(09-25-21) The Long Wall: Stumbling over the same stone of legalism with tapering

A week full of headlines about Evergrande has not prevented the indices from finishing positive, saving Wall Street in this turbulent week, with a strong dollar and a falling euro. Metals and the dollar have given up ground and caused the debacle in the indices. Cryptos have recovered some of the price lost last week. Oils have gained value due to production problems that have not changed since last week.

A week of indecision that has ended with a timid recovery in the West, both the US and Europe have had a week plagued with indecision due to the Evergreen giant and the debt crisis, ending the week in positive territory.

The behavior of currencies has been that of a strong dollar against all its crosses at the end of the week, highlighting the movements of USDJPY, USDBRL, USDMXN, and EURGBP upwards. And AUDUSD, GBPUSD, NZDUSD, USDCAD to the downside. The eurozone has suffered from the events in Evergrande, and the loss of confidence. The supply problems of raw materials and intermediate goods slowing down the German economy referred to by Clemens Fuest, president of the German economic research institute, coupled with the ECB's communication makes the ECB a moderate institution in an environment of central banks acting more hawkish, which may influence the euro in the long term after other central banks raise interest rates (EFE). The British pound has been dancing on the edge of the knife after its monetary policy decision of 0.1% interest. The combination of economic problems and pessimistic expectations has generated a shoulder-head-shoulder pattern this week. Festivities in Japan, China, and Hong Kong have marked the week. Australian RBA minutes and building permits have set the trend. Canadian jobless claims and retail sales have marked a strengthening of the Canadian dollar.

Metals and the dollar have given up ground and caused a debacle in the indices much of this week continuing the previous one, experiencing a timid recovery. Gold (XAUUSD) finished the week at $1,750 after falling as low as $1,740. Silver (XAGUSD) finished at $22,415 touching $22,090.

The crypto scene this week has been starred by the Chinese government, with a central bank of China that qualifies as illegal all business with Bitcoin and cryptocurrencies, and since 2017 the exchanges were banned from operating in this market and has called them criminal activities and vetoed by law. It has put an end to mining and alludes to Crypto trading as an element that has damaged the economic and financial order giving rise to criminal and illegal activities. The Chinese government will deepen monitoring and early warnings about suspicious trading activities in their country. (crypto-news). This has caused Bitcoin to recover its price. On the contrary, Evergrande's problem has once again highlighted that many institutional crypto investors have exited the said market in search of liquidity so as not to be caught off guard by what is coming. (crypto-news) Law professor specializing in finance, Saule Omarova, has been nominated by Biden to chair the OCC or US currency watchdog. This. has demonstrated her opposition to Bitcoin and cryptocurrencies, as well as private banking. Despite this key news, the week has been littered with other positives for the scene, such as the sponsorship of an Exchange FTX to the Mercedes-AMG Petronas Formula 1 team, or the Philadelphia 76ers' partnership with Crypto.com. More and more companies are offering the use of cryptos, both for investing and trading. (decrypt) Twitter has launched its Bitcoin tipping service and authentication with NTF. This week we saw USDBTC end at $42,301 and USDETH end at $2908.

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Energy commodities have spent their week on a bullish push ending both West Texas and Brent futures higher on the back of the US market woes. They ended the week on USOIL at $73.98 and UKOIL at $78.05.

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In total, it covers 6,000 kilometers of Chinese territory. It is not strange that its original name in Chinese is changcheng, the "longwall". Because of its serpentine course, its image has been associated with that of an enormous dragon, the symbol of the imperial monarchy in China. From Shanghaiguan, on the edge of the Gulf of Bohai, on the eastern coast of the Yellow Sea, to the west at Jiayuguan, an impressive fortress that marks the end of the historic defense, already in the desert areas of the province of Gansu. It begins at the Korean border, along the Yalu River to the Gobi Desert, along an arc that roughly delineates the southern edge of Inner Mongolia.

