China

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The latest escalation in the binary version of modern warfare (i.e., that fought with a Bloomberg instead a stealth fighter), comes from China, which the NYT reports has just halted shipment of rare minerals to the US: "China, which has been blocking shipments of crucial minerals to Japan for the last month, has now quietly halted shipments of some of those same materials to the United States and Europe, three industry officials said on Tuesday." As we disclosed a few weeks ago, prepare for an explosion in various rare metal prices...

China has raised its key interest rate by 25 bps, marking only the first time it has done so since announcing it has recovered from the global crisis. Undoubtedly, this is its response to not being labeled a currency manipulator. However, as the US will most likely never raise rates again, and with the Yuan still pegged to the dollar, unlike in a typical recovery, where this would signal the elimination of excess liquidity in an attempt to prevent inflation, this time it is a largely symbolic move. Nonetheless, this will put some serious pressure on Chinese stock markets, on the US futures, and will be very "positive" for the dollar, which ironically defeats the whole point of the exercise.

Today's most important piece of news for holders of precious metals comes from the far East, where Kim Choong-soo, governor of South Korea’s central bank, told a parliamentary committee on Monday, that the country: "needs to give careful consideration to the matter of increasing gold volumes in the foreign reserves.” In other words, as the FT summarizes, "South Korea, holder of the world’s fifth-biggest foreign exchange reserves, is considering expanding its small holdings of gold to diversify its dollar-heavy portfolio." Last week, a mere unsubstantiated whisper that China was doing the same sent gold $10 higher. So with the regional game theory framework changing, as more countries rush into the yellow metal, will China finally be forced to come out of its shell of gold shyness and officially start accumulating, sending gold soaring?

You didn't think China was just going to do the rockaway and lean back, lean back, lean back. Nope - China Daily says: "A currency war is spreading as the dollar's value against major world currencies has continued to decline in recent days" and calmly confirms what everyone esle knows: "It is the dollar that triggered the currency war. Seemingly a market move, the depreciation of the dollar is actually active." Check to you, Tim Geithner and your currency manipulation report. What is remarkable, is how simply and accurately CD writer Li Xiangyang captures absolutely everything that Bernanke is trying to achieve.

A new report by MainFirst Bank provides more ammo to the China bears. In "Why China's Growth Rate May Halve" author Bijal Singh has a very gloomy forecast on the country's growth rate, concluding it may "struggle to grow faster than 6%, given that China is now fully employing the vast bulk of its available urban labour force, and given that the Chinese working age population has stopped growing and is on a declining path." Singh takes Rosenberg's earlier rhetorical question about why collapsing profit margins have not yet impacted prices and believes that increasingly more companies will be forced to rationalize their operations, driving a stake straight through the heart of all those pushing for the tech bubble part 2: "Demand growth of 4%-6% may cause Chinese firms to shift focus from growing capacity to better management of existing capacity. Rather than capex equipment providers, computer service firms may be the winners in China over the next five years." The main driver for the GDP growth is that, due to the GDP being a function of job growth and productivity growth, it is the latter of the two which casts the assumption of GDP growth of 8% in perpetuity in doubt. "Over the last decade, productivity growth in China may have been no different to that experienced in the developed world. But China has been able to throw capital at the economy to grow its workforce at a rapid rate without incurring inflationary pressures." Said inflationary pressures are precisely the reason why the country is so cautious to do anything material about either its exchange rate (and today we yet again got confirmation of just who wears the pants in the Sino-US relationship), as well as its interest rate. All in all, changing demographics and economic conditions will make it increasingly difficult for China to manipulate its way into the required growth curve, which may well be the biggest risk to not only the BRIC growth story, but to that of the developed world as well (because now, unlike before somehow, decoupling is expected to work).

According to Reuters, a senate aide has confirmed that Tim Geithner has pissed his pants and seeing the sudden surge in the dollar following rumors that a bunch of hapless politicians were about to blame America's depression on China and call it a manipulator even as the US prepares to print $1.5 trillion in new paper, has delayed the currency report until after the G20 meeting in November. One wonders just what telephone conversations occurred between Geithner and Wen Jiabao in the past 20 minutes, and what the mutual assured destruction trump card (or 850 billion) used this time was.

Update: Now it is getting really interesting - Reuters reports that according to a Senate aide, the currency report will be delayed. If all was to be smooth sailing, one wonders why...

Today, the Treasury will finally come out with its currency report, which will conclude whether China is or isn't a currency manipulator. While the fall out from the former could well be dire, and result in various political and fund flow consequences, it appears that this is precisely what will be the outcome. Attached is a note from RHM Global according to which the adverse outcome is all but certain.

