People's Bank Of China

• Beijing on edge amid coup rumours (FT) - as predicted two days ago, do not expect any official media update on this critical matter, until after the outcome, whatever it is
• Goldman scours emails for use of word "muppets" (Reuters)
• Germany to Balance Budget Early (WSJ)
• Osborne Gives and Takes From Rich in U.K. Budget Balancing Act (Bloomberg)
• Big Spending at Fannie, Freddie Should End, Watchdog Says (Bloomberg)
• Volcker Says U.S. Needs Reforms in Finance, Government (Bloomberg)
• Chinese Firms, Regulators in Talks on Yuan-Fund Program (FT)
• Ireland Said to Ready Bank-Debt Proposal for ECB Review (Bloomberg)

It was one short week ago that both Australia surprised with hotter than expected inflation (and no rate cut), and a Chinese CPI print that was far above expectations. Yet in confirmation of Dylan Grice's point that when it comes to "inflation targeting" central planners are merely the biggest "fools", this morning we woke to find that the PBOC has cut the Required Reserve Ratio (RRR) by another largely theatrical 50 bps. As a reminder, RRR cuts have very little if any impact, compared to the brute force adjustment that is the interest rate itself. As to what may have precipitated this, the answer is obvious - a collapsing housing market (which fell for the fourth month in a row) as the below chart from Michael McDonough shows, and a Shanghai Composite that just refuses to do anything (see China M1 Hits Bottom, Digs). What will this action do? Hardly much if anything, as this is purely a demonstrative attempt to rekindle animal spirits. However as was noted previously, "The last time they stimulated their CPI was close to 2%. It's 4.5% now, and blipping up." As such, expect the latent pockets of inflation where the fast money still has not even withdrawn from to bubble up promptly. That these "pockets" happen to be food and gold is not unexpected. And speaking of the latter, it is about time China got back into the gold trade prim and proper. At least China has stopped beating around the bush and has now joined the rest of the world in creating the world's biggest shadow liquidity tsunami.

The run into Chinese Lunar New Year has again seen higher than expected Chinese demand for gold and China's voracious appetite for gold is surprising even analysts who are positive about gold. As Chinese people's disposable incomes gain and concerns grow over inflation and equity and property markets, Chinese consumers and investors are turning to gold as a long term investment hedge. There is informed speculation that commercial Chinese banks may have taken advantage of the recent price dip to build stocks of coins and bars and accumulate bullion. China's demand for physical gold bullion has rocketed past India with the country now overtaking India in the third quarter as the largest gold jewellery market according to the World Gold Council. There is also informed speculation that some of the buying was from the People's Bank of China with one analyst telling Bloomberg that “there is always the possibility that some purchases were made by the central bank.”

All you need to know.

Overall, there are both internal structural factors and external global factors, which contribute to the making of an epic hard landing in China. China will be really vulnerable when the US and Europe both unleash the quantitative easing. These are things China has no control of. Nevertheless, the best China can do to avoid the worst is to continue the painful structural adjustment: marketize the “big four”-dominated banking industry to allow for more efficient monetary allocation; Transform the labor intensive low value-added economy to the high value-added knowledge economy; reform the wealth redistribution system to empower the broad consumer base and honor its promise of a consumption-led economy.

While the US enjoys the luxury provided by the dollar’s world currency status and diplomatic alliance with many major trade partners to export its liquidity and inflation, China enjoys none of that. They should look at the dollars in their hands with fear and doubt. So called Beijing consensus makes little sense, because the world is fast changing, pegging a country’s growth to a certain set of policy tools or a certain reserve currency (the US dollar) is equally dangerous. The battle between Keynes and Friedman has long proven the only consensus is to adapt and change. Right now China needs to adapt and change fast. Or this will be the best time in history to short China.

Goldman's Jim O'Neill said in a recent interview that the world's future prosperity depends on China's growth. If he's is right, then don't count on that much world prosperity, at least in 2012. 

Hours after the details of the Euro Summit were released when it became clear it will be yet another failure, following a drop in the Euro Basis Swap by 10 bps to 127 bps, to week earlier levels, and not following a rise in the all important EURUSD, it was time to recycle old rumors all over again, knowing full well some positive market reaction had to be engendered or else the entire rally of the past two weeks would be undone, here comes the latest regurgitation of the tried and (very much un)true "China to Rescue the World"^TM rumor, this time from Reuters. The media company which has become the latest conduit of favorable market rumors says that "China's central bank plans to create a new vehicle to manage investment funds worth a total of $300 billion to improve returns on the world's largest stockpile of foreign exchange reserves, a source with knowledge of the matter told Reuters. The vehicle would operate two funds, one targeting investments in the United States and the other focused on Europe, said the source, who asked not to be named because of the sensitivity of the matter. The vehicle's goal is to make more aggressive overseas investments for higher returns, said the source along with a second, independent source, who also declined to be named." So far so good. And the bad news: "Details of the venture are still under discussion but key personnel for managing the venture have been agreed upon, the sources said." Oh, and the funds have names, but that's all. So to summarize: details are unknown, China growth is collapsing, home prices and inflation are supposedly plunging, and it is now conventional wisdom that the PBoC will have to bail out China all over again from a hard landing, but... the key personnel for a fund that may or may not exist and which will have no impact whatsoever on the $2 trillion in rolling European debt over the next two years, have been selected? And futures are up on this?