How could the Chinese of the V century build more than 21 thousand kilometers that took a generation to prevent the passage of the most terrible warriors of the world? The largest artificial structure in the world. This wall was created in the beginning in five parts because of the invading nomads from the steppe. The history before the unification of the Qin dynasty (221 BC), after its unification, sacrificed thousands of forced volunteers in its construction.

When the emperor Qin Shi Huang ruled, he initiated the construction of a wall on the northern border. Then the Hang dynasty, and successors until the Ming dynasty, which was the one that revived the reconstruction. The territory was divided into different states, allied or confronted according to the circumstances in the previous period of the fighting kingdoms. The first great wall, composed of different walled projects, was built with clays, and as time went by, military advances forced the Chinese to reinforce their line of defense. The first emperor ordered one of his generals, Meng Tian, to build a great fortification along his northern border, inspired by the policies of the past.

The massive structure was built on granite blocks, with bricks and solid rock. The bricks made it almost impossible to climb with defensive battlements. Between the brick walls, the gap was filled with rubble a stable core, and paved with smooth stones. 7 meters thick impenetrable. Thousands of people started one of the first industrial-scale productions in the world massively creating bricks and cemented with a mortar that was also agglutinated with a very common element of that time, rice water, used to make it more durable. How they could move these bricks to the top of any mountain had only one solution, manpower. The Ming dynasty was the one that gave it that grandeur and final finish that survives to this day.

Over a million men were put to work on the wall in extreme conditions in both summer and winter. This brutal regime caused the death of a great number of men for the common good of the country. Those who worked on its construction ranged from soldiers to peasants forced to abandon their crops and move north to satisfy the wishes of the Sovereign and were considered condemned by the State. A state that was de facto a police state where any infraction of the law was punishable by harsh punishments. And these sentences were often the aforementioned punishment.

?His path was not a simple straight line, but it followed the purpose of the line of fire and vigilance. No enemy in his right mind would want to fight against an army stationed on it. This wall also required a large army, approximately one million men to cover the entire wall. The production of their watchmen's crossbows, were mass-produced, with their crossbow triggers created in mass-produced bronze and designed to fit perfectly into the wall, and poisoned to be lethal in a crossfire. It involved cannons and stone bombs, as well as a system of towers and battlements, and defensive communication.

The reason for building the wall was clear - invasions cost Chinese merchants, farmers, and lords too much. The massive structure served to defend against tribes such as the Xiongnu, whose descendants include Attila's Huns, who contributed to the fall of the Roman Empire. Qin is credited with the idea of the Great Wall, and the Ming wall far surpasses the first emperor's wall. The duration of its construction lasted for 1,500 years.

Originally, the Qin ruled a smaller empire than the Ming, who were heirs to the vast empire conquered by previous dynasties. The danger at that time came not only from the north but also from the interior of Asia, from the regions located in the central part of the continent. The Ming carried out military campaigns beyond their borders to prevent offensives from their neighbors and to extend their empire, their main enemies being the Mongols, who had dominated the throne of the country for almost a century. They changed the capital from Nanjing ("The capital of the South") to Peking or Beijing ("The capital of the North"), intending to control the border and this forced them to reinforce the defenses of Peking and the Emperor's Forbidden City. The onslaught of the nomadic peoples, particularly the Manchus, prompted the Wanli Emperor to reinforce the line substantially, increasing military spending. It was these that would bring about the fall of the last Qing dynasty with the help of Ming officers. This would be what those who had contributed most to the Great Wall defense, became the last proper dynasty of China. For the Chinese, the wall was not only a defensive element but the frontier between civilization and the barbarians represented by the Huns, Turks, Mongols, etc. Considering itself the center of the world, the only civilized world.

