China: the next zombie

The headline from yesterday’s Wall Street Journal “markets” section: “Stocks extend slump“.

The Dow down again yesterday. Just 28 points. Still in the wrong direction.

Could we be at the beginning of the meltdown that Marc Faber warned about?

Yes, of course. But you never know. Mr Market is a joker. You never know what he’s up to.

It hardly matters. At today’s prices, there is much more risk on the downside than there is reward on the upside. After hitting the highest earnings in decades, what are companies supposed to do next? And with household income still flat or falling, how are they supposed to do it?

Smart readers should be out of stocks. Unless you’ve got a very long-term outlook and are prepared to ride out this deflationary/bear market cycle (which could take ten years or more), you should be out of stocks. At least out of US stocks.

But if you’re out of stocks, what are you in?

Bonds? Nope.

Then, what?


“I keep telling my clients”, said a stockbroker we spoke with yesterday, “that there’s no shame in holding cash. But they don’t want to hear it. They think you can’t make money in cash. They’re worried about inflation. They just want to be fully invested. But right now cash is not a bad thing. It might be the best investment they can make”.

Yes, dear reader, there is a time for every purpose under heaven. There’s a time to make money. And there’s a time not to lose it. This is one of those times… when the best you will probably do is not lose money.

And the best way to do that now is to hold cash. You might lose a little upside. More likely, you’ll lose a lot of downside. And then, when the bottom finally comes, say in 2017, you’ll be prepared to buy.

But don’t be in a hurry. Japan shows us what can happen. In more ways than one.

First, you can get a bear market that knocks 75% off the value of your stocks and keeps them down for the next 20 years.

Second, you can get a response from the feds that turns your whole economy into a zombie. This has been one of our themes for years. Now, the mainstream financial press is catching on. Here’s John Plender writing in the Financial Times:

Japan counts ‘zombie’ cost of easy money

The debate about the effectiveness of unconventional monetary policy measures such as quantitative easing remains perennially inconclusive. Yet the experience of Japan suggests there is one clear negative outcome from ultra loose monetary policy: it does structural damage to the economy.

The deeper problem is that this monetary ease tends to freeze the existing industrial structure. Looked at from the Austrian perspective of Von Mises, Schumpeter or Hayek, the Japanese bubble that burst in 1990 fostered economic distortions they dubbed “malinvestments” – credit-driven investments in real capital that prove loss making when a credit bubble implodes. The results of these misconceived investment decisions take a long time to work their way out of the system, while industries that expanded in response to high demand in the bubble are left with excess capacity. The elimination of this excess and the process of adjustment to a new industrial structure to reflect changed demands, which in Japan’s case means a greater service orientation to address an ageing population, is invariably painful.

In effect, low funding costs in Japan have impeded the process that Joseph Schumpeter dubbed creative destruction because “zombie” companies have been kept afloat at high cost to the competitiveness of others.

Mr Plender focuses on China as the next country to be plagued by zombies. In an effort to keep the growth rate high, China is making capital too cheap and funding too much capacity that is unneeded.

But his definition is too narrow. He refers only to excess and unprofitable companies (or entire industries) kept in business by super-low financing costs.

What really happens is that the whole zombie world is supported by the government from food stamps to F16 fighter planes, from banks to builders, from junkies and drug addicts diddling disability payments to four-star generals diddling around with their biographers at public expense. Gradually, little by little, more and more of the nation’s energy and resources go to feed the zombies.

You may think that a lot of zombies will fall off the ‘fiscal cliff’. Not likely. While the election was ahead, neither party had anything to gain by compromising. Obama would seem weak if he agreed to domestic cuts. The Republicans would look spineless if they gave in to higher taxes.

But now that the election is over, both Republicans and Democrats have an interest in coming to terms to keep the zombies off their backs. The Republicans will agree to tax increases. The Democrats will agree to spending cuts. The whole exercise won’t amount to a hill of beans.

The important question is how much of the nation’s energy goes into zombie support rather than productive activity. After the compromise, the amount is likely to be about the same.

The feds can do a lot of things. But they can’t continue to add debt at four times the rate of additional GDP without going broke. Nobody can do that.

And they can’t prop up banks, insurance companies, the housing sector, disabled people and defence contractors without creating a zombie economy.

Something will have to be done.

So, if a government can put men on the moon, why not the zombies?

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  • Tim Kyle

    Excellent precise article. Why do we keep voting in those people
    without an ounce of financial sense. Debts have to be settled sometime – regardless of who owes them.

  • K V Ramani

    Wicked humor, as always. If only it weren’t the sad reality.