China

This morning China is forced to do some unpleasant diplomatic damage control. After an earlier report in Kyodo News disclosed leaked documents that China has revised its escalation doctrine to initiate a pre-emptive nuclear strike in response to a conventional attack, the country is now furiously scrambling to refute any such "interpretations." After all the last thing the already volatile North-South Korean theater needs is the worry of an unstable big brother next door who may just type in the launch codes if an artillery shell veers a few degrees off course. In its original report Kyodo announced that The Chinese military will consider launching a preemptive nuclear strike if the country finds itself faced with a critical situation in a war with another nuclear state, internal documents showed Wednesday. The newly revealed policy, called "Lowering the threshold of nuclear threats," may contradict China's strategy of no first use of nuclear weapons under any circumstances, and is likely to fan concern in the United States, Japan and other regional powers about Beijing's nuclear capability. Per obtained documents, the People's Liberation Army's strategic missile forces, the Second Artillery Corps, "will adjust the nuclear threat policy if a nuclear missile-possessing country carries out a series of air strikes against key strategic targets in our country with absolutely superior conventional weapons." China will first warn an adversary about a nuclear strike, but if the enemy attacks Chinese territory with conventional forces the PLA "must carefully consider" a preemptive nuclear strike. Of course, there is only one country that has "absolutely superior conventional weapons" and they know it. Which begs the question: why was this leaked now, and considering the recent spike in Chinese stealth fighter sightings, is China trying to send its biggest debtor "ally" a not so secret message?

Today, despite the announcement by Chinese Vice Premier Li Keqiangin in Madrid that China is willing to buy as much Spanish debt as that of Greece and Portugal (but not Ireland), or roughly €6 billion each, CDS in both the core and the semi-periphery, are back to record levels (El Pais and Reuters sources). Spain was last seen trying to catch up with Illinois, somewhere in the mid 300s, while Belgium also took out record wides at 225 bps. On one hand this is beneficial news for Spain, now that China is seemingly instituting its latest sphere of influence, but in reality is just doing all it can to precent the euro from collapsing (and thus killing Chinese exports to its second largest trading partner, the EU) and with net issuance in the country expected at just €47.2 billion, Spain may have well gone the distance to plugging as much as 13% of its net funding needs for the year. However, and what is spooking markets more, is that, as we reported yesterday, today European Commissioner Michael Bernier will publish a “consultation
paper” outlining ways to shield taxpayers from banking crises, chief among which is the renewed floating of the debt haircut idea.

After Muddy Waters came out with research two months ago that singlehandedly destroyed recent Chinese NYSE IPO, RINO, we predicted that there would soon develop a cottage industry of micro investment firms who do diligence on various Chinese frauds (and there are many of them), establish a short base, and subsequently release a research report in the name. Today we get the latest such possible casualty: meet China Green Agriculture, a Xian, China firm founded in 2000, which "engages in the research, development, manufacture, and distribution of humic acid based compound fertilizers in China... The company also engages in the development, production, and distribution of agricultural products, including fruits, vegetables, flowers, and colored seedlings." Sure enough the company IPOed on the NYSE in mid-2008, and if the just released research report by J Capital Research is correct, the firm is about to join such other disgraces as RINO in the NYSE IPO dunce corner. To wit: "In this report, we present compelling evidence that China Green Agriculture (NYSE:CGA) has significantly over-stated its true revenues and earnings. We estimate that CGA’s value is no more than $2.85 per share, as opposed to its current market price of $9."

The Chinese rhetoric on US Treasury holdings is once again heating up. After a year ago former PBOC advisor Yu Yongding called for a reduction in China's holdings of US Treasurys, popular magazine Caijing published another call to arms by the disgruntled ex-central banker. In apparent disagreement with traditional monetary policy and the Yuan peg, Yu said that moving towards a more market-driven exchange rate would mean reduced intervention in the foreign currency markets, giving China the option of winding down its holdings of U.S. debt. "China should strive to reduce instead of further increasing (its holdings of) dollar assets," he said. "Specifically, China should reduce the growth of its foreign exchange reserves as soon as possible. Furthermore, with the Fed now firmly holding far more US debt than China, the world's fastest growing economy is realizing that is negotiating power when it comes to US leverage via bond holdings is getting smaller with every day. Perhaps the country is finally realizing that it would be best to sell to the Fed now when it can, rather than some time in the future, when it has to, and do so on Bernanke's terms.

Fear about defaults and more bailouts throughout the European Union (UN) has pushed Gold to an all-time high of $1,432.50 an ounce on Dec. 7. The market’s emotion related to the European debt crisis is clearly reflected through the interaction between Dollar, Euro and Gold.

While the world is still unwrapping the surprise Christmas gift from China in the form of an interest rate hike of 25 basis points, this other piece of news with ample implications to the auto industry seems to have gone largely under the radar.

Of course we felt that last week's zero-volume move higher was fake, Fake, FAKE but, when the acting is that good, there's nothing else you can do but sit back and enjoy the ride.

