China

One of the main catalysts for today's European market action was the Italian 1 year Bill issuance which was supposed to set the tone for Italian bond demand, especially since thanks to ISDA's stupidity (which had made it clear CDS will not trigger in any event as the organization is completely spineless), there is no reason to any longer hedge a negative basis at issuance. Well, Italy did pull it off, although at terms that a month ago would have inspired shock within the market. "The 6.75 billion euro sale was the first test of appetite for Italian paper since a surge in nerves that it will be next to fall in the euro zone's debt crisis due to domestic political tensions and a combination of high public debt and low growth. The gross yield on the 12-month BOT bills rose to 3.67 percent from 2.147 percent at a previous auction in June. This was the highest level since September 2008, according to Reuters calculations on Italian Treasury data. The bid-to-cover ratio fell to 1.55 times from 1.71 in June, when the treasury sold a slightly lower 6 billion euros in total." However, even this data was very suspect after 10 Year Italian-Bund spreads hit a new record wide of 355 bps earlier as the Italian contagion is now fully on. In response, both the ECB and China are now rumored to be scooping up all peripheral bonds in the secondary after a long hiatus as the ECB is on the verge of panicking, side by side with European bond investors, following remarks by Dutch Finance Minister De Jager who said, as predicted yesterday, that a Greek selective default "Is not excluded anymore."

China's inflation battle would be a vertical battle climb for Beijing, and is nowhere close to "have peaked in June" as many analysts have predicted.

Europe is now openly burning once again (Italy-Bund spreads just hit a new record), the US is 9 days away from being bankrupt, and completing the trifecta is China, which just failed to sell half of the proposed 50 billion in CNY of local government debt at an auction, courtesy of the SHIBOR supernova which oddly only Zero Hedge has been covering. From Bloomberg: "China’s finance ministry failed to sell all of the three-year debt offered at an auction on behalf of local governments as a cash crunch curbed demand. The ministry sold 23.9 billion yuan ($3.7 billion) of bonds at a yield of 3.93 percent on behalf of 11 provinces and municipalities, falling short of its 25 billion yuan target, said a trader at a finance company required to bid at the auction. The Shanghai interbank offered rate, or Shibor, for three-month yuan loans, was fixed at 6.24 percent today, near a record high of 6.46 percent reached on June 28. “While the interbank borrowing cost is so high, investors won’t spend money on local government debt,” said Huang Yanhong, a bond analyst at Bank of Nanjing Co. in Nanjing. “Demand is low also because the debt’s secondary-market trading isn’t active. After you buy it, you can only hold it till maturity." Who would have possibly thought that 7 week money costing 7% and more could have implications and stuff...

The PBoC just announced its 3rd interest rate hike for 2011. In a statement just released, the Chinese central bank hiked its one year benchmark deposit and lending rates by 0.25%. To those following the 1 and 2 Week SHIBOR and repo rates this is hardly a surprise, as the recent liquidity thawing experienced an abrupt reverse in the past two days. In the meantime, expect to see more realization that the Chinese soft landing may be in for some bumpy times.

The timing on the earlier pronouncement that rating agencies may have found religion could not have been better. Not even an hour later, here comes Moody's with a blockbuster which may put China's "White Knight" status, at least as ar as Europe is concerned, in grave danger. In a report just released, the rating agency not only warns that China's debt problem is "bigger than stated" (i.e., China is hiding a ton of ugly stuff off the books), but goes ahead to quantify it: "Of the RMB 10.7 trillion (about $1.6 trillion) of local government debt examined by the Chinese audit agency, RMB 8.5 trillion ($1.3 trillion) was funded by banks. However, Moody's has identified another potential RMB 3.5 trillion ($540 billion) of such loans that the Chinese auditors did not discuss in their report....we find that the Chinese audit agency could be understating banks' exposures to local governments by as much as RMB 3.5 trillion." Naturally, the implication is that this is an absolutely willing "omission" (thank you central planning), which means that of China's $5.8 trillion GDP (or whatever imaginary number the Polit Bureau is happy with throwing around for mass consumption), $540 billion is debt that is "unaccounted for", most likely due to being, well, bad. That would be equivalent to saying that $1.4 trillion of US corporate debt is delinquent. And lest anything is lost in translation, Moody's drives the steak through the Dragon's heart: "Since these loans to local governments are not covered by the NAO
report, this means they are not considered by the audit agency as real
claims on local governments. This indicates that these loans are most
likely poorly documented and may pose the greatest risk of delinquency." So let's get this straight: a country which has 10% of its GDP in the form of bad debt, is somehow expected to be credible enough to buy not only Greek debt, but the EURUSD each and every day? Mmmmk. In the meantime, Dagong downgrades the US to junk status in 5, 4, 3...