At that time the formula found by the first Qin emperor was to issue debt, exploit his vassals and servants in the name of the common good of the empire. The political thought of the Legist School, which promoted the Legalism of Shen Buhai and Shang Yang, is utilitarian. The main objective was to strengthen the power of the monarch. The basis of the functioning of the state revolves around these three concepts: The Legal System, Political Stratagem, and Authority. That is, the legal system, generates very severe laws, rewards those who bring benefits, and punishes lawbreakers. The second indicates that the ruler must have the right knowledge to know how to govern by confronting his political opponents and thus maintain his position and power. And the last one indicates that the good and iron authority and control of the ministers should be preserved. "Fa (Law or Principle), Shú (Method, Tactics or Art) and Shi (Legitimacy, Energy or Charisma) encompass the model of thought of this system. It does not contemplate Confucianism and makes the law only represent the "Tao" that is embodied in men. In dynasties after Qin legalism was discredited, and ceased to be an independent school of thought. Ancient and modern Confucian observers of Asian politics argue that Confucian ideas merged with conventional Confucianism and played an important role in the expression: "Confucianist on the outside and Legalist on the inside". This made the country politically and militarily more powerful than its enemies. Until its fall.

The standardization of the language by the first emperor, protected today by the tomb of terracotta warriors, led to the murder of scholars and the burning of copies, which is still remembered today. This led to the completion of the hundred schools of thought and cultural expansion, and the Golden Age of Chinese Philosophy called Confucianism (School of Scholars). The victory of the Qin hawks. Without philosophy in the midst, tyranny, and oppression run rampant, fighting against the ethics of respect for parents and the family figure promulgated by Confucius. The apparent calm promulgated by the emperor is only apparent.

Massive wars of conquest, extensive construction projects, and high taxes made his court very unpopular. A peasant captured the capital of Qin together with the leader of the Chu establishing the Han empire. They killed a total of half the population of the region. The 40 million people were reduced to 18 million during the period of the warring kingdoms. The impoverished people were kidnapped from their homes. The history of the Qin dynasty was nothing more than an attempt to create a present that in the end ended up being unsustainable.

Evergrande gives the feeling of being a reflection of this thought that continues to last to this day and was implanted in the government of Xi Jinping and all the current big businessmen of that country. Pharaonic works, the creation of thousands of ghost towns that have hardly any inhabitants, and are urban conglomerates designed for a hundred or two hundred times the size that is occupied, and a whole series of economically unsustainable projects. The important thing about Evergrande is that it is uncovering this desire to "reconquer" its territory through mega-constructions and excessive real estate projects that have no public to buy them and are more of a government obsession than a necessity.

The prelude to what is to come could be called the Black Swan. The end of an economic model started in Breton Woods seems to be coming to an end. The Soviet socialist model and the capitalist model in which they coexisted with many elements to take into account. The fall of the soviet model in 91, made the west survive thanks to this fall and facilitated the expansion in the east. The end of an economic model based on infinite expansion, sooner or later the situation was repeated in 2007 and 2008 with the Subprime and Leman Brothers, and Evergrande is one more element of this systemic bankruptcy.

This real estate company highlights what is happening in the housing market. A gigantic bubble that can only work if housing prices are made to rise and there is inflation in products, and mortgages are getting higher and higher. The financing market has two traditional ways of buying a home, through a mortgage loan or cash purchase. In the most common case, one applies for credit in the primary credit authorities such as banks or savings banks, and in countries like the United States or China, this debt that the bank sells this mortgage debt to the secondary market, which can be repeated indefinitely and infinitely. The issuance of bonds is what finances the bank loans can be resold. And every bank, savings bank, etc. can repeat this operation over the course of a year. They can buy the whole mortgage and hold it to maturity, buy a pool of mortgages called mortgage-backed securities, basically junk, which caused the American markets to crash.?In this way, a pension fund owns a pool of mortgages and is entitled to receive a percentage of the underlying principal and interest on the mortgage.

