China

Gary Shilling is now firmly in the anti-China contrarian bandwagon. In this interview with Bloomberg's Erik Schtazker the legendary investor, who called Japan's lost decade when everyone was just as bullish on Japan as Goldman is now on China, Shilling shares the same view on Chinese record excess capacity as Hugh Hendry did some months ago: "You can't trust the [Chinese] numbers... They have kickstarted their economy in the last year - it's a stop go economy, they can do it fast, they don't have to worry about EPA audits, they just let the bulldozers roll when they want to build a new road or whatever. The point is they build an awful lot of excess capacity and the question is how are they going to use it because American consumers aren't buying their exports the way they used to and their domestic economy isn't that strong... Chinese consumer spending is 36% of GDP and is a declining share over the last two decades. They don't have a a big enough middle class. In China there were 110 million people with over $5k per capita income, enough to give them discretionary spending but that was only 8% of the population. In this country it is 80% of the population." And on the yuan: "If they took off all the controls and Chinese could invest abroad, the yuan would probably go down because people would want to diversify... I think the political leaders are aware of that possibility they sure don't want to be pushed around, and Obama made a huge in trying to push them again. Remember China was dominated by European in the last century and they want to run their own country." While we completely agree with Schilling, we believe that the current transformation in US society, which is in the last throws of contract abrogation, in not paying mortgage and credit card bills, we may well see a last push in Chinese imports, after which any disposable income in the US middle class will plunge and will take the US economy down with it as well. The problem, as we have repeatedly pointed out, the cash return on such "assets" as iPads and Kindles is zero, not nearly enough to pay down 39.95% APR credit cards.

Moments after China's $7.2 billion March trade deficit was announced, the Chinese Ministry of Commerce was blasting away at critics of the CNY peg. According to Market News, the MofComm stated that "the recent steady decline in China's trade surplus and the trade deficit post in March again show that the yuan exchange rate is not the key determinant in the country's foreign trade balance." He has a good point - what is, is the endless printing of paper money by China used to keep its residential sector screaming ever higher, while at the same time taking advantage of the same generosity from Ben Bernanke across the Pacific, which in turn benefits China just as much as it does the US. The reason is simple - continued destruction of the dollar, which will commence shortly, will benefit China as well, further facilitating its export economy, while its own printing goes straight to boosting imports. In this way, the confrontation of Chinese and US monetary policy can be seen nowhere better than in the Chinese balance of trade: and judging by the increasing trade deficit, the Fed's influence is starting to wane. Soon enough, when the Fed's marginal impact on the CNY is negligible (via dollar printing and via the CNY peg which is not going away any time soon), China will truly have no other option but to rely on its own consumer class, even as it still seeks to reap the benefits of increasing exports. Our belief is that the deficit will drift slowly higher, however what will become evident will be the ever greater absolute amount of both imports and exports in China.

In March China recorded its first trade deficit after 70 straight months of trade surpluses, which has occurred even despite global calls that the Renminbi needs to be revalued by about 20%. The primary reason for this was that in March China imported a total of $119.4 billion worth of goods - the single greatest amount recorded in history. This was offset by $112.1 billion of exports, well below the record exports China was pumping out in late 2008 in the mid $130 billion range, and the $130.7 billion exported in December of 2009. Below we present a summary of the key highlights of China trade balance over the past 3 years.

In a Charlie Rose interview to air later, Jim Chanos repeats his warning about all hell breaking loose once the China bubble bursts and puts a timeline on the event - late 2010 or 2011. "Supply will equal demand at some point. It always does, and then there is this precarious tipping point when suddenly you can't sell a project and then it's just as if everyone from the port side of the cruise ship goes to the starboard side of the cruise ship all at once. You get a tipping point, you get this light-bulb moment - "I've got to get out while I can." And the buyers dry out. It's as old as market itself." Chanos also voices his opinion on the CNY, and ever the contrarian, he, just like Edwards and Zero Hedge, implies that the CNY is actually overvalued, contrary to what the NYT's paywall may want you to believe: "Chinese exports aren't the problem here. And what if it turns out that by having to nationalize lots and lots of real estate bad debts, the RNB is devalued." All spot on, however we disagree with Chanos' conclusion that this is something that nobody is expecting: note here and here.

