enough to know when this will happen and I'm certainly respectful of the fact that a cornered animal will bite, scratch, claw -- and potentially kill -- to ensure survival.

Those animal spirits have laid many bears to rest over the years and to be honest, I'm unsure if the downside disconnect has now become a tad too obvious. Psychology, as with the markets, moves in cycles of denial, migration and panic.

One thing for sure, however. If and when the wheels wobble off the global financial wagon, the warning signs will be obvious with the benefit of hindsight. Unfortunately -- or fortunately, depending on your preparedness -- the crimson die will already be cast.

Welcome to the finance-based, debt-dependent, oh-my-goodness mindset, where the only true preparation is legitimate financial education.

We know what happened next: Global markets were crushed, the S&P 500 (INDEXSP:.INX) suffered an organic 2:1 split, and Shock & Awe followed, an extension of a grand experiment that continues to play out.

And lest you think anyone knows how it will - how a "free" market will react after being manipulated for almost five years - think again. In order to make an educated assessment, you must have experience in the matter, and there isn't a person on Earth - in the history of Earth - who has navigated this course before.

So here we are, in the irony of ironies: The United States of America, home of The Statue of Liberty, The Constitution, and The Freedom Tower, continues its attempt to guide markets on a course they deem to be in the best interest of our nation.

Across the world, communist China, where they don't even enjoy the freedom of speech, is attempting to ensure the forward freedom of their markets. It would be amusing if the stakes weren't so darn high.

Here's the twist, and it's a biggie. Given ZIRP (zero interest rate policy), one can intelligently argue that interest rates have been artificially compressed for upwards of five years. Forget for a moment the $10 trillion or so that's been used to prop up the markets in an effort to jumpstart the US economy - that's another conversation altogether, particular given our anemic growth - let's focus purely on rates. If the age-old adage holds true - the longer the compression, the more vicious the unwind - a wild ride may await global investors.

As first discussed in Ojai in 2005, "The problem that comes from engaging in high-risk behavior for which the consequences are absent, even if only temporarily, is that such high-risk behavior begins to appear normal, and the entire scale of risk gets adjusted and pushed out."

Risk hasn't disappeared; it just morphed from one reality to another. The frightening element, however, is that it continues to be cumulative.

Good luck today.



R.P.

Twitter: @todd_harrison

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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

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