For example, if a pension fund can buy 1000 mortgages for 20 years, with a fixed interest rate of 100 thousand dollars each, this represents not only 100 million dollars of these securities guaranteed by a mortgage. In this way, the money of the pension fund on duty enters the real estate market thanks to companies such as Fannie Mae and Freddie Mac, which are dedicated to guaranteeing the majority of mortgages in the USA. They are known as Government Sponsored Enterprises (GSE). These guarantors provide a risk reduction for lenders who make loans and for investors who might buy them. This makes them more affordable and contributes to the availability of 30-year fixed-rate loans. Loans that cannot obtain collateral from these GSEs are more expensive. GSE-guaranteed loans are known as conventional loans because they meet certain government regulations, such as maximum loan amounts, while the others are set by the companies. This is how Fannie Mae makes a profit. If it fails, these mortgage-backed securities are confronted by the SGE. What matters to the Evergrande case are the ones that do not meet the requirements. These packaged products are sold to foreign investors, and if something goes wrong, Fannie Mae is responsible. For example, the junk houses in Canada, which they sell for 6 or 7 million dollars, something that would be worth 50 or 100 thousand dollars and causes the worst houses in any city like Toronto in the poorest neighborhood to cost 2 or 3 million dollars. So these people in charge, who have an additional $1 billion in funding coverage. They have caused it to spread to a planetary setup of bestial implications. The problem is that investors are unaware that their capital is invested in these types of hedge funds. These GSEs can re-create yet another overlap of these securities in what is known as the Real Estate Mortgage Investment Conduit (REMIC).

?The term real estate mortgage investment conduit (REMIC) refers to a special purpose vehicle (SPV) or debt instrument that pools mortgage loans and issues mortgage-backed securities (MBS). REMICs are investments that can be considered pure blind bets, generating income for issuers and investors. They divide portfolios into tranches, are repackaged and marketed to investors as individual securities that can take many forms, and are generally considered pass-through entities. They are therefore exempt from direct taxation. This big bubble is as much as $4 trillion adding all the bubbles together.?(freddiemac.com) REMICs were created in the Tax Reform Act of 1986. In March 1988, they began issuing these types of products and issued the first gold-backed REMICs in 1990. In June 2019 they began offering the option to combine UMBS and Supers issued by either Freddie Mac or Fannie Mae and deliver them in a Freddie Mac REMIC.

This type of repurchase agreement or swaps, apparently necessary for the business, amounted to 550 billion. The only positive stable flow of interest is the securitization of mortgages for their principal. The other three parameters, represent obligations and feed, and represent a rapid and steady growth of the housing bubble that causes it to feed on itself the last 20 years, represents a higher unemployment rate, higher interest rates, a growing number of increasingly desperate homeowners, it is inevitable that they will soon reflect a wave of mortgage defaults. And these risky bonds amplify the crisis and threaten to bankrupt the GSEs. The reason is that they are infested in all sectors by many big banks. And we are seeing the end, the end of the collapse that can be seen coming at cruising speed. It takes as long as it takes to drink a coffee that a simple news item reflects a fact that has multiplied the value of a titanic show.

Evergrande is not the only representative of this economic vandalism that has been paid for by debt. A liquidity crisis like this can lead to a solvency crisis. In debt of 300 billion and with only an available 15 billion dollars with half of the debt committed to suppliers, that is, a tenth of what it needs to cover the problem. Most of its assets, almost two-thirds are real estate inventory, not something that has a high turnover. Homes take time to sell, if you lower the price too much being highly leveraged, your cash would not be enough to cover the debts. Occasioning as we relapsed in a severe solvency problem of the master scale. The second reason why inventory quality is abysmal. Most of Evergrande's assets are unfinished projects in secondary or tertiary cities in the country. This means many additional years of maturity. The rest of the Chinese real estate sector is shaking. There will be a massive liquidation with bestial discounts, and it will affect companies that were already providing real estate services more sustainably. Chinese banks will suffer a lot, they will close the credit tap and there will be fewer citizens who can borrow to buy a house. So the liquidity and solvency crisis will spread in a chain, not only affecting the Chinese economic system, globally. Even cryptocurrencies like Tether can be creditors of Chinese banks if they collapse. That's why everyone is hoarding liquidity. Entities fear a Leman or Minsky moment, a deflationary crisis. Central banks are expected to act and stabilize the situation at the cost of zombifying the Chinese economy. If it doesn't happen on a massive scale, we can panic.

