The Economist on the Chinese Economy: I Wish I Was Taller

I've been told the whole world grinds to a halt to watch the new season of Game of Thrones, but I've never given one thin dime to HBO so I've never watched it.   I still think one of the best shows of all time is Seinfeld. One of my favorite episodes was "The Cartoon." Elaine gets a cartoon published in the New Yorker. Elaine says the pig says, “I wish I was taller.”  She comes to realize that she subliminally plagiarized the caption from Ziggy.

I’m sure it was the same phenomenon when The Economist published this article on the credit boom in China. The author discusses the BIS research on the history of credit booms, the speed of credit growth, and the gap between credit growth and trend growth, with a wider “gap” tending to expose an economy to greater risk of a crisis. Where have I read that before? Ah, on MacroMan!!

Look, I’m sure I’m not the only one that nerds out to “Liberty Street Economics” and the BIS. What I love about The Economist version is, well, how awesome it is. They don’t caption their articles, but this guy is an absolute professional. Check this out:

“On a rollercoaster, riders climb upwards slowly, their suspense building, then plunge downwards quickly, their stomachs lagging a little behind. In its deleveraging efforts, China’s government hopes to do the opposite. It has allowed the country’s liabilities to mount quickly. Now it wants them to plateau or drop gently (relative to the size of China’s economy), leaving stomachs unchurned.”

Dang. I wish I could write like that. The article goes on to say that growth and inflation have closed a material portion of this gap in 2017, which is a valid point. But it is still well above levels that the BIS would suggest imply economic stability.

Top shelf financial writing aside, this did force me to look back on my analysis from six weeks ago. As so often happens, the analysis stands the test of time, but the trades are a little shopworn. I did pitch them as hedges for a larger risk-seeking portfolio, but you are even farther away from low-delta strikes in currencies like SGD, CAD and AUD---and while 5y5y AUD receiver swoptions are probably still skulking around the same area, CAD rates are higher.

My outright ideas to short CLP and COP are looking relatively good--CLP only recently made a material move stronger on stronger copper prices, but COP has weakened back above 3000 on continued weak oil prices and the stagnating domestic economy.  

It brings up a dilemma in macro trading, tail hedging, or practically anything I guess--if you have a long time horizon, even in a couple of months you can move far enough away from strike prices to take out the gamma you are supposedly paying up for. I continue to like the hedges I brought up the first time around--heck, they may be even cheaper now. The price action of the past couple of months shows that timing is key...but if you are running a large portfolio you are likely not being paid to make decisions about market timing.

That is why it is of great importance to find tail hedges at a reasonable cost in the context of a broader portfolio that is seeking long-term excess returns for a unit of risk. Otherwise, The Great Volatility Ambien Pill of 2017 will put you to sleep and you’ll wake up with in a bad neighborhood with your wallet missing.

The article closes by saying, “Credit, on the other hand, should be a vehicle of economic progress, not a circular thrill ride.” True...but since the breakdown of Bretton Woods, global credit has undoubtedly been a thrill ride of historical proportions. As China continues to ratchet up towards the next peak, we can only speculate when we will reach the top and how steep the inevitable drop will be.

That’s the best I got, Economist writer. Your move.  

Shawn
TeamMacroMan2@gmail.com
@EMInflationista