Austria's central bank, Oesterreichische Nationalbank (OeNB) delivers headlines ranging from opaque to criminal these days.
Market observers scratch their heads about a secretive agreement between the OeNB and the People's Bank of China (PBoC) that makes Austria the first non-Asian country permitted to engage in Renminbi investments with its Chinese counterpart as the intermediary. Further media inquiries were stonewalled.

Yesterday, Barclays' Ben Powell of macro sales sent out the following note to clients, which referenced a as of then unconfirmed report in the China Securities Journal: "China putting 1Tr RMB into its banks?? Very positive no? The attached bloomberg story suggests that China may inject >Tr1 Yuan into its banks deposits before the end of the year. This is a meaningful number vs the Tr7.5 RMB that the banks are expected to lend in 2011 as a whole. So what? 2 things. Most obviously this is cheap liquidity to Chinese banks that should see SHIBOR continue to fall and banks shares to rise. And secondly more broadly this would seem to suggest (again) that the rumours of easing are true. This will add fuel to the soft landing argument that I have been pushing. Remain long Chinese banks on very simple easing + bearishness = up thesis." Granted the Barclays spin was to go long China (incidentally just in time for the biggest drop in the Chinese market since October 20), but the real take home here is that China is now actively pumping money to bail out its own banks once again! And not just token money - €158.2 bilion. So how much money will be left to fund the European bailout which is oh so contingent on Chinese generosity? The short answer? Pretty much nothing, as confirmed by the fact that today's €3 billion EFSF deal was underbid and the underwriters were left holding about €500 million of the total issue. As usual, good luck Europe with your multifunctional Swiss EFSF Army knife.

The People's Bank of China set the yuan's central parity rate against the U.S. dollar at 6.3737 on Thursday, a second sequential major drop and down from Wednesday's 6.3598. This follows a weakened fixing of 6.3598 on Wednesday, down from the record high fixing of 6.3483 on Tuesday, just before the Senate decided to launch the first salvo in the Sino-US trade wars. Surely news of the collapse in Chinese exports will merely reinforce the theme that the USDCNY is in sudden need of devaluation and be a loud slap in the face of the Senate which will now come face to face with its utter worthlessness.  In Hong Kong, the offshore yuan spot rate was fixed at 6.4407 against the greenback on Thursday, compared with Wednesday's 6.4923. The fixing is based on an average of bids from 15 participating banks and is calculated by the Treasury Markets Association, a Hong Kong-based industry group. We are hardly the only ones who noticed the escalation in spot USDCNY wars by the PBOC, which now appears hell bent on showing the US its peg can go lower in addition to higher (inflationary consequences be damned) - from the WSJ: "The yuan fell sharply against the U.S. dollar in early Thursday trade, after the Chinese central bank surprised the market by guiding its currency weaker for the second consecutive day despite the dollar's global weakness." So even as the USD is plunging against the hope-driven Euro, which has soared 600 pips in the past week on nothing, the USD is now jumping against the CNY for no other reason than mere demagogic policy. And this environment in which central bank decisions are all that matter is the one in which traders hope to make a living based on rational market decisions (as otherwise one can flip a coin in Vegas)? Good luck.

Bubbles, especially if supported by governments and central banks, wreak havoc when they burst. And in China, there are new ominous signs.

All you need to read.

Gold’s London AM fix this morning was USD 1,896.50, EUR 1,341.13, and GBP 1,174.67 per ounce. The gold fix was higher than Friday’s in all currencies (USD 1,854.00, EUR 1,301.23, and GBP 1,143.81 per ounce). Despite continuing denial, a recession in the U.S. is inevitable; the question is only with regard to how deep the recession is and to the nature of the recession – inflationary, stagflationary, hyperinflationary or deflationary. The consensus, especially amongst Keynesians, is that deflation is most likely. However, given the degree of currency debasement being seen internationally stagflation is also a risk. Hyperinflation, as being experienced in Belarus today, is the macroeconomic and monetary ‘black swan’. There are growing concerns that the Eurozone crisis might degenerate again soon due to the Greek debt crisis and risk of default. Over the weekend talks between Greece, the IMF and ECB representatives over new bailout funds broke down. The euro has fallen and the German local elections have added to concerns over Greece.

Relevant news (better late than...)

As was predicted last week, China's rating agency Dagong, unlike its worthless western counterparts, has come through on its threat to downgrade the US in the event a subpar debt ceiling deal was hammered out. As Xinhua reports, 'Dagong Global Credit Rating Co. said Wednesday it has cut the credit rating of the United States from A+ to A with a negative outlook after the U.S. federal government announced that the country's debt limit would be increased." Confirming that not being branded a NRSRO is the only thing that allows a rater to still think straight (and not in terms of lost client revenue if one goes ahead and tells the truth), Dagong's decision was spot on: "The decision to lift the debt ceiling will not change the fact that the U.S. national debt growth has outpaced that of its overall economy and fiscal revenue, which will lead to a decline in its debt-paying ability, said Dagong Global in a statement." So while Moody's, which is now certified as the laughing stock of the sheep herd (sorry Mark Zandi, you will never be promoted to anything in this administration - we promise you), pretend that all is well and that the only thing better than $14.3 trillion in debt is $16.8 trillion, China demonstrates what happens when a rating agency actually knows how to do addition and/or long division.