There are more than 1 million college-educated "ants" in China making an average $286 a month. While China seems to have an over-supply of college grads, the United States, on the other hand, is not producing enough college-educated workers, at least according to a new study released by Georgetown University.

The CPC (Communist Party of China) was founded on July 1, 1921 in Shanghai with a large working class support base. Throughout the past 60 years or so, China has never deviate much from socialism. With rapid growth, cracks are starting to surface.

It seems that the global economic decline is not limited to the Japapense maanufcaturing base: as expected in a globalized world, manufacturing weakness has now spread to both China and the UK, whose PMI indices are both fractionally above stagnation. On China: "China's official Purchasing Managers Index fell to a 28-month low to 50.9 in June, (below expectations) with the imports index tumbling to 48.7, the lowest since August 2010. It was followed shortly after by the HSBC China manufacturing PMI for June, which slid to 50.1, marking the lowest level since the second quarter of 2009. The drop was sttributed to: "falling liquidity levels, higher interest rates and shrinking tighter
credit availability." Which means that the PBoC will be forced to act to rekindle its industrial base even as prices are still not under control and the upcoming inflation print is expected to come north of 6%. The UK's own PMI also was below expectations, coming at 51.3 on consensus of 52 and below May's 52.3 "The CIPS Manufacturing Purchasing Managers Index (PMI), a composite index measuring manufacturing activity, came in at 51.3 in June, down from a revised 52.0 in May, hitting its lowest level since September 2009...UK manufacturing sector activity growth has slowed dramatically in the CIPS series since early 2011. In February the headline index posted 61.5, matching January's record high for the series. In March the manufacturing PMI posted 56.4, then 54.4 in April, then the revised 52.0 in May, its lowest reading since September 2009. Now it has fallen to 51.3 in June, just 1.3 points above the 50 stagnation level." As a result the central banker dilemma is now at its peak, as the banking cartel is unclear if it should hike rates and stimulation inflation, or further lower and cause outright stagnation. As we said a few weeks ago, this is what centrally planned stagflation looks like. But luckily we have the US, whose Chicago ISM is expected to once again indicate a reverse decoupling is the name of the game for a few months, as despite a global economic contraction, the US is somehow growing, despite the end of QE2 and no fiscal stimulus anywhere on the horizon.

Following the abysmal decision by the Obama administration, presented in IEA letterhead, to release crude stockpiles, the resulting lower prices lasted less than one week, and in the case of gasoline, the price has actually surged way above the decision day fixing. So what is an administration with no credibility to do? Why double down of course, and sell even more crude at firesale prices to the Chinese. Per Reuters: "The International Energy Agency could decide by mid-July whether the release of strategic oil reserves needs to be extended for a month or two, an official said." And there is that transitory word again: "Richard Jones, deputy executive director of the
IEA, said he believed the release would be temporary since demand would
likely drop in the fourth quarter." Well demand may drop, but the last time demand was actually relevant in price discovery was sometime in the 20th century. Welcome to the era of oil prices defined by monetary policy.

