I am doing a spot on CNBC Squawk Box tomorrow morning to talk about what’s going on in China and its connection, if any, to the big Friday sell-off of global stock markets. As you will see below in the talking points I sent the producers to brief the anchors, a pretty small event in China–a modest drop in their manufacturing purchasing manager’s index–is triggering a very big reaction from investors. I have no idea how to forecast this sort of thing but I am pretty sure of a few things: 1) the developed countries are starting to grow again, 2) rising US interest rates this year are forcing investors to sell tons of emerging market assets they spike their yields while rates were zero here, 3) there is still almost $3 trillion in excess bank reserves in place that are finding their way into rising business loans and asset prices. As long as these conditions remain I want to be fully invested in US assets. My favorite stock and biggest position for some time has been Blackstone (BX). They hugely benefit from increased bank lending. The talking points are below FYI:

-Investors seem to have their finger on the trigger, with small bits of news leading to big price changes.

-One of those small bits of news was the weak china growth news that triggered a big Friday sell-off.

-HSBC “flash” China manufacturing PMI January report 49.6 (50.5 December).
Translation: China manufacturing is likely to fall a little in coming months.
most components down (orders, jobs, backlogs, prices, delivery times, inventories)
but Jan OUTPUT index actually increased to 51.3 (51.4 in December)

-Couple things to remember.
This is a “flash” (preliminary) report–final report 1/30.
HSBC report has more small companies than next week’s (2/1) official report.

-Manufacturing will continue to be weak relative to services as govt tries to rebalance from too much infrastructure spending and manufacturing to more service sector jobs. Low growth in US/EU/Japan also a factor. Some migration out of Japan to cheaper sites (Vietnam).

-The small company story is important. Central bank has been trying to “rein in” the shadow banking sector (black market in loans) since last summer when interest rates spiked. This is where China’s small, fast-growing companies get their working capital. There is a structural problem in China. Big banks only lend to big companies; there is no formal lending channel for small, private companies. Most of China’s growth, and most of capital spending, comes from these small, private companies. China needs a way to provide steady working capital for these companies, which is why growing more small private banks was in the reforms announced last month.

-There is no banking crisis in China although there are some bad loan issues with China’s non-bank lenders (trust companies), especially their loans to local governments to finance infrastructure projects in recent years.

-Property prices are rising again but no bubble there to pop because there little debt financing and no securitized mortgages.

-Chinese government is concerned with stability, but more worried about creating enough jobs, containing pollution and corruption, and providing enough affordable housing to avoid political ‘unrest’ than debt or banking issues.

-Bottom line: China will continue to grow but at at gradually declining rates for a long time. Investors will be spooked every time there is a new number.

-In addition to the specific China story, there is a much bigger global story in play. The death of the carry trade.

-world is growing a little faster this year but it is the developing countries (US, EU, Japan) that are improving. They don’t buy commodities, they buy iPhones and copy paper.

-The emerging market carry trade is unwinding. In recent years weak growth in developing countries has kept interest rates at zero (QE) so investors borrowed in dollars to buy emerging market assets at higher yields. This made hot money problems in emerging markets. Stronger growth and rising rates now in the US are forcing investors to sell their emerging market assets, which means soft growth, weak stock markets, soft commodity prices there.

-Biggest upside opportunity 1) US asset prices driven by $3 trillion in excess bank reserves left behind after QE. (leveraged finance (e.g., BX), real estate best way to capture it and my 2 biggest positions today.

-Biggest risk 1) US long-term interest rates are going much higher. 2) Assets that depend on low US rates for support are going to get killed, including interest sensitive stocks and emerging market stocks and currencies. There are 40 reasons why I never encourage investors to invest directly in Chinese stocks, but to do so through ‘surrogates’ (BHP, RIO, FCX)in safer places (Australia, Korea, US,…) but this is not a time to buy them either because growth in China is not high enough to support rising commodity prices today.

So I am fully invested in US stocks but am staying away from bonds and emerging market assets for now.


When our daughter Katie was 3 years old, she referred to the list of things you make at the beginning of every year as “New Year’s Revolutions.” One of my New Year’s revolutions for 2014 is to start writing again.