Geithner and the Obama Administration are rolling the dice with its China policy in a very high stakes game. They are trying to force China to revalue the yuan. If we crap out, we face the possibility of trade wars and a collapse of international trade. I believe they don't understand what they are doing. This is big. Don't count on politicians to do the right thing.

As was expected in light of recent FX moderating overtures by Beijing, China will not find out if it is or is not a currency manipulator on April 15. The NYT reports that the decision from the Treasury will be deferred until after China President Hu Jintao visit Washington. "China experts said it was unlikely that China would have agreed to the visit unless there was at least an informal assurance by the Treasury Department that it would not be named a currency manipulator either on or around April 15 — the deadline for the Obama administration to submit one of its twice-a-year reports on foreign exchange to Congress." This does not mean that China will refloat the CNY, but that we are merely back to square one, after some loud TV appearances by politicians, and some even louder columns written recently by so-called pundits.

In what could be a first step to appeasing the US and its requests for CNY revaluation, Caijing has reported that China may be considering expanding the daily yuan trading band. The yuan currently fluctuates up to 0.5% around the central CNYUSD parity set by the PBoC - today, for example, the CNY was stronger by 1 pip from 6.8264 to 6.8263. As reported by Market News, citing an
unidentified Chinese government source, "If the central bank does not want to see a quick rate hike, a
better way to fight inflation would be to expand the daily yuan trading
band to allow the yuan to appreciate properly." One interpretation of this development is that China, anticipating a delay of the Treasury report widely expected to brand China a currency manipulator, will placate the US just marginally and split the baby in the middle, by allowing a trading band expansion. Of course, this will do nothing to actually revalue the Yuan, devalue the dollar and boost US exports, but it will allow the Obama administration to save face and say "look, China made a concession" which the teleprompter will explain is an indication that the Obama administration now has the upper hand in Sino-US negotiations, followed by a round of applause from yet more to be soon unemployed people.

On April 15 the Treasury will issue its report on International Economic and Exchange Rate Policies. Following a massive push by politicians and economic pundits alike, the probability that China will be branded a currency manipulator is extremely high, if not certain. Following the last few days of adverse developments in the Google censorship saga, it is unlikely that China will accept that particular title with a wink and a smile. And while China was previously named a currency manipulator in the past, the last time this occurred was in 1994. To say that a lot has changed since then is an understatement. What happens after April 15, 2010 is anyone's guess, although for some perspective of the bullish cash, here is Goldman with their range of expected consequences. Of course, what is good for Goldman is bad for Goldman's clients so keep that in mind, especially since this is a sell-side piece.

China is now playing hardball, and this is even without Paul Krugman being in the picture (yet). The WSJ reports that China has now blocked virtually "all searches by Chinese users on Google
Inc. sites Tuesday, sharply escalating the battle with the U.S.
Internet giant a week after it stopped obeying Beijing's censorship
rules." This is hardly unexpected, yet what it means is that just as the US stock market will now be defined by QQQQ, C, BOFA and now APPL, as consumers decide against paying their mortgage and reroute their meager unemployment checks into advance orders for the iPad, so the Shanghai Composite will be determined solely by BIDU.

China may have just taken the first retaliatory step against Google, after the search enginge decided to relocated its service out of Hong Kong. As the website created by Google to keep track of Mainland China service availability indicates, mobile services for the first time have become partially blocked on March 28.

