China

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.

Essentially, growth is not the problem for China, but nor is it the solution.

SkyNet has taken over the market, it now appears poised to make labor and wages redundant (and while we hardly welcome our new robotic overlords, we doubt anyone would shed a tear if the House and Senate replaced its 535 corpulent windbags with a bunch of Johnny 5s engaged in binary colloquies). The world's biggest non-debt based slave-driver, Taiwanese technology giant Foxconn, also known as the place where all of your iPhones, Pads, etc, are made, has just announced that it will deal with rising wages by doing what US-based quants have figured out years ago: outsource it all to robots. About a million of them. The irony is that the last time we looked at Foxconn, we asked: "what happens when this million realizes it can only buy half a McRib sandwich with the money it makes, courtesy of the primary US export to China, and demands a pay raise. What happens to Apple margins then?" We now have our answer. Per Xinhua: "Taiwanese technology giant Foxconn will replace some of its workers with 1 million robots in three years to cut rising labor expenses and improve efficiency, said Terry Gou, founder and chairman of the company, late Friday. The robots will be used to do simple and routine work such as spraying, welding and assembling which are now mainly conducted by workers, said Gou at a workers' dance party Friday night." As a reminder, with over 1 million workers, Foxconn has enough people on its payroll that if mobilized would be the 5th largest army in the world, and just after WalMart in total number of employees, albeit instead of spread out around the world, are all concentrated in one small space.

In 1978, the year China emerged onto the world stage with its four modernizations, China, a country with four times the population of the United States, had a paltry gross domestic product of $216 billion, less than eight percent of the United States. China exposed her strategy of four modernizations to the world as if to say, “Please invest in China and we will ensure that our workforce is educated, and that our business infrastructure is stable for your investment.” Yet, this openly expressed strategy, that may have seemed to the rest of the world as a difficult but noble goal for China to achieve, was only the tip of China’s Grand Plan, and only the part she wanted the world to see.

EurAmerica’s history with China was one of gunboat diplomacy, exploitation, and forced trading. When China opened her borders again in 1979, EurAmerica’s merchants were enthusiastic to exploit an opportunity again. Yet, China had not forgotten EurAmerica’s role in the Opium War, the Sino-Japanese War, and the Boxer Rebellion. China would never open her border again to be exploited. When she finally opened her border in 1979, it was from a position of power, deep strategy, and long lived planning that suggested EurAmerica was finally ripe for reverse exploitation. China’s grand plan was to emerge as the 21st century world power.

Via The Sceptical Market Observer.

For all those who believe China will continue carrying the world on its shoulders (we guess after yet another 2 week failed sting at US-based global growth "leadership", inverse decoupling is over yet again) we have some very bad news. None other than traditional permabull in all maters financial, Citi, has insinuated the sun may be setting on the great Chinese "growth case".

You read about it previously on Reuters, now here, as per your 1^st amendment protected right, is the full text of the statement issued by the Chinese Propaganda Department seeking to prevent broad dissemination and distribution of the news of the two high speed trains from Saturday. To wit: "The latest directives on reporting the Wenzhou high-speed train crash: 1. Release death toll only according to figures from authorities. 2. Do not report on a frequent basis. 3. More touching stories are to reported instead, i.e. blood donation, free taxi services, etc. 4. Do not investigate the causes of the accident; use information released from authorities as standard. 5. Do not reflect or comment." Obviously, that failed spectacularly, and as was reported earlier, has generated a broad wave of discontent among the population for this glaring attempt to put bureaucratic incompetence and corruption over human life. One thing is certain: at least America's own version of the DOT(ruth) is modestly more subtle... For now.