In particular, there are two things on my mind. The first is practical; I believe that we are in the early stages of a change in economic direction that will rival the shift of inflation that separated the ’70s from the ’80s, only in the opposite direction.

The second is more theoretical. I started my professional life as an academic economist doing all the things professors do. Then, like Odysseus, I wandered off to try my hand at being policy adviser, forecaster, restructuring adviser, board member, and finally private equity investor. After 30 years, I too found my way home–in my case back to teaching. For the past 3 years I have taught Macroeconomics, Finance, and a course I invented called Topics in Far From Equilibrium Economics and Finance to the PhD students at Claremont Graduate University. To do that, I had to read all of research published while I was away. Although I love the students, I find the state of economics today to be very strange–almost silly–and nearly useless. I want to write down a few of these “Rip Van Winkle” thoughts (I know I am changing metaphors here but I don’t think that either Rip or Odysseus would be offended and, besides, it’s my blog :)

Here are a few thoughts on the first topic that I wrote up to brief Larry Kudlow before doing the last show of the year with him on New Year’s Eve. Our topic was what investors should expect for 2014. You can watch a video of the spot at the following url:  http://video.cnbc.com/gallery/?video=3000231976&play=1

  • 2014 is going to be a ‘feel good’ year, like the front end of a New Years Eve binge, with increased Fed stimulus, higher growth, contained inflation, and strong stock and real estate markets. Investors need to take full advantage of 2014 and protect themselves against rising interest rates down the road.
  • There is only one big story for 2014, the Fed. Contrary to the common belief that the Fed tightening, Fed stimulus will be greater in 2014 than in any previous year. The right way to measure stimulus–the pressure of policy on growth and prices–is not whether the Fed is ‘buying bonds’, it is the stock of outstanding bank reserves that banks can still convert to business and consumer loans. Bank reserves today stand at $2.6 trillion and banks hold $2.5 of which are excess reserves in excess of reserve requirements earning 0.25% interest. Before the financial crisis, total bank reserves were $85 billion; excess reserves were $0, their normal level. But the Fed is still increasing reserves by $75 billion per month, which will push excess reserves past the $3 trillion mark by early next summer.
  • There is no example in the history of the world where banks permanently sat on a mountain of excess reserves. Banks face the same investment (arbitrage) incentives as we do. They earn less than 1% on their cash reserves at a time when stock prices are rising at 25% per year and home prices are rising 13% per year. That arbitrage is irresistible, which is why business loans have been growing every week from $1200 billion at the bottom of the financial crisis  to $1603B today, higher than pre-crisis levels. The burden of new regulations are making them lend slowly (especially  small banks); but they are lending.
  • The $2.5 trillion wall of excess reserves has been leaking through the banking system in the form of rising asset prices. In the early days, it showed up as vanishing discounts on the assets–mortgage backed securities and secondary private equity interests–that had collapsed during the meltdown. Now liquidity is pushing into stock and real estate markets; over the past 2 years, stock prices are up +45% and home prices are up +25%. Banks are making ‘covenant lite’ loans to private equity firms again, which is fueling rising M&A and IPO activity. These gains will continue as long as the wall of excess reserves is in place.
  • Fed stimulus is leaking through into spending and growth too. Net worth is up +$6 trillion over the last year to $77 trillion, and more people are working. GDP will grow by more than +3% in 2014.
  • Short-term interest rates will remain low next year but long rates will resume their climb.
  • Stay fully invested. Both stock and real estate prices will rise in 2014.
  • Asset prices will rise but not all assets will be equal. Real estate is the sweet spot, along with leveraged finance, where private equity sponsors are benefiting from increasingly available debt financing to buy companies with weak trailing profit histories cheap and sell them at higher multiples in a few years. (Blackstone (BX), Apollo (APO), and Oaktree (OAK) are good examples. FYI: I own all three.) Small companies—dependent on banks for working capital–will outperform big ones too as the credit crisis thaws and they enjoy improved access to working capital and sharply lower cost of capital.