When all else fails, just make stuff up. That appears to be the Plan B for Goldman analyst Helen Zhu, whose take on the faster than expected Chinese rate hike over the weekend is beyond incredulous: "even though our economics team believes that rate hikes are more of a signaling tool rather than the most effective way to curb inflation, we believe this move will be welcomed by the market." So now we know that according to Goldman, rising mortgage rates are good for the economy (that dropping mortgage rates were good is beyond obvious), and the removal of excess liquidity (we have yet to check on where the 1 week Chinese repo rate is) is just as good if not better than the endless pumping thereof. H.M.M.M.M. Fair enough: does Goldman also provide free lobotomies to those clients who followed its FX trading advice in 2010 and are now wanted by the Feds for involuntary manslaughter by way of insanity? Incidentally, we attribute the current drop in ES by 0.5% only to the fact that Brian Sack has been precluded from reaching his Bberg terminal due to snow, and hit the "any key", which on his keyboard just happens to be Buy. And since there is no POMO today, the momo crew may be about to hit a Panic button of their own.

Following Friday's failed 3 Month Bill auction, things in China are once again getting interesting, just as the rest of the world has decided to sleep right into 2011. The PBoC, in a surprise move, hiked its lending and deposits rates by 0.25%, the second time the bank has done so since October 19, when its then-raise was the first in 3 years. And by all accounts the PBoC is not done: consensus is for three 25 bps moves by the end of 2011: that the PBoC is starting early may be an indication that the country is starting to seriously worry about its soft landing prospects. Yet one thing that is certain is this move cements the CNYUSD peg: despite all the rhetoric, China will keep the currency peg come hell or high water, as it eliminates any monetary trump card Bernanke may have (just as Germany loves being part of the EUR which has such insolvent countries as all PIIGS members backing up the rear). What is unclear is whether the PBoC has now decided to avoid the RRR hike path as the preferred approach to combating inflation. It is assumed that his action will have a soothing impact on the Chinese 7 and 30 Day Repo rates come Monday, as else more failed bond auctions are certain to be in store for Shanghai in 2011.

China has been ranked as the top growing country among the G20 since 2001 and is expected to retain that title for at least another five years. However, the news coming out of China for the past three months has not been good.

One look at the overnight EURUSD chart shows a straight vertical line up earlier in the session (at least before an almost comparable and equal line straight down following the Portugal action by Moody's), which was driven by news that Chinese vice premier Wang Qishan expressed his support for EU efforts to ensure financial stability. Yet the biggest indicator of just how bad sentiment in Europe continues to be, China support or not, are the results from the Spanish T-Bill auction. And after auctioning €3.88 billion in 3 and 6 Month T-Bills off earlier today, the yields rose once again to record highs. The 3-month T-Bill auction for €3Bln came at a bid to cover 2.14 vs. Prev. 2.34, at a yield 1.804% vs. 1.743% previously. Just as disappointing the 6-month T-Bill for €0.88bln, came at a bid to cover of 5.15 vs. 2.65 previously, importantly at a yield of 2.597% vs. Prev. 2.111%. In other words, despite billions of ECB sovereign bond purchasing, and despite the recent shift in sentiment that Europe is not in free fall, arrested after Reuters spread false rumors that the IMF would bail out Europe, things are once again turning ugly for the continent, as there is no way that a country can sustain its funding needs when the 3 Month cost of credit is at such a huge differential over 3M Euribor, which today clocked at 1.022%. If not even the arbs, who are the only ones left active in this market, want to put the compression trade between unsecured and sovereign debt, then there is little reason to be optimistic.

The main focus of QE2 is not domestic but international, exporting inflation and forcing BIC's hands. This is highlighted by Brazil's immediate and very public, very undiplomatic response as well as Bernanke's very undiplomatic jab at China shortly after QE2 announcement. In this it's been very successful. BIC have been trying very hard to resist. Although India has given in and raised rates, Brazil and China (along with other export economies such as Japan and South Korea) have been resorting to other means. But for how much longer can they resist?

Following increasing concerns that China may finally realize that its repeated RRR hikes are insufficient and the PBoC will finally be forced to do the right thing and hike the general interest rate (or depeg the Yuan, but that ain't gonna happen), or otherwise withdraw liquidity, the 7 day Repo Rate has jumped to 3.58, the highest since October 2008, when there was no liquidity in the markets anywhere following the Lehman collapse. This merely indicates that obtaining liquidity in China, either directly or indirectly, is becoming increasingly more costly and problematic. But surely this news, together with the escalating riots in Athens, as well as the fact that gasoline prices this holiday season will be the highest on record, are not only priced in but in fact positive for the US stock market, which now responds to no negative news whatsoever, and jumps on the smallest hint that the latest fiscal and monetary stimulus is trickling through in the economy.

The October TIC Data is out (although courtesy of the total and ridiculous redesign of the Treasury's website, is a complete nightmare to navigate). Net foreign purchases of US securities amounted to $54.7 billion, down from a revised $90 billion in September, and even more from $136.3 billion in August. Net foreign purchases, net of adjustments and US purchases of foreign securities, amounted to $7.2 billion, substantially lower than expectations of $51 billion. Digging through the data reveals some interesting trends, namely the purchases of LT Treasurys, while still positive, plummeted from purchases of $78.3 billion and $117 billion in the prior two months. The savings grace is that foreign purchases of Corporate Stocks remained relatively strong, at $16 billion. Looking at China we observe that the country actually sold off Long Term UST (while buying Short Term Bills): this means that the Fed, with its $966 billion in US paper is now untouchable at the top of all holders of US Treasurys.

That’s STAGflation, as in stagnant economy, not the more benign INflation, as in the stuff the US pretends doesn’t exist.