Keynes once said that markets can stay irrational longer than you can stay solvent.
I love this quote because it speaks about the power of narratives, and my humble adaption of that would be:
‘‘Narratives can dominate macro longer than you can remain solvent’’.
This is why today we are going to cover the two strongest narratives out there:
The two narratives are visualized in one simple chart:
To understand what’s going on in China, we need to take a small step back.
The Chinese stock market has been pretty much in a free fall despite regular attempts from authorities to stabilize markets.
In the meantime, the real estate market continues to suffer and Chinese policymakers are grasping at straws trying to stimulate the economy.
To understand what’s going on in China we need to talk about the concept of balance sheet recession.
A balance sheet recession is a toxic economic loop where after being burnt by deleveraging and lower asset prices households and corporations refuse to take in new credit and focus on just repaying their debt and shrinking balance sheets.
That causes a vicious loop of further deleveraging, lower asset prices, and lower economic activity which can’t be stopped with lower interest rates.
Let's first quickly cover how our credit-based system works in normal times.
The top part of the chart above shows what happens then:
But what happens during balance sheet recessions (bottom part of the chart) instead?
How do you structurally fix a balance sheet recession, and is China moving in the right direction?
For sure you can’t fix it by lowering interest rates and Japan shows us why.
In the early 1990s, the Japanese real estate bubble burst and the world’s most famous balance sheet recession unfolded – the
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