China

There has been much talk about the FT's story that China could be evaluating its eurobond holdings. So much in fact that the Chinese State Administration of Foreign Exchange has issued an official statement denying the validity of the story: an unprecedented step by the Chinese to respond to market rumors. We are surprised that SAFE actually found time to write this up with all the EUR buying that everyone in China seems to be doing these days. "China's foreign exchange reserves as a responsible long-term investors, and always adhere to the principle of decentralized investment, the European market in the past, present and future foreign exchange reserves are one of the most important investment market." For a minute there we wonder what they were expected to say: "Yes, we are only buying gold and oil going forward. So please don't buy it ahead of us."

Is China about to start dumping its $630 billion in eurozone debt holdings? Maybe not yet, although the FT reports that China's State Administration of Foreign Exchange, the central bank's foreign reserves manager, has "expressed concern about its exposure" to the PIIGS. Obviously, with China moving away from dollar denominated assets for the past six months would represent a "big strategic shift" as "last year, the Chinese were trying to reduce their exposure to dollar assets by buying eurozone assets. This would be a complete reversal." Additionally a Chinese diplomat noted that, "The euro’s fluctuation will have an impact on China’s thinking, but it’s only one element” in any decision to allow the Chinese currency to rise, He Yafei, a vice foreign minister, said, according to Bloomberg." The question then arises of just what assets China would be comfortable holding? Alas, the only readily available answer we can come up with rhymes it old and has 79 protons.

First a glance at the macro scene in China and then a look at how our China short thesis has played out thus far. Feel free to compare my work to Goldman and the other big banks, the challenge is welcome.

1.    N. Korea denies sinking S. Korea ship, warns that any retaliation will trigger 'all-out' war
2.    White House calls ship sinking a peace-challenging 'act of aggression' by N. Korea
3.    White House says North Korean action is challenge to international peace and violation of armistice pact

Hugh Hendry, whose previous appearances have been well-logged by Zero Hedge, and who is currently raking the money thanks to long Treasury bet and his EURUSD short from when the pair was 20% higher, has never been a fan of China, and almost got into a fight with Marc Faber recently discussing the country's future prospects. In fact, Hendry uttered this memorable soundbite back in February, in which he mopped the floor with Goldman permabull Jim "BRIC" O'Neill: "I love Jim O'Neill. I love that Goldman Sachs guy. He says you either get it, or you don't. I don't get it. In the future there will be a Confucius saying: the wise man not invest in overcapacity. The flaw of the business model, at the center of it is a craving for power as opposed to profit." BusinessWeek reports that Hendry has now officially put his money where his mouth is and has bought puts on 20 companies that will profit from “a dramatic collapse” of China’s growth. With the Chinese stock market approaching 52 week lows, will Ecclectica soon become the next Paulson & Co. hedge fund iteration, even as the latter continues (allegedly) to bet on a US recovery, and thus stands to lose tens of billions if the thesis does not play out (although we are fairly confident Paulson's long stock positions are matched by even longer CDS hedges... but without additional data, we can never be sure).

China has been the investment darling for the last couple of years. As US economic woes continued to mount and the EU ran into debt problems, many an analyst continued to talk about China as if it had decoupled from the rest of the world. The Chinese government, much like the rest of the world’s industrialized nations, injected billions upon billions of stimulus into their economy, sending auto sales, home sales and stock prices soaring. Chinese citizens, with an average income of roughly $4,000 a year, piled into the aforementioned assets in droves, looking to flip property and paper in the spirit of capitalist speculators here in the US. But, like the US, the dream of profits for the citizen proles will soon come to an end.

Has it already started?

By now you have undoubtedly heard both that China's economy is now officially overheating and about to blow the NO2 canister, courtesy of another dramatic pick up in credit-driven "growth" and a unmitigated liquidity explosion, and that as a result its stock market has officially entered a bear market. Here are some additional thoughts on China's economy from Citigroup.

The chorus of anti-Chinese sentiment is becoming troubling: after virtually every major hedge fund manager has recently voiced in support of a Chinese bubble pop, with today's most recent statement by Marc Faber just the cherry on top, could Farrell's rule #9 be relevant here and with everyone expecting the endgame, one would end up not occurring? Earlier Marc Faber said in a Bloomberg TV interview that "China’s economy will slow and possibly “crash” within a year as declines in stock and commodity prices signal the nation’s property bubble is set to burst. The market is telling you that something is not quite right. The Chinese economy is going to slow down regardless. It is more likely that we will even have a crash sometime in the next nine to 12 months." Roger's sentiment comes on the heels of the latest Chinese increase in the reserve requirement (RRR) which has had a nasty effect on Asian markets overnight (and, briefly, on US futures as well). Alas, the Chinese action is not enough, as even JP Morgan admits: "PBOC’s 50bp RRR hike underlines two messages on monetary policy: (1) More tightening in China is needed; (2) Pace of action will be moderate. BI should again signal it is in no hurry to hike."

What do you do when your last multi-trillion stimulus is expiring and its effects no longer generate asset bubbles as you once did? Why, you launch another multi-trillion stimulus of course, although if you are the US you call it something funky like Pennies for Prosties, Benjies for Bodyrubs or something comparable. China has no problems with nomenclature so it calls it how it is: as Bloomberg observes, "China will announce in August a new stimulus package of possibly 4 trillion yuan ($586 billion), the China Business newspaper reported on its Web site, citing unidentified sources. The plan, from China’s National Development and Reform Commission, will likely cover nine industries including information technology and new energy, the report said." So much for monetary prudence. At this point all economies will spend money into overdrive until each and every economy (that can print its own currency) simply implodes into a Keynesian supernova.

sia is on its way back up to an historical weighting of 50% of world GDP/ that means china’s economy triples from here. Another $500 billion stimulus package is sitting on the shelf. Don’t count on China bailing out our $14.4 trillion economy. (FXI), (DBC), (DYY), (DBA), (PHO).

Here comes protectionism: South Carolina Senator Lindsey Graham has told reporters that he has 80 or 90 votes of support in the Senate (guaranteed passage) if his Bill to stop Chinese currency "manipulation" were to ever get to the Senator floor. Graham must be getting some serious voter push to get this passed asap: "I understand why the administration is reluctant to push China, but unfortunately we're running out of time. This will be the year." With the delay in the official US Treasury's stance on the Chinese manipulation stance set to expire soon, Geithner must decide if the fall out from an escalation in trade war at the highest level is worth the offsetting legislation that now seems set to pass should he chicken out once again. The end result, of course, will be the same not matter what: tariffs, duties, subsidies, and generally protectionism. How the collapse of trade helps boost the great export-oriented US boom is beyond our meager analytical skills.

Olivier Blanchard, chief economist at the International Monetary Fund (IMF), talks with Bloomberg this morning about the prospects for an asset bubble in China. Blanchard, speaking from Washington, also discusses the impact of sovereign debt on global economic growth.

Although it would seem that the Goldman-linked SEC case single-handedly killed the price of gold, it was only a catalyst to a technical correction that was overdue. Furthermore, gold’s long term outlook is further solidified by a couple of new “China factors.”