One of the more notable events in the past week was the previously discussed reopening of the Iranian Oil Bourse, an attempt by Iran to launch a venue that bypasses US sanctions against Iran which has prevented payment in the world's reserve currency for Iranian goods. "Big deal", some will say, this is not the first time Iran has attempt to upstage the Great Satan. Well, true, although as OilPrice said last week, "what it would take for Iran’s new exchange to survive and flourish are some heavy-duty customers that Washington would be wary of picking a fight with, and Tehran already has one – China... China, the world's largest buyer of Iranian crude oil, has renewed its annual import pacts for 2011. In 2010 Iran supplied about 12 percent of China's total crude imports. According to the latest report of the China Customs Organization, Iran's total oil exports to China stood at 8.549 million tons between January and April 2011, up 32 percent compared with the same period last year. Iran is currently China's third largest supplier of crude oil, providing China with nearly one million barrels per day." Still, the perceived provocation to Uncle Sam should China go ahead and slap America in the face by accepting the existence of the Kish exchange, would echo around the world. Which is why many don't think much if anything will happen. Until today, that is: according to the FT, China has decided to commence an barter system in which Iranian oil is exchanged directly for Chinese exports. The net result: not only a slap for the US Dollar, but implicitly for all fiat intermediaries, as Iran and China are about to prove that when it comes to exchanging hard resources for critical Chinese goods and services, the world's so called reserve currency is completely irrelevant. The implications of this are momentous, especially for US debt, whose indomitability is only predicated upon the continued acceptance of the currency it backs as a global reserve. If China is now openly admitting to the world that it does not need US monetary intermediation, and by implication, the "debt" backing said intermediation, what then? And who will follow China next?

CNTV has released the first video of the horrific crash in which two bullet trains collided and 4 train cars fell from viaducts. The full clip can be seen below.

The rumors were true: after printing on the verge of a contraction back in June, July's HSBC Manufacturing PMI is now sub 50, or 48.9: the first sub-50 print in this particular series in a year. This confirms that the manufacturing sector is now in contraction mode. The immediate kneejerk response is a 20 pip slide in the EURUSD which has retraced half the surge on the earlier, and repeatedly priced in, news about the nth Greek bailout. Now if only China could slow down that inflation to go alongside its economic contraction, which unfortunately as the following chart from Bloomberg demonstrates, will be a difficult proposition.

The EU accounts for roughly $400 billion of China’s exports, making it China’s single largest export market. So if Europe collapses, China’s economy takes a BIG hit. Remember, China is a centrally controlled economy, NOT a dynamic open market economy. Put another way, the entire China “economic miracle” is based on the current system continuing to operate in some form (China can continue to export, rip off intellectual property that is developed elsewhere, throw its weight around, etc).

Precisely a year ago, a summary report by Fitch shone the first, if relatively weak, light on the massive Chinese securitization industry which had for years allowed the country to fund its housing bubble without forcing the banks to actually take much if any of the loan risk associated with this unprecedented expansion. At the time of the Fitch report, the securitization discrepancy was not deemed to be excessive and at about RMB 1 trillion in annual issuance it was promptly swept under the rug. Nonetheless the key statement remained: "Fitch believes the vast majority of these transactions are not publicly disclosed by Chinese banks, and few, if any, traces of the loans remain in financial statements." More recently, and long overdue, Moody's took a refresh look at the same problem and on July 4 released a rather disturbing report which found "that the Chinese audit agency could be understating banks' exposures to local governments by as much as RMB 3.5 trillion." At 10% of GDP, the number sure is starting to get larger. Today we present what we believe is the most comprehensive report we have seen to date on the matter of the Chinese "Shadow Banking" industry courtesy of SocGen. For those who enjoy putting things into perspective, SocGen quantifies the total shadow banking system in China to be as large as RMB10 trillion (or 55%, of the Total Social Financing of RBM18 trillion): nearly USD1.5 trillion. While the number is not massive (considering that the most recent corresponding shadow banking number for the US is well higher at about $16 trillion), it keeps increasing as a portion of GDP. Why is this important? Because as SocGen's Wei Yao says, "The currently unsupervised development of the informal financing market delays the intended impact of monetary policy tightening, but adds to the risk of precipitating a liquidity crunch of the entire financial system later." So it this Chinese shadow banking system a potential monetary time bomb, destabilizing the PBOC's efforts at normalization and adding materially to systemic risk? Read on.