Happy New Year and more to come,


I did a spot today on CNBC’s FastMoney where the topic was reports of declining China growth. Here are the talking points I used to brief the anchors for the spot FYI.

China is slowing somewhat this year due to

-weak growth in Europe (China’s biggest trading partner and

-shrinking property market (residential property prices falling in all major markets)

-policy is also pushing fixed asset investment spending down, consumer spending up as a way of changing the structure of the economy over time

-Western observers are making too much of the slowdown. When they do, they sell China stocks. Slowdown will be modest, from 9% last year to 8-8.5% this year.


-income growth is strong in cities, even stronger in rural areas

-government finances are very strong (tax revenues growing 2x GDP)

-monetary policy is easing

-restrictions on owning property, mortgage loans, being eased

Investment ideas

-It’s not Kansas out there. Investing in China is still very risky

-rule of law still weak (property rights, courts, judges)

-transparency still lacking (audits, financial statements, insider dealing)

-so be careful investing directly into the Chinese market

Safer way to invest in the China growth story

-buy companies in safer places that make their money in China.

-China growth is driven by flows of resources.

-natural resources from south Asia (Australia, NZ, Indonesia)

-technology from north Asia (South Korea, Singapore, Taiwan)

-capital from Hong Kong, Singapore

-build a portfolio of stocks from these areas to mirror China growth

-Stocks in my portfolio today on this theme are down big today on the weak growth news. I will be buying more. They include:
-RIO, Rio Tinto, aluminum, copper, iron, energy
-BHP, BHP Billiton, coal, iron, aluminum
-FCX, Freeport-McMoran, copper, gold
-EWY, ETF for South Korea, (Samsung is 21% of the index), Chinese cell phones
-EPP, ETF for Pacific ex-Japan, i.e., Australia, NZ, Singapore, Hong Kong
-EWS, ETF for Singapore
-CAT, Caterpillar, (China infrastructure investment moves a lot of dirt)
-PTR, Petrochina, (Chinese stock, bet on rising oil consumption inside China)
-EMR, Emerson Electric, US capital goods exports to China
-YUM, Yum Brands, US company owns KFC franchises in China


FYI: I will do a spot on CNBC’s Kudlow & Company tonight at either 7:30PM Eastern time or 4:30PM Pacific time. The topic will be US/China trade. As you may have seen, the US, EU, and Japan filed a complaint today with the WTO alleging that China is restricting its exports of rare earth minerals (tungsten, molybdenum, etc.), which was quickly followed by tribal chest-thumping contest by both Obama and Romney.

Wait, somebody wants China to export MORE of something? I will try to interject a little logic into this emotional topic tonight. Hope you can tune in.

PS: Here is the link to the CNBC video of the spot.

Dr. John Rutledge “Tuesday Lunch Series” 2-14-12 from CGU School of Politics & Economics on Vimeo.


I did a spot on CNBC Squawk Box this morning to discuss the impact of the recent unrest in China. Much of the news surrounds stories about migrant worker protests. As I wrote yesterday, the drivers for the protests making the news is not ideology–it is practical life issues like pay, jobs, work practices, discrimination, and corrupt local government officials. Wen Jiabao recently said that corrupt officials is China’s greatest crisis. Last year more than 146,000 corrupt officials were arrested in China; 97% of them were at the county, city, or village level.

Our discussion this morning turned on the impact on the US. The biggest US risk is supply chain interruptions, much like the Japanese earthquake. Just under half the manufacturing capacity in the world is in China. Much of it is in southern China, especially Guangdong, where the factories are operated by migrant workers from Sichuan, Hunan, and Xinjiang. Recent job losses in Guangdong caused by “hollowing out,” (businesses moving to cheaper locations in Vietnam and other Asian countries) are a real problem. Migrant workers are often the only source of income for their families in poor villages in western provinces. Rising food prices has also put the squeeze on migrant worker incomes, even though the incomes are rising at 10% per year.

All this is interesting, but what I care about are the people. It is easy to lump groups of people together and call them “migrant workers” if you have never met them. Not so easy when you know their names.