Over the past two weeks, we have been suggesting, tongue in cheekily, that despite the relentless desires of everyone to sell the EUR, it has continued to drift higher, due to some inexplicable force with bottomless pockets, which, after some deductive logic, we assumed was China. It turns out we were correct. Naturally, figuring out what China does with its $3 trillion in foreign reserves is sometimes more complex than brain surgery (except what it does every time it sees a barrel of oil for sale: then it is pretty much guaranteed what it will do). But when it comes to preserving its 3 rounds of horrendous European down payments, it was pretty logical that China would do everything in its power to prevent a waterfall effect that would result in Europe imploding in a ball of illiquid singularity. The WSJ has confirmed that China's SAFE is actively doing all it can to transfer billions of its dollar-denominated holdings into euros. And while this does not mean the EUR is the new reserve currency, it certainly means that China has now become the deciding factor as to just who is (much to the chagrin of Markel, and delight of Geithner... for the time being).

China is struggling with inflation, speculation, an increasingly polarized society and even some social unrest. Shilling continues his 5 part China article today on how the country is strolling along the path leading to Hard Landing.

Some time ago it was revealed that in its rush to catch up with western military technology, China has now developed an aircraft carrier and a stealth fighter (reverse engineering efficiency notwithdtanding). Now, it appears that China has developed its first ever unmanned drone. Wired has the latest: "It was another big reveal in a long history of them. Six months after the Chinese air force let the first photos of its new stealth fighter
leak online, Beijing’s military has “accidentally” showed off another
secretive weapon system: a small drone, apparently used to scout ahead
of China’s fast-growing fleet of warships. Details of the Unmanned Aerial Vehicle — gleaned entirely from a snapshot
(.pdf) taken by a Japanese navy patrol plane last week — are sketchy,
at best. But the new UAV certainly represents a step forward in China’s development of American-style spy drones." Of course, the "leak" is anything but, and is merely another attempt to demonstrate its ongoing scramble to keep up with the US across all verticals. After all: why peg to the dollar, if you can't peg to the military. And while these attempts at oneupmanship are childish, expect to see a very vocal response from the headline hungry general population which may soon find itself in a "panic" over the fact that the biggest communist power in the world is suddenly getting "just as strong."

As expected, China is the new IMF. No surprise there.

• CHINESE PREMIER WEN TELLS BBC WILL LEND TO EUROPEAN COUNTRIES HAVING TROUBLE BORROWING

All this means is that China will do everything in its power to prevent the ECB from launching an outright unsterilized monetization episode, which will double the amount of importable inflation (plunging EUR) to hit the Chinese domestic economy, and destabilize the already shaky stability, so critical for the Chinese communist party. And since the USD and the CNY are pegged, this has the added benefit of devaluaing the CNY instead even more if not against the USD, then against the CNY, which is now importing European sovereign risk and will continue to do so, until China finds itself in the same lock out as half of Europe currently.

In continuing its recent pursuit of "white knight on full retard tilt" policies vis-a-vis the endless European bailout, and throwing good money after bad after horrible after totally lost, today Chinese premier Wen Jiabao said that not only would China do everything in its power to preserve the EUR (after all that CNY needs to be cheap against some currency) and "work for expeditious recovery and stable growth" but also unveiled that it is now preparing to go ahead an buy Hungarian bonds. As if owning Greek, Portuguese, Spanish and Irish debt was not enough. It seems China has learned from the best, and either knows something others don't (except for the SHIBOR market of course) or is actively preparing to become Too Biggest To Fail by making sure that should something bad happen to it literally the entire world will follow it into the depths of hell. Which, as Jamie Dimon, Vik Pandit, Lloyd et al have known for the past 3 years, is not a bad strategy. Look for China to keep buying up ever more European debt as it intertwines its fate with that of the rest of the central planning cartel: a development we can only compare to the ever deteriorating Spanish Cajas desire to buy up as many semi-healthy banks as they possibly can to prevent a policy determination to shut them, and their billions of bad debts, down.

Step aside IMF, China is now in the driver's seat. Officially.