?For years China had been fuelling its growth through pure and simple exports, especially to Europe and the US. If the engine of China's growth until 2007 was to make the West go into debt, after the Western regulatory changes in Europe and the US, the Chinese authorities were no longer going to buy more debt on a net basis, paying cash, importing, and exporting to China, because it was trying to deleverage from then on. Instead of focusing on exports, the government had to put more weight on domestic spending. Instead of working on credit, it should redirect its effort to the domestic market. From 2008 to 2018 or 2019 there has been a structural shift to more domestic consumption. Until 2007 their growth had been about 14% and they didn't know how to approach this shift other than by indebting their own country with consumption. The answer was to increase indebtedness, and Chinese private debt has risen from 100-120% of GDP, and from 2008 onwards debt soared to 220% of GDP. That is, doubling the percentage of debt over GDP. Growing on the back of over-indebtedness causes asset bubbles, generalized bad investments that at some point collapse and make it difficult to pay the debt, and when they cannot be paid the whole financial system of the country collapses and plunge the Chinese house of cards into a deep depression. In 2014 it almost happened when it was financing its growth by playing with US interest rates. With the famous "Quantitatiphysics", quantitative easing, flooding the Chinese financial system with dollars. Borrowing at low-interest rates in the United States, to acquire Chinese financial assets at high-interest rates, which facilitates the financing of indebtedness without the need to depreciate the yuan, but from 2013 the US began the Tapering, which limited the sending of capital to China and the return of this to the United States. So all the debt piled up in China thanks to cheap US credit disappeared. That's when the Chinese government decided to cut China's central bank interest rates to endogenously stimulate its borrowing. It remained relatively high from 2011-2014 and yet they fall from 2014 onwards. China's indebtedness fell from 6% to 4.35%.

The Chinese Communist Party wants to force a cooling of the country's brick sector and is weighing down Chinese economic productivity. Almost 30% of Chinese GDP depended directly or indirectly on construction, similar to the peak of the Spanish real estate bubble. The percentage of Chinese technological exports has been stagnant for years, and the total factor productivity of the Chinese economy has been stagnant since 2015. Because it coincides with a burst of Chinese indebtedness in that sector. The government fed that bubble with its cheap credit policies. But now it is trying to seek to get it to abandon other types of industries with a more technological component. And the Chinese government wants to avoid that. HNA group already went bankrupt earlier this year and is a third of Evergrande, and the Chinese government did not intervene to save it. Another reason, more ideological type of the Chinese communist party: The common prosperity, seeks greater equality of income and wealth, seeking to emerge the middle class, what the communist party wants to do is to laminate the mercantilist capitalist business class, which could become a counterweight to the state. So to speak, it is cutting off heads by curbing the big fortunes in China. The bailout of Evergrande is a potential systemic risk especially for the Chinese economy, but there are reasons to let it fall. The underlying problem is over-indebtedness since 2008 and over-investment in activities such as real estate.

This already happened in the time of the first emperor of China, and it is just the first example of one of the economic collapses that have been replicated eventually. At that time, they paid for it with blood and fire. The Chinese economic model is likely to reduce its power based on hyper-developmentalism. With slower economic growth, with a per capita income about 4 times lower than that of the United States. Let's hope that the debt bubble is not transferred to other sectors and does not feed international price inflation.

Both counterparts from different eras, the first emperor and the longest-serving president in the Chinese government seem to have conquered the world with their wallets and the debt of their people. Shi forced himself to create the Great Wall to facilitate Chinese mercantilism and Xi seems to have repeated the same equation. As is visible, you can always stumble over the same stone. Again, and again, and again. We will have to pray that another mausoleum full of "terracotta and debt" soldiers are not being built to bury the economic problem. The sustainability of China's economic growth depends on the decisions made by President Xi's expansionist government. The Chinese curse of "living in interesting times" seems to be something we have to suffer these days.

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Happy Trading and Happy Friday!

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This article only expresses my opinion and under no circumstances represents an investment recommendation, but a purely educational document.

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