Wednesday, July 8, 2015

Deleveraging the Dragon

"The mother of all evils is speculation--leveraged debt."
--Gordon Gekko (Wall Street: Money Never Sleeps)

The China meltdown is attracting more attention after its stock markets were hammered again yesterday for a 6% loss. In an attempt to stem the selling, more than half the issues trading on China's mainland exchanges have been halted.

How this action, or any other intervention by policymakers, stems rather than exacerbates downside pressure remains to be seen.

The problem here is the problem everywhere when markets melt down: leverage. Borrowing to buy more stock magnifies returns on the way up, but it also magnifies losses on the way down.

It's been easy to borrow money to buy stocks in China. Structures such as so-called 'umbrella trusts' have made it easy for even rural peasants to get into the game on margin.

Mix in propensity for governments to bail out risk-seeking gone awry and you have a toxic combination.

Of course, the Chinese case, like the Greek case, should be a wake-up call for US investors. After all, US margin debt rests at all time highs.

Alas, the psychology of denial is an interesting thing. We can be certain that people won't recognize the problem until the margin calls arrive.

position in SPX

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