China

Morgan Stanley's Qing Wang has created a new tracking concept, the China Macro Risk Radar (CMRR), whose sole goal is to provide a framework to asses and monitor risk events of low to moderate probability (high probability events already have their own standing at the firm and are singled out in client calls) and high impact. As part of its inaugural edition, MS has assigned 10 risk events to four different categories on the CMRR - each risk event is assessed according to six aspects, including its description, content, potential impact, likelihood, timeframe, and evolving direction. We present the top 10 items that are of concern to investors in China, and are likely to provide even more ammunition to the ever increasing roster of China bears.

The back-to-back super-sized traffic jams near Beijing has landed China on the top spot among the cities with the world's worst traffic. While the world seems quite fixated on the length--miles and number of days--of these mega jams near Beijing, there's also a serious message--the under-capacity of China’s infrastructure.

One of the world's bigger financial mysteries: the official breakdown of the Chinese FX reserve balance, received a rare moment of transparency today when the China Securities Journal gave the official tally of the $2.45 trillion stockpile: 65% in dollars, 26% in euros, 5% in pounds and 3% in yen. Which means China holds about $1.6 trillion in dollars, and, courtesy of the (recent record) trade surplus, growing. This distribution is roughly in line with expectations and with the world average FX holdings. Nonetheless, the massive concentration of dollar positions prompted Hu Xiaolian, a vice governor with the
People's Bank of China to warn that depreciation loomed as a risk for
foreign exchange reserves held by developing counties. As Reuters quotes, "Once a reserve currency's value becomes
unstable, there will be quite large depreciation risks for assets," she
wrote in an article that appeared in the latest issue of China Finance, a
Chinese-language magazine published under the central bank. Most certainly this is a tacit warning for US monetary policy, which is, of course a paradox, since ongoing dollar depreciation is CNY-beneficial due to the ongoing (semi) peg. China would love to have its cake, eat it, and to export twice as much of it if possible.

Today's stunning if true news comes from Stratfor which has just issued a blast notifying of circulating rumors "in China that People’s Bank of China (PBC) Gov. Zhou Xiaochuan may have left the country." If proven true, this will be the proverbial first rat bailing on the sinking ship. It gets scarier vis-a-vis prospects of US bonds: "The rumors appear to have started following reports on Aug. 28 which cited Ming Pao, a Hong Kong-based news agency, saying that because of an approximately $430 billion loss on U.S. Treasury bonds, the Chinese government may punish some individuals within the PBC, including Zhou." Um, $430 Billion in losses? Hopefully this explains why next month's TIC report won't show any incremental increase in Chinese holdings of Treasuries (and most likely quite the opposite). Stratfor continues: "Although Ming Pao on Aug. 30 published a report on its website indicating that the prior report was fabricated by a mainland news site that had attributed the false information to Ming Pao, rumors of Zhou’s defection have spread around China intensively, and Zhou’s name has been blocked from Internet search engines in China." Even if Zhou is safe and sound in Beijing, the fact that China has experienced nearly half a trillion in losses on its UST holdings is shocking, and means that the US Treasury bubble may be approaching the popping phase.

Moody's is out with a surprisingly frank appraisal of the Chinese banking system's precarious capitalization trend, by looking at the recent RMB 54 billion capital raise in the interbank market by the domestic arm of the Chinese Sovereign Wealth fund (CIC), which was "the first part of an RMB 187.5 billion overall fund-raising
program mainly to provide additional capital to the three largest
state-owned banks, a policy lender, and a policy insurance company." As Moody's oh so correctly concludes: "Recapitalizing banks with bond proceeds from banks is credit negative
because it increases the effective leverage of the banking system. The
transaction’s impact on the system is limited in this case because the
increased leverage is not significant, but it would be problematic if
effective leverage continues to increase and China’s economic growth
stalls." Moody's stops one step short of calling this transaction what it is: using debt purchased by other banks to recapitalize deteriorating loans on the banks' asset side: "the increases in assets and equity are artificial and without real
economic substance: the increase in reported equity on banks’ balance
sheets enables the banks to lend more and effectively leverages up the
system. Assuming banks fully deploy the capital raised, the resulting
increase in the risk-weighted assets would be RMB 187.5 billion divided
by 11.5% (the minimum capital requirement)." What is also not said, but is glaringly obvious, is that the Chinese sovereign wealth fund is likely in a major need of recapitalization, courtesy of its extensive US financial sector equity holdings.

A floundering Jim O'Neill has never seen decoupling as wide as it is now, and the man is now openly hallucinating, seeing every non-developed country as a potential BRIC (see this Friday's FT OpEd: How Africa can become the next Bric). Well, of course, China needs its resources. Soon every open mine will be a "BRIC" to be exploited by Chinese interests, which come, see, and suck the place dry as they build yet more vacant cities, ghost towns, and highways to nowhere, hoping they can sustain the illusion of the world's greatest bubble for a few more months. Which is precisely all those who are betting on a collapse of China are playing it not with China CDS, but those of Australia: for when the worm turns, Bad in Beijing, will be nothing compared to the Massacre in Melbourne. Yet even Jim's nagging conscience is not allowing him to blindly continuine to ignore the other side of the coin, namely that he is once blatantly wrong, and decoupling never did, and never will occur: "What can emerge if Ben Bernanke and the Fed is wrong? What if this
slowdown is sustained, and we actually move into another recession? The
American Dream needs something new. In conventional terms, it needs
booming private investment and booming exports. And they might happen. I
find it hard to see how net exports were such a genuine real negative
contributor to Q2 GDP as reported today, and I strongly suspect this
will be reversed. But what if it isn’t? The scope for more conventional
fiscal stimulus is hardly available. So in this light, the US needs its
own BRIC equivalent. How about something real on the infrastructure
front ? ( a nice mode of transport downtown Manhattan from JFK would be a
sign). How about literally some forced measures to shift the auto user
on masse from conventional fuels ( combined with a major hike in
gasoline taxes)?" Jim's conclusion: now that China is actively moving to developing its own middle class, perhaps it is time for the US to finally roll over and admit its consumer are on longer the world economic dynamo. He asks whether it is time to "borrow a few hundred million BRIC consumers?" Surely China will be ecstatic that the US will now be funding the development of its own middle class. As for ours...Oh well.