I thought I would just take a minute to inject a little humanity into the story by posting a few pictures of the kids I work with in the migrant worker schools in China. For several years, my partner Fred and I have organized teams of university students to work in primary schools in poor villages, often migrant worker schools. We have done projects in Tibet, Yunnan, northern China, and tried to do one in North Korea that failed to happen. In each case, we supply the students with books and materials to build libraries and kitchens, plant gardens, pay student fees, and give the children pencils and paper. The students spend a month or more in the schools teaching and working with the children.

Here are a few pictures from one of our recent projects in a migrant worker school in northern China.

The photo above is our team for a migrant worker school project. Fred (white t-shirt just in front of me) is my partner in all the projects we do. Ethan (black Rutledge capital shirt in front of me) was team leader for this project. The other team members are students at China Agriculture University.

Below are a few of the children, including an unforgettable kindergarten student showing me her very beautiful graduation dress.

This is a migrant worker school classroom. The classrooms have no doors and no heat in the winter–the students weal heavy coats in class to stay warm.

Finally, the picture below is a very special one for me. We were able to arrange for 15 of the students graduating from the migrant worker school to go to the official public school nearby, which will allow them to later go to university. They needed clothes, school supplies, and the like to fir into the new school. This is a picture we took on their first day of class. I keep this photo on my desk.

I hope you get to meet some of these wonderful children one day for yourself.


My friend John Tamny, who runs the Op-Ed operation at Forbes, emailed last week asking me to fire up my Forbes column again, I couldn’t be more pleased. My first column is below. Hope you enjoy. You can view it on the Forbes.com website by clicking here, or at RealClearMarkets by clicking here.

China Inflation: The Canary In the Coalmine
The real inflation story is here in the United States.

Rising inflation in China has investors running scared, fearing that Chinese central bank tightening will end global growth. They are worrying about the wrong problem. China’s inflation problem is transitory and will not interrupt China’s growth. But it is a canary in the coal mine that should warn us of a serious, long-term, inflation problem building up in the U.S.

China’s most recent inflation figure, 5.3%, is a very big deal in China. In Chinese history, periods of high inflation are associated with social, economic, and political unrest, something China’s leaders do not want. In spite of their extraordinary growth record since Deng Xiao Ping opened China in 1978, China’s per-capita GDP is just $4,399 ($7,481 purchasing power adjusted), less than one-tenth of the $48,157 U.S. level. They need 30 to 50 years of uninterrupted high growth to bring Chinese living standards up to current developed country levels. That’s why their central bank, the People’s Bank of China, has raised reserve requirements for Chinese banks five times so far this year to more than 20% today and adopted a number of other policies to curb price increases, such as selling food from government stockpiles.

China’s inflation is not high across the board–it has been driven by two factors: rising food prices and rising energy and industrial commodity prices. So-called “core” inflation, excluding food and energy, is still quite low, productivity is growing 10-12% per year, and there is widespread excess capacity in Chinese industry that is keeping finished goods prices in check.

Since China’s currency is, effectively, pegged to the dollar, soaring global food, oil and commodity prices, expressed in dollars, are the culprit. Both can be traced to U.S. policy mistakes. The Fed tsunami that increased bank reserves by 17x since 2008 is driving global energy and industrial commodity inflation. And Fed policy, along with our misguided ethanol policy that has diverted 40% of U.S. corn production into ethanol, have more than doubled corn prices in the past year.

The impact on China will be short term. Rising productivity and excess capacity will return inflation to lower numbers. And their monetary tightening won’t derail growth for the simple reason that monetary tightening in China isn’t as effective as it is in the U.S. Growth in China is largely driven by small, private companies that do not get their working capital from banks. China’s banks are not nearly loaned-up. And Chinese companies are enjoying strong cash flow, driven by roughly 15% average sales growth (10% real GDP growth plus 5% price growth).

The real inflation story is here in the U.S. For us, China’s inflation is the canary in the coalmine. The Fed has increased the stock of bank reserves by more than 17x since they turned on the printing presses in 2008. That’s enough money to more than double the U.S. price level in the next decade.

