China

In my last article, I outlined the current financial/ economic relationship between China and the US. In particular I focused on the manner in which China is diverting its money and resources away from the US Dollar and US economy. Indeed, in my opinion, when push comes to shove it is China, NOT the US who holds the trump cards on the major issues.

Over the past twenty years, few people have been as discredited in their worldview as New York Times columnist Thomas Friedman. The thorough fall from pedestalized grace of the Pulitzer Prize winner, whose latest book, "The World is Flat: A Brief History of the 21st Century," not at all surprisingly won the inaugural Goldman Sachs/Financial Times Business Book of the Year award, can only be compared to that other New York Times columnist who will go down with the debt-leaking titanic, kicking and screaming, that no matter the impending global default, he is right. And as the premise of globalization goes through its own death rattle, just like the ridiculous Keynesian notion that only more debt can save us from record debt, globalization's biggest advocate is monetizing his last remaining ounces of credibility. Below, we present Fora TV's recently released Asia Society interview with Friedman who discusses at length his view on the parallels and differences between China and the US. Note: absolutely nothing of significance will be learned in this presentation, which is merely a rehash of stale, faulty and thoroughly discredited assumptions yet it is a good starting point to learn about all that is flawed in the prevailing view of how the two countries are supposed to coexist in the future. In other words: take verything Friemdna says and flip it 180 degress, and you will be on the right path.

China's economy appears to have reached a critical threshold of complexity and obscurity that renders it uncontrollable. Recent reports of surging bank loans, real estate speculation, industrial growth and inflation triggered a sharp decline in the Shanghai stock index yesterday. A recent comparison of food prices in Boston and Beijing found that China is now more expensive than the US. Though the first link states that the average urban wage in China is about $3,000 a year, my sources in China report that a college-educated worker makes about $6,000 a year--about one-eighth the average U.S. income of $49,777. A mid-level manager might make $12,000 a year--an excellent salary in China. Food eats up (sorry) about 40% of the average household budget in China, roughly in line with the percentage U.S. households devote to housing/mortgages. As I have noted here before, it's not the absolute percentage rise in essentials such as food and energy that matters, it's the relative impact on lower-income households that matters. A 10% rise in food prices in a household that spends 10% on food (a typical upper-middle class U.S. household) results in a "statistical noise" 1% increase in the family budget. In a family budget with 40% devoted to food, a 10% increase in food meaningfully crimps household spending. A doubling of food prices would be catastrophic.

The trade imbalance between the US and China, a hot button between the nations for the last decade or so, is finally going to start to stabilize in the summer of 2011. However, it is doing so with a de facto devaluation of the US dollar and its buying power.

As we get Treasury International Capital data for one more (delayed) month, we realize just why QE will be a part of our financial landscape for a long time. In November, the formerly largest US credit (before it was overtaken by the Fed), lowered its Treasury holdings by $11.2 billion from $906.8 billion to $895.6 billion. And while overall there was strength in purchases of domestic securities by international entities, both private and official, which came at $93.9 billion in the month, split $61.8 billion in UST, $14.2 billion in agencies, $4.7 billion in corporate bonds and $13.3 billion in equities, the inflow into equities from foreign sources is far less than US sourced equity purchases of foreign stocks. But once again the biggest threat continues to be the rotation by China out of US Treasurys and into other securities... unless of course the UK continues to do China's bidding. UK holdings of US debt surged by a ridiculous $34.2 billion as direct bidders consolidated their holdings. Somehow the UK now holds $511.8 billion in US debt compared to $477.6 billion in October. What is troubling is that at this rate China will drop below Japan in total US holdings, a differential which has dropped to just $18.4 billion.

All bullish on the western front on Friday, as a worse-than-expected 0.6% (vs 0.8% expected & prior) December retail sales figure is overshadowed by a 40bps tick up to 1.5% CPI YoY in December (vs 1.3% expected), a 50bps tick up to 0.8% IP (vs 0.5% expected), and earnings beats from JP Morgan Chase and Intel.

A look at the week ahead, which is expected to be more of the same. Per Goldman: "The Econfin meeting on Monday will keep the focus on the Eurozone periphery and the governments' ability to enhance the framework already in place. Inflation data out of Malaysia, UK, New Zealand and of course China will keep the issue of inflationary pressures on the agenda. Of these prints, the most critical is China’s CPI and the question of China tightening. We do expect inflation to have softened in December to 4.2%, but rising food prices through January so far suggest this softness will be short lived. We expect the Central Banks of Poland and Brazil to hike rates by 25 and 50bps respectively in response to inflationary pressures. Rates are likely to be kept on hold in Canada, Mexico and South Africa. The Turkish central bank is expected to cut rates by 25bps. The November TIC data will be dissected to determine foreign appetite for US assets."

Those looking for vol in stocks really should shut down their E-Trade account and get some forex terminal. As we have been stating for well over 6 months now, with the Fed artificially ramping stocks, and making stock vol extinct, daytraders continue to be forced to find other avenues to day trade volatility. And the FX is just that market. The EURUSD has just done its daily 200 pip song and dance, putting yet another several hundred Japanese housewives using 50x leverage underwater by 10 times their capital amount. But at least China is happy. Oh and yes, with $4 trillion in FX turnover per day in 2010, this kind of mindblowing volatility is sure to end well.

