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Tuesday, December 28, 2010

Thinking of Going All-In On China ? Think again..

suggest the authors of two recent articles.

In MARKETWATCH, Chris Oliver passes on the conclusions of Royal Bank of Canada strategist Brian Jackson, who interprets China's surprise interest rate hike over Christmas as a possible sign that " Beijing has lost faith in other measures to rein in the rapid credit growth fueling housing and food inflation ".
Efforts to cool the pace of credit expansion through higher reserve requirement ratios, bank-lending targets, lending restrictions and other methods are losing traction.
“Officials will need to put more emphasis on adjusting the price of credit — that is, interest rates — to keep policy at appropriate settings,” Jackson said in the note. “The Christmas Day move suggests that Beijing is coming around to this view.”
But China’s increasingly sophisticated financial system circumvents government controls, with lending taking place via trust companies or gray accounting practices, according to Jackson.

And in a separate, INVESTOR PLACE piece, Michael Shulman cites several reasons traders should bet against China, going forward.

Shulman dismisses the Christmas Weekend interest hike as "window-dressing."
Chinese banks have unspeakably conflicted relationships with their big borrowers, and small increases in interest rates will not slow down underlying speculative fever. Chinese land developers and industrialists are now engaged in financial musical chairs — they will keep borrowing to grow until they absolutely, positively cannot borrow any more, assuming someone else will get left standing without a chair. Well, the U.S. financial crisis began when Bear Stearns found itself without a chair.
So despite what you hear from the China bulls out there — and there are plenty of them — 2011 will not be the “Year of China” for investors … unless they plan on shorting China stocks and ETFs, that is.
Shulman agrees with savvy hedge fund manager Mark Hart that China is in the “late stages of an enormous credit bubble,” and the “economic fall-out” will be as “extraordinary as China’s economic out-performance over the last decade.”

While " China’s commodity imports are driving the price of everything from iron and coal to rare earth minerals " its excess production capacity far outstrips consumption.
This has created false prosperity and inflated asset values in exporting countries. The bulls believe the country will eventually use this capacity and consume these commodities as it builds out roads, bridges and other public works. However, this kind of public-funded consumption can only go on for so long since it is fueled by government credit, which is already overextended.
China is now in a trap of its own making by restricting the flow of capital and pegging its currency, the yuan, to the dollar.
With $2.4 trillion or so in dollar-denominated bonds, any revaluation diminishes the value of these bonds. This is what Japan did as it accumulated reserves through tough capital controls and then watched its newfound wealth melt away when the world forced it to let the yen appreciate.
As the value of Chinese foreign reserves diminishes, so does the capital base supporting the credit bubble, meaning China is not likely to revalue their currency, and so the trade war begins.
Finally, Chinese " bellicose behavior " is thinning its trade partners' patience.
Recent events on the sea, on the Korean peninsula, in cyberspace and in Chinese prisons have laid bare China’s grasp for world power, exposing the nation to harsh criticism, and with this politicians in the United States and Europe have begun to abandon a veneer of tolerance for Chinese trade policies. The trade war, if it comes, will be a trigger for major market problems.

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