The weak dollar and soaring gold, oil, commodity, and food prices are warning signs of what is to come. I do not believe the Fed will have the political will to shrink bank reserves back to levels that will keep inflation in check. Financial reform legislation has undermined the political independence of the Fed. Inflation hawks at regional Fed banks are resigning. Inflation doves are firmly in control. And monetizing our ever-expanding government debt in the coming years will be politically easier than shrinking bloated entitlement programs.

Ironically, this story will ultimately force China to abandon their fixed exchange rate with the dollar, not in response to pressure from our government, but when China’s leaders decide that U.S. policy has become too unstable and too inflationary to serve as a useful anchor for their price level. When that day comes, it will not be a good day for the U.S.


I wrote an op-ed for the Christian Science Monitor a few days ago on US/China relations. You can read it by clicking here. It deals with the question of when China’s GDP will exceed US GDP. My point is that the answer depends on us.
Can we stay ahead of China? Yes!
But it will depend on America’s political will to fix its own problems, rather than blaming them on China.

I was approached by a man at the supermarket who penetrated my Southern California disguise of baggy shorts, T-shirt, and deck shoes with no socks and asked if I was me? (Yes); the one who talked about China on CNBC? (Yes); then the question I hear all the time, “Are the Chinese going to let us to stay rich?”

He is onto something. Whether we stay rich and powerful is hugely important. Economic, political, technology, and military power go hand in hand. But whether we stay rich is not up to China; it is up to us – determined by how fast we grow. We didn’t need China to get rich; we don’t need them to stay rich. But we do need to get our economic growth act together.

While the United States is the biggest, richest economy in the history of the world, it’s about to get passed by. China’s gross domestic product will exceed US GDP within the next decade – of this there is no question. At recent relative growth rates – 10 percent for China, 2 percent for the US – China’s GDP will exceed US GDP in 12 years. Adjusted for purchasing power, China’s GDP will exceed US GDP in just five years.

Being the second richest guy in the room, of course, isn’t the end of the world. But it’s not as good as being No. 1. Just ask the Europeans or the Japanese how they feel about US dominance in recent decades.

Of course, China has more than four times the number of people as America does. So in terms of annual income per person, Americans remain far ahead: $48,157 versus $4,399 (or $7,481, if measured in terms of purchasing power). At present rates of growth, it would take 30 years for the average Chinese to exceed American standards (25 years, if adjusted for purchasing power). This assumes that Chinese growth can keep outpacing America’s growth by the same rate, which becomes harder to do as China’s economy becomes larger and runs into more resource constraints on the availability of energy, commodities, and other resources.

So Americans have an opportunity to stay ahead in terms of income per person – and that won’t depend on China. China’s high growth rates are not the result of manipulating its currency or restricting trade: Manufacturing employment in China is falling, too. Instead, they are the result of huge saving and investment levels and intensely competitive Chinese markets. Private companies account for more than 70 percent of Chinese economic activity now and for essentially all new growth, jobs, and tax revenues.

Which brings us to the real question behind my supermarket pal’s query. Do we have the political will to stay No. 1?

To do that, we are going to have to tackle our real problems – the ones that put us in this spot. We are going to have to fix our schools so our kids can read, do math, and graduate. We are going to have to reform our tax system so people have incentives to work, save, and invest again. We are going to have to replace our so-called entitlement programs with ones we can afford so we can rein in unsustainable spending, runaway budget deficits, and the growth of government debt before it reaches the point where default or permanent 1970s inflation – with the attendant 20 percent interest rates – are inevitable. We have to restore the Fed’s political independence and commitment to price stability.

To do all these things we must talk with voters about our problems like adults, not blame our troubles on others. If we face up to these problems we can do more than stay rich, we can continue to lead the world.

But make no mistake about it. In that world, there are going to be two big elephants in the room, the US and China. There will be plenty of legitimate issues – energy supplies, environment, and terrorism – to solve. Playing the blame game runs the risk of bringing these two elephants into conflict, with unthinkable consequences.

I am convinced that the security and welfare of my children will depend more upon the quality of US-China relations than any other single issue. We simply must get to know each other to find common ground to work together for mutual security and prosperity. And the US must get back to the economic growth that allowed us to earn the No. 1 spot in the first place.


