How a Chinese Equity Black Monday Transmits to a Global Money Supply Collapse

China’s stock markets are having a really bad day. A black Monday, down 8.45%, with knock on falls in closely intertwined markets such as Japan and Australia- and now spreading globally.

There are still those that doubt whether a stock market collapse has an impact on ‘real’ economies – so it is worth spelling out precisely the transmission mechanism via the banking system.

Stock market bubbles are fulled on speculation – on what Guzman and Stiglitz (2015) call tellingly ‘pseudo wealth’.  It is the collapse in that pseudo wealth that causes aggregate demand collapse in the wider economy.

The transmission mechanism is through the banking system, principally through the collapse in the perceived real value of equities and company assets held as security on loans.  Collateral enables banks to leverage their ability to lend – their ‘lending power’.  Banks are not passive intermediaries they can create money at the stroke of a pen, but not without limit.  They need existing assets (equity) and then leverage those assets depending on the collateral lenders provide and future perceived income streams from lending.

When perceived future revenue streams provide to be pseudo-wealth then this has a strong feedback loop on the ability of banks to lend.  Non performing loans increase and banks can leverage less with less collateral to bank their existing loans books.  The ability of banks to lend – their lending power – their ‘charter value’ as it is known collapses.  From levering we go to deleveraging and the familiar debt deflationary cycle described famously by Fisher and elaborated by Minksy, Steve Keen and others.

In good times banks expand the money supply, but this is not deflationary as the money is destroyed on repayment of loans and if the investment is used to reduce factor inputs it may raise wealth and even deflate prices increasing real wealth.  If however the loans are spend on assets and ‘pseudo wealth’ the repayment of debts in a downturn becomes purely deflationary not backed by increases in productivity and we get a depressionary cycle.

This is why an equity collapse, in a highly leveraged economy, can have non linear impacts on money supply and growth.  In China a collapse in formal bank lending will also have a knock on impact on shadow banking because of the carry trade to less well regulated shadow banking.

Can the global economy cope with a trillion dollars knocked off equities in one day? What matters though it how leveraged that equity is.  The answer is straightforward; it is highly leveraged and no it can’t.

Their is only one possible response for the Chinese authorities.  Flood the Chinese banks with ‘helicopter money’ to prevent a banking collapse, it that leads to a collapse in the Yuan so be it.  The global response has to be to avoid a ‘currency wars’ response.  This is precisely what was done to the Japanese banking system in the Great Depression and worked well compared to the dramatic austerity in Europe for example in the same period.

Their would be some irony then if China and its closely interlocked economies saw their savior in an economic measure derided as ‘Corbynomics‘.

6 thoughts on “How a Chinese Equity Black Monday Transmits to a Global Money Supply Collapse

  1. Corbynomics, while superior to the idiocies of austerity is still a thoroughly orthodox and incomplete policy. If you’d do all manner of infrastructure etc. spending, which god knows the UK and USA desperately need, and also implement both (remember there ARE two mechanisms in Social Credit) you’d actually attain an equilibrium…and with the macro-economic discount mechanism that is rebated back to the merchants who give the consumers the discount….you could have equilibrium AND price
    deflation…with a roaring economy! All economists and economic pundits are nascent social crediters…because it accomplishes the particles of truth in the agendas of both the left and the right.

  2. That transmission only happens if banks are run along assumptions that are current in the West. If you operate on a different set of assumption – that debt is swapped for equity and the state recapitalises the banks as required then all that changes is the perceived risk of those deciding what gets funded by a loan and what doesn’t.

    There is no need for collateral in a fiat banking system. It is a prehistoric artefact a comfort blanket that generally turns out to be an illusion once you get a systemic collapse.

    • It is true that China is ‘special’ but China is not sui-generis

      Firstly there is the huge carry trade from state owned banks to none stateowned shadow banks – 1/5 of the sector

      Secondly none state owned banks are increasingly important

      Thirdly there has been huge lending in dollars from banks outside china

      Yes the ability of fiat to be able to issue collaterol does enable china to avoid liquidity crucnhes much easier than other nations, but it does not mean it is without consequences and normal rules dont apply, after all increasing base money simply devalues the currency and the ‘impossible trinity’ kicks in.

  3. Let me rephrase my comment above:

    All economists and economic pundits are nascent social crediters…because it much better and much faster accomplishes the the agendas of both the left and the right, and without including their mutual idiocies either.

    Go figure why either would object to it? Maybe they’re both more concerned with power and control….than the freedom they say they are seeking.

  4. All of the problems extant and described above “must” occur only within the wholly unbalanced monetary and economic paradigms of Debt ONLY and of scarcity ONLY. Balance those paradigms with a consumer financial paradigm of monetary grace/monetary gifting and an over all concept of grace as in (mental and systemic) balance and flow and you’ll have a system that includes and allows for both Debt and relative but decreasing scarcity…and yet actually works in a free flowing fashion from top to bottom, from trillionaire individuals and corporations all the way to the person on the street…unlike the present one that inherently erodes profit, purchasing power and wealth and so sets in motion all of the frenzied attempts of millionaires and billionaires to hold onto or increase money they’ll never spend via derivative “weapons of mass destruction” and that equally tempt carry trades and currency wars that eventually erupt into hot wars.

    Hypnotized by Debt and Scarcity Psychopaths and psychopathically unbalanced systems are a bad combo. I suggest we evolve a third alternative like Distributism/Distributive Social Credit, whose paradigm is Grace and whose primary intention is individual freedom. Profit and even power and control can then fit seamlessly and almost entirely benignly…beneath those more humane and all encompassing ideas.

    It seems that every two thousand years or so the concept of Grace helps Man understand himself better. Re-discovering that concept this time around will not only do that, but also help us understand and apply policy in the economic and monetary systems so that individual freedom and systemic free flowingness can become the reality.

    • And just in case the “unrealistic” argument is trotted out I remind you I’m talking about a SYSTEMIC policy INTEGRATION of both Debt and monetary gifting. And yet, yes I am also talking about replacing the PRIMARY IDEAS, the PRIMARY PARADIGMS of Debt ONLY and scarcity ONLY with a new paradigm of Grace as in giving back and forth, and Grace as in elimination of waste and excess made “necessary” by uber production in a failed attempt to create sufficient demand to equilibrate the system. and

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