Interview with Vitaliy Katsenelson on the challenges facing China and Japan and the implications to the rest of the world.

It appears that the next round of the trade war is imminent: per Reuters, Senate Finance chair Baucus has said that the Senate is "poised to follow" the House in passing China currency legislation. Expectations were that this law would not pass for a while and certainly not before the mid-terms. It appears the Senate, in its own attempt to generate some populist Brownie points, and unable to grasp that the whole point with the weak CNY is an even weaker USD. What this is certain to do is escalate an already tenuous situation, and lead to even more jawboning in US-Sino relations. We are confident that the decreasing indirect participation in the recent 3 and 10 year auctions is a direct consequence of what China's retaliation will ultimately look like.

And so gold takes off, as the CRB index passes 300, with America blissfully unaware $100 oil and 20% U-6 unemployment is next, leading to a total collapse in the economy. The catalyst: Bloomberg reports China to put more reserves in gold. This time gold is flying even as the dollar is not getting crushed, implying that capital flows are not simply "gold on, dollar on." The surge in gold once is again making relative stock gains for the day priced in gold negative. With nobody daring to actually short stocks on fear of random buy-ins (such as the one in IWM today) Gold continues to be the way to express a negative bias on stocks, and one which on a pair trade basis has been profitable on any historical horizon basis as gold's "beta" is better than that of stocks.

China released its September trade balance data, which at $16.9 billion, missed expectations of $17.8 billion, and was a sizable drop from the $20 billion in recorded in August, however was a 30.5% increase from a year ago. The reason for the sequential drop in the number was due to imports which at $128.1 billion surged to an all time high. This being China, of course, it was offset by a surge in exports to its two main export markets: the US and EU. US exports, much to the protectionists' chagrin, came at the second highest on record, or $27 billion, even as imports also grow marginally to $9 billion (see charts below). The the export saving grace was Europe, which imported $28.8 billion worth of Chinese goods, for a trade surplus (from the Chinese perspective) of $14.9 billion: the highest since the Lehman collapse. And confirming that September was a very much trade driven month, the gross notional trade balance with the Rest of the World (ex US and EU), surged to a record $99.7 billion ($44.1 billion in exports and $55.6 billion in imports, both at near or fresh record levels). The ongoing trade surplus will surely lead to more calls for Yuan revaluation, which of course simply means CNY-USD unpegging, as the CNY continues to benefit mostly to the Fed's ongoing devaluation of the dollar. How this is lost on our Congress critters and Senators is beyond us. Want CNY revaluation? Stop killing the dollar. And due to to traditional pick up in the trade surplus in the month of October, we expect screams for trade war to get ever louder next month once a fresh record Chinese export number is posted.

Recent rumors of a hike in the Chinese deposit reserve ratio, were finally proven true, after earlier today China suddenly, and unexpectedly, hiked the deposit reserve ratio by 0.5% for 6 big banks for two months, to a level of 17.5%. As this is a modest liquidity-withdrawal move, it is a substitute to an overall rate hike which has also been rumored to be in the works. Of course, with the US about to embark on a "rate-lowering" equivalent move via more QE 2, it would be silly to believe China would actually follow through with this at this point, and put itself at a disadvantage. As such this modest stop gap overheating-prevention move makes sense. Whether it will be a catalyst to reverse the recent move higher in domestic Chinese stock market remains to be seen.

Jailed Chinese dissident Liu Xiaobo won the 2010 Nobel Peace Prize on Friday for "two decades of non-violent struggle for human rights". China is totally livid and called the award "an obscenity".

Combine Kyle Bass's fatalistic outlook on Japan with some simple geology and you get the following thought experiment from Hinde Capital: "Imagine that there was a full-scale exit out of JGBs. There is 900 trillion yen worth of JGBs outstanding that is 10.588 trillion US dollars at 85 yen, today’s rate. At $1,300 per troy ounce gold this is equivalent to 8.14billion ounces or 253,000 tonnes (8.14bn /31250) of gold. Now we are not for one moment saying that this is realistic, as if there was a rush from JGBs they will not be valued at par and not all JGBS will be exited. However it just goes to show how much gold could rise to reduce the amount needed to convert savings. Let’s say gold went to $13,000 then only 25,000 tonnes would need to be found for Japan. Now if you add inflation of the currency and a few noughts you can see how gold can be valued at almost unlimited numbers. Anyone still think $1,300 is too rich?"