(June 14, 2011) Last week I had the pleasure of participating in a public forum hosted by the Common Ground Committee in Darien CT. You can watch a  video of the forum at the Common Ground Committee’s website.

The thesis of the forum is to explore a controversial topic and look for common ground–areas where both sides can agree–to use as a basis for building a solution. Our topic was China: Threat or Opportunity?The forum was moderated by John Yemma, editor of the Christian Science Monitor, where I ran an op-ed on the subject ahead of the meeting. The combatants were Henry Tang, Alan Tonelson, Peter Ford, and myself, with Kraft Bell facilitating the event.

The answer, of course is yes; China is both a threat and an opportunity from the viewpoint of the US. People are finally realizing that China is big and growing fast. People here know very little about China because most Americans do not travel there and because we still have a cold war image of China in our heads–grey jackets, bicycles, red books. Trust me; that image is no longer true of China.

China will overtake the US in GDP within 5-10 years. China and the US will soon be the only two elephants left in the room. We simply must expend the energy to get to know each other because conflict between the two elephants would be unthinkable. I am convinced that the security and prosperity of my children’s and grandchildren’s lives depends more on the relationship between the US and China than any other question.

I hope you enjoy the video.


I did a spot with Larry Kudlow tonight to discuss today’s retail sales reports that seems to have been a major impetus behind today’s huge stock market increase. Great to work with my old friend again. Not many know this, but Larry and I have been working together since 1976 when he was Chief Economist at Paine Webber and I was a professor at Claremont Men’s College (known as Claremont McKenna College today).

The US Advance Advance Monthly Sales for Retail and Food Services Report for was down -0.2% for May (+0.3% excluding motor vehicles), and +7.7% over year ago levels (+8.2% excluding motor vehicles.) Analysts focused on the numbers excluding motor vehicles because the supply chain interruptions caused by the Japan earthquake made a significant dent in assembly and sales. The stock market interpreted this number as “no double dip recession”. Nice.

The Chinese retail sales number was even better. May retail sales were +16.9% over year earlier levels and a big jump over April. This was important because US investors have been hyper-ventilating over the idea that China’s growth was about to end. (They did this about once every 6 months. I don’t know why.) The truth is retail sales in China are doing fine, signaling continued strong growth.

The interesting stuff, as usual, is in the details. Among the components of the retail sales index sales of oil products were +42% above year ago levels, jewelry sales were +43%, and grain and edible oil sales were +24%, revealing the effects of rising oil prices, gold prices, and food prices. But middle class luxury items were up big too including  cosmetics (+20%), personal care goods (23%) and garments (22%). Government policy is trying to increase the consumption share of GDP relative to the investment share, which should keep retail sales strong in coming years. (If you want to watch a company in this sector, Haier Group makes washing machines and water heaters and is a powerful brand in China. Haier’s revenues should grow 20% next year producing 25% earnings growth–the stock sells for 15x 1011 earnings and 8x 2011 EBITDA in the Hong Kong stock market.

Other supporting growth news this week include:

  • +13.5% industrial production growth in May.
  • +34.6% real estate investment growth January-May
  • +33% Real estate sales growth January-May
  • +25.8% fixed asset investment growth January-May.

Less positive news:

  • +15% M@ growth in May is a little slower
  • +5.5% CPI inflation in May is a big number

China’s central bank raised reserve requirements today again for the 6th time this year (after 6 times last year) to 21.5%. They are doing this to show the government’s concern about inflation, which means rising food and gasoline prices to the man on the street. These tightening moves are not as tough as they would be here in the US–banks are not nearly loaned up anyways. But if they keep beating on this horse long enough it will surely have an impact.

Larry made a point during the show that I think is worth remembering. From our perspective, a little slowing in China and a little lessening of inflation pressures are not necessarily bad things. Slower growth and lower inflation would be easier to maintain.

China’s stock market was up big today after being driven more than 12% lower since April by falling growth worries. I think that market is pretty cheap today, as are the stocks of US companies who sell retail products in China. That’s where I am putting my money.