Just because China was already delighted with Obama's reception of the Dalai Lama, here come John McCain and John Kerry warning China to mind it territorial waters, because apparently US national interests are threatened. Per the FT: “We are concerned that a series of naval incidents in recent months has raised tensions in the region,” said John Kerry, the Democratic chairman of the Senate foreign relations committee, and John McCain, the former Republican presidential candidate. “If appropriate steps are not taken to calm the situation, future incidents could escalate, jeopardising the vital national interests of the United States.” The logical follow up is glairngly obvious but here it is: "China is likely to see the comments as a provocation as they echo remarks by Hillary Clinton, US secretary of state, last year that infuriated Beijing. Speaking at the Asean Regional Forum (ARF) in Hanoi last July, Mrs Clinton angered Beijing by saying the US had “a national interest in freedom of navigation . . . in the South China Sea." What is surprising is that the US is dumb enough to bait China with such provocations as the US Treasury market is now, more than at any other point in the past 3 years, reliant on Chinese bond purchases. And for all those who claim that China has no other alternative where to recycle its trade surplus dollars, we bring you exhibit i) the EURUSD, where China sells dollars and buys euros, and ii) Eurozone bonds over the past months, which it has been gobbling up ravenously. So yes: it does have alternatives, and it may very well make a rather forceful statement to that extent.

The Treasury released its May Treasury International Capital data today, which confirms recent trends: while China, both domestically and through the UK, and Japan both added to their gross exposure of US debt in May, Russia's holdings continued to tumble in line with warnings out of Moscow discussed previously and with the continued Kremlin rotation out of Treasurys and into gold. And while Putin has obviously had enough with shenanigans in the US, the same can not be said for his posturing colleagues in China (and Japan) who at least two months ago, brought their holdings of US to 2011 (and record) highs of $1159.8MM and $912.4MM respectively. So much for China dumping bonds. Another source of Treasury demand: petrodollars, which saw their UST holdings in May hit an all time high of $229.8 billion. Overall, gross purchases of Long-Term US securities by official and private foreign buyers declined modestly to $44.6 billion from $44.8 billion. Netting out foreign securities purchased of $21 billion, yields net flows of $23.6 billion on expectations of $40 billion, or in other words May saw a modestly lower inflationary impact due to an influx in foreign capital in the US economy. Also when netting out US purchases of foreign securities as well as changes in bank dollar-denominated liabilities the net number was -$67.5 billion.

• China 2Q GDP rises 9.5% y/y vs est. 9.3%; rate is slowest since 3Q 2009.
• 1H GDP rises 9.6% vs est. 9.5%.
• June industrial production increases 15.1% y/y vs est. 13.1%, rose 13.3% in May; June IP up 1.48% q/q
• 1H IP up 14.3% y/y vs est. 13.9%
• June retail sales rise 17.7% y/y vs est. 17.0%; 1H retail sales rise 16.8% vs est. 16.7%
• 2Q GDP up 2.2% q/q vs 2.1% in 1Q
• 1H fixed asset investment exc. rural rises 25.6% vs est. 25.7%
• NOTE: GDP grew 9.7% y/y in 1Q.

As of this morning China has migrated from a purely symbolic European White Knight to an actual one. While overnight trading action was set to recreate the panic from September 15, 2008, suddenly something changed. That something? China. Per Dow Jones: "Bunds give up nearly all of Tuesday's early gains with the September contract just 12 ticks higher on the day at 129.26 after making a spike at 130.91, a gain of 177 ticks from the open. The latest, unconfirmed, rumor pushing bunds lower is that China is behind the supposed ECB enquiries for peripheral debt prices. As yet no official confirmation from market sources of any central bank buying. In the cash space, the 2-year yields 1.235% and the 10-year 2.65%." As China has been actively buying up EURs over the past two months and is now massively underwater on a cost position that may be in the hundreds, but is certainly in the tens of billions of dollars, the ongoing collapse in the EUR currency will now force the PBOC to resort to increasingly more drastic measures to protect its strategic investment. The irony of this is that the Swiss National Bank, which this morning had to watch in horror as the EURCHF plummeted to 1.15 and for the longest time has been fighting the Fed (which loves a strong EUR) has been joined by the PBOC, which is now also trading on its behalf. The First Central Bank War is now officially on.