Thursday, July 9, 2015

3 DEBT-LADEN CHARTS TO RUIN YOUR DAY ... WHAT HAPPENED IN CHINA ISN'T GOING TO STAY IN CHINA

Three debt-laden charts to ruin your day ...

Check out the graph below. In light of what's happening in China's markets, what does the graph tell us about the relationship between using borrowed money - or "margin debt" - to purchase stocks and market activity?


To give you an idea of how much borrowed money - or "margin debt" - has flooded the Chinese market think about this: Between June 2014 and June 2015 the amount of borrowed money in the Chinese stock market jumped from 403 billion yuan to 2.2 trillion yuan.

Now check out the graph below. What does it tell us about the relationship between borrowed money and market activity in the United States? Be sure to pay attention to where the brown bars are located.


What both graphs tell us is that, just like China, market players in the United States have issues with using borrowed money to purchase stocks too.

Big time.

Specifically, the first graph (which I used while discussing China's debt charged stock market here) tells us that the market collapse we're seeing in China can be traced to the sharp increase in the willingness of people to buy stocks with borrowed money.

Let's be clear here. Buying stocks with borrowed money, or margin buying, can be a good thing. But things can get ugly when the regulations, fundamentals, and common sense go wrong.

What happened in the lead up to the Great Crash in 1929 is illustrative.


Buying on margin was so popular in the 1920s that up to 90 percent of what was purchased during The Roaring 20s was purchased with borrowed money. In this scenario a person with $10,000 could end up with $100,000 worth of stock because all you had to do was put down 10 percent of the purchase price.

With lax regulations and weak oversight it was pretty easy to then go to an unwitting banker or financier and say, "Look, I'm worth $100,000 so lend me $900,000 so I can purchase even more stock."

And just like that, someone with $10,000 in the bank could be holding $1 million worth of stock. They could then do it all over again because they now had access to even more collateral.

With a nod towards common sense, today market players are required to have far more than 10 percent in collateral on the books if they want to borrow and buy stocks in the NYSE.

But deregulation and new rules about what counts as collateral have allowed financially troubled market players greater access to play in the NYSE in the United States. This helps explain in part why 2008 happened. It also helps explain why we have another U.S. market collapse on the way, as the next chart helps us see.


In a few words, while the NYSE has been climbing over the years, more and more market players (they're not investors) with negative credit balances have been operating in our markets.

To those of you looking at the green areas - where you see "positive credit balances" - all I can say is grow up. Seriously. The green areas reflect the periods when the Federal Reserve and the Treasury Department (especially after 2008) jumped into the markets with cheap money and easy credit.

Put another way, the green areas represent our on-going bailout in perpetuity for America's increasingly aggressive market players.

There's more, but the key is understanding the characteristics behind our debt-laden markets, and how China is simply helping us see the bigger picture. This piece from Vox really does a great job of explaining what happened in China, and why we need to reevaluate how our market economy actually works.

- Mark

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