Watch this one.

Rumors of Gold's imminent death in a liquidation-driven collapse continue to be greatly exaggerated, and in fact the shiny metal continues to perform inversely to stocks, which take on ever more water, and is a confirmation that the market expects continued dollar destruction courtesy of the Marriner Eccles residents. And courtesy of the World Gold Council's just released Gold Demand Trends update, there is an explosion in demand for the precious metal which will likely not cease any time soon: in a nutshell, in Q2 demand for gold surged by 36% from 770 tonnes to 1,050 tonnes: a huge move, and one which solidifies the thesis for a fundamental rise in gold, aside from all the talk that gold is now just a backstop to Central Bank idiocy. Lastly, the WGC sees a huge demand coming out of Chinese consumers for gold in the future which will provide a constant bid floor: "Recent developments in China are likely to have positive longer-term implications for this increasingly important market. The PBoC, together with five other ministries/regulators published a proposal to improve the development of the domestic gold market, (“The Proposals for Promoting the Development of the Gold Market”). This further reinforces the WGC’s view that there is huge potential for gold ownership to increase among Chinese consumers, in a market with tight domestic supply, as discussed in our China Gold Report – Year of the Tiger, March 2010." And the firm's conclusion on demand trends: "As demonstrated earlier, gold’s relevance as a preserver of wealth is
enduring, even in conditions of relative economic optimism, since
historically gold has a capacity to provide investors with both
confidence and a sure and steady means of enhancing the consistency of
their returns." So what was the bear case on gold again?

What is the monopoly for providing cell phone services in the China worth? More than 5 million new subscribers a month. A 3.5% dividend yield means you should put this stock on your speed dial. (CHL).

While China is the top U.S. debt holder in the world, percentage-of-GDP-wise, the U.S. receives relatively very little non-bond investment from China, mostly due to the long existing tensions over various issues, including but not limited to, trade imbalance and currency. However, there has been some changes on both sides since CNOOC was blocked from the Unocal acquisition in 2005.

What if we told you there was a trade that was appealing, obvious, talked about daily and yet you hadn't heard of it? Would you be interested? What if we told you there are fixed income instruments being bought with a higher yield than US treasuries in currencies that are undervalued; and there is a high probability these currencies will soon appreciate; and the yields on the bonds will decline? What if we told you the same institution that is buying the bonds controls the timing of the bond's underlying currency appreciation and is directly responsible for the current undervaluation of the currency, and the higher yield offered? What if we told you the institution was China?

- Faros Trading

Where The Economist “Big Mac” Index Finds Currency Value.

Andy Xie follows up on his earlier Op-Ed that describes how the Fed is implicitly funding the stimulus in places like China. In a simplified version of the article, he talks to Bloomberg's Betty Liu, recapping the key issues."When the Fed prints money it is just creating inflation in emerging economies. But when the inflation in the EM gets high enough, it will bounce back, it will become inflation in the US." As to why EM countries would be unable to manage their inflation, Xie says that most emerging economies are focused more on holding down their currencies, as they see "global demand as relatively weak", seeking more than anything to keep their exports competitive. "That force is allowing them to allow all the money to come in and become inflation." And unfortunately Andy does not think unemployment is going lower any time soon, attacking the very core of the Fed's dual mandate: "I don't think high unemployment is a panacea for keeping inflation down." Of course, if inflation does strike the EMs, and wage increases are demanded, making the paying field a little more level, it may just be precisely the stimulus that the US needs to get its wage structure marginally more competitive on the global playing field.

Today's Treasury International Capital data had some unpleasant disclosures about the flow and size of international capital flows. The gross headline number of inflows was as expected higher, coming in at $44.4 billion, consisting of $33.9 billion in net foreign purchases of long-term securities ($16.6 billion purchases by private investors and 17.3 billion by official institutions), as well as $10.4 billion in sales of foreign securities by US individuals. This brought total foreign holdings of US securities to just over $4 trillion for the first time ever, or $4,009 billion. So far so good, however looking at the composition of purchases, it appears that foreigners were frontrunning the Fed already in June - they bought $33.3 billion in LT Treasuries, and $18.2 billion in agencies, precisely the categories that the Fed would be monetizing, even as they sold $13.5 billion in corporate bonds (the highest amount since January 2010), and $4.1 billion in corporate stocks, the most since July 2008. What are foreigners seeing that all the mutual funds are also seeing (with 14 straight outflows from domestic equity funds), yet the HFT, Primary Dealer group is so stubbornly ignoring? Most importantly: Chinese Treasury holdings dropped to a 1 year+ low of $843.7 billion, following reductions in both long-term and short-term treasurys. China now has almost $100 billion less in USTs compared to the peak of $940 billion in July 2009. One wonders what China is buying with the sale/maturity proceeds.

I'd be Surprised if any of my readers were Surprised by the Surprises announced in the sovereign economies these days...