Something interesting happened on the way to China's bailout of Europe. After recently China stepped up its Eurosupport rhetoric, and even put a token amount of money where it mouth is, €1.1 billion in directly placed Portuguese bonds specifically, and who knows how much in secondary market purchases, many of the clouds over Europe, and specifically the Euro, have been lifted temporarily, resulting in a modest jump in the EURUSD from just under 1.29 last week to nearly 1.32 today. Which makes sense: after all the EU is China's second biggest trade partner, and as a habitual importer, China needs the EU's currency as strong as possible to preserve its imports. Yet what is odd, is that over the past 24 hours we have received numerous notifications that it is none other than Chinese banks that have been selling the EURUSD! Which makes one wonder: is China's European "rescue" just one big bait and switch distraction?

After a week ago Zero Hedge speculated that China Green Agriculture (CGA) may be the "next Chinese fraud" based on an extensive report by J Capital claiming the company could be shell worth about 80% less than it was trading at the time, it appears that the SEC has finally shut down its midget porn TV station and realized that the microcap market it is supposed to be policing has become a playfield of fraud and 10(b)-5 lies, and has decided to launch an inquiry into the company's operations looking at the fraud allegations. Once again, Zero Hedge is happy to have brought attention to a problem some may consider epidemic: namely pervasive market fraud and lies.

A few days ago, when it was first announced that Portugal is contemplating a direct placement of bonds (with amount and buyer undisclosed), we speculated: "Reuters reports that Portugal is in the process of making a private
placement of bonds, without announcing details on size or the buyer. Our
guess: buyer is China, and size is about €1 billion." We were off. By €100 million. The WSJ has just confirmed that China was indeed the buyer, and the amount purchased was €1.1 billion. It is unclear if, as we suspect, Goldman Sachs was the underwriter on the transaction.

We have already seen Chinese ghost cities, rickety buildings, and a construction spree that makes our own unionized labor force seem positive antiquated. Time to add empty malls to the list. The latest confirmed sighting of Chanos' "treadmill to hell" China real estate bubble thesis comes from Bloomberg's Paul Allen who reports from Dongguan, China on the New South China Mall, which has remained mostly vacant since it opened in 2005. Allen tours the South China Mall, originally conceived as the world's largest mall, and finds retail space that has been largely vacant since 2005.  Allen reports, "The reality at South China Mall is somewhat different: shuttered shops, unfinished, never occupied by a single tenant. The few retailers that are here have favorable leases, but little profit."  Allen also states that despite obvious problems, the mall’s owners plan to expand to more than one million square meters of retail and residential space will be available.

For all seeking a reason why China will never voluntarily drop its CNYUSD peg, and why it will now actively buy PIIGS debt indefinitely, in its attempt to keep its currency low against the EUR and fixed against that ultimate debaser of currencies, just take one look at the December trade surplus. Even as gross trade surged to an all time high with total imports and exports just shy of $300 billion, at $295.2 billion, December's trade surplus plunged from $22.9 billion in November to just $13.1 billion, the lowest since March and April when China actually had a stunning trade deficit, and a nearly 50% miss to consensus which was at $21.4 billion. The total 2010 trade surplus was $183.1 billion, down from $196.1 billion in 2009 and $295.5 billion in 2008. This means China has increasingly less linen (primarily dollars) to recycle in purchasing such items as copper and gold, and, to a much lower degree, US Treasurys. As the charts below demonstrate, the drop in exports was largest to the US (down 16.4% sequentially), the EU (down 11.5%) and, to a lesser degree, the Rest of the World (- 9.1%). Bottom line: should the EUR hit parity with the USD, and should the CNY continue appreciating vs the USD, this trend will get increasingly uglier, slowing down the Chinese economy even more, which in turn will continue to make the case for a China-led rebound ever weaker, and the case for increasing Fed UST monetization ever stronger (in the absence of Chinese purchasing power). Welcome to the connected world, where monetization is really an indication of weakness.

Liu Wei, a director with China's State Administration of
Foreign Exchange, the foreign exchange reserve manager responsible for administering $2.6 trillion in FX reserves, told Caing.com today that "Quantitative easing carried out by the U.S. Federal
Reserve could exacerbate global currency interventions, hurt the
developed countries and fuel flows of speculative capital into emerging
market economies." Additionally, and contrary to all those who believe that commodity prices have in some cases tripled over the past year based purely on goodwill and not excess money, Wei also said that the Fed's quantitative easing program may have some
stimulus impact on the U.S. in the short term, but also that it could
add to global inflation pressure and fuel asset bubbles "so that the
global economic recovery and growth face greater uncertainty." Pretty much as we have been claiming all along.

Who says the xtranormal bubble has popped? Today we present the latest "bearish" cartoon with one particular take on Chinese currency manipulation. While we don't necessarily agree with the argument that Chinese monetary policy is the "single most protectionist policy in the world" as China is merely holding up a mirror to the Fed's own monetary tools, it does provide some entertaining perspectives. On the other hand, the observation that China takes 6,000 jobs for every billion dollars in incremental trade deficit, is spot on.