The People’s Bank of China (PBoC) is also playing an increasingly supportive role for gold on the demand side. PBoC’s gold holdings are currently at 1.6% of its US$2.4tn total reserves – a fraction by international standards. If PBoC decides to rebalance its books to its recent peak gold holding as a proportion of reserves of 2.2% in Q4 2002, WGC estimates it could account for a total incremental demand of 400 tonnes at the current gold price....Assuming the US Geological Survey’s figures are correct, China may exhaust existing gold mines in just six years. - World Gold Council

If there is one topic that has been beaten to death, reincarnated, then Friend-o'ed three more times by everyone in desperate need of a Google hit or a TV appearance, it is Greece and China (and also Manchester United if you live in the UK). This will not stop us from presenting this FT clip, in which Goldman's Jim O'Neill and Nouriel Roubini spar over the Greek bailout and the Chinese economy (and, you guess it, Man U). Guess who is the optimist and who is the pessimist. For the most part a bland recreation of each pundit's party line, although we do appreciate Roubini's reminder that the immediate catalyst responsible for the 20% Black Monday drop (at a time when the market was poised on a precipice much as it is today) was a topic near and dear to everyone: the announcement of a trade war.

"20 years ago we had a large trade deficit with Japan and Germany. The dollar was weakening but the Germans and Japanese were resisting, and the US got angry. And the US Secretary of the Treasury Baker got on TV on Sunday and said if you don't let if move we are going to retaliate. The next day the stock market crashed 20%."

Are the starts aligning for a repeat appearance of just such a crash, especially as the US has mere days left in which to brand China a currency manipulator?

The maestro managed to run away from the old folks' bent on monetary destruction home just long enough to carry this amusing interview with Bloomberg TV's Al Hunt. Tomes (will) have been written about Greenspan's dementia, just as books will be available on the Kindle one day analyzing his successor's massive mistakes which are slowly but surely leading to an American day of reckoning, so we won't comment much, suffice to point out some of the key highlights in Greenspan's presentation. Most amusingly, note the escalating battle between Greenie and the Fed's new vice-chairman Janet Yellen, who blatantly contradicted Greenspan's that higher interest rates would have prevented a housing bubble. For all it's worth, Alan's response is actually quite interesting: "We tried to do that in 2004. We ran into a conundrum. For decades, every time the Fed raised its short-term rates, the 10-year note, which is really the proxy for mortgage rates, the yield went up with it. This time, it did not. And the reason it did not, is you cannot have the 10-year note determined both by arbitraged global finance and individual central banks. As a consequence of that…starting in the period where the sensitivity of the early stages of the bubble were building up, it was very clear that what was determining the rise in prices was movements in long-term mortgage rates going down, not the federal funds rate." In English, this is quite intriguing: China, which at about this time started running up massive trade balances, essentially became indifferent about US monetary policy, as it gobbled up everything east of 5 Years, with a preference on the 10 Year. The reason for this is the US consumer became the one driving force behind the massive Chinese economic expansion. With the consumer out, and with China set to report its first trade deficit in 6 years, and the Fed pulling out its support of mortgages, and the Chinese National Bank pulling liquidity, the move in 10 Year over the next few weeks is now more critical than ever, which is why the 10 Year - 30 Year MBS spread is paradoxically pressured at an all time tight spread, as all the early MBS shorts are covered, forcing pundits to say MBS are cheap as fighting momentum in this market is professional suicide. To be sure, this technical push down will soon end. And when this last coiled spring blows out, watch out below, first in housing, then in rates, in corporates, and last, in equities.

The yuan-induced heated debates prompted two prominent economists--Paul Krugman and Jeffrey Frankel--to come up with two versions of swan songs for China. Ironically, the two, however diverging, could still lead to the same "next black swan" scenario warned by Albert Edwards at SocGen last November.

"Many clients have congratulated us for flagging up this outturn back in November last year. We said back in November that ?China will be heading into a trade DEFICIT (!) throughout 2010. This is a mega-call and will have major financial market implications?. Unfortunately I have not pushed this call hard enough. Why not? Well, because as the implications are so very non-consensus, I knew noone would take it seriously. With the pre-announcement of March?s deficit, investors are now more willing to listen." - Albert Edwards, SocGen