China Begins Liquidity Tightening, As Bubble Threat Looms

While the domestic money printing syndicate refuses to accept the glaring reality that endless money printing causes unavoidable hyperinflation (the only question being when), China has decided it is time to start closing the spigot. Bloomberg reports that, "China’s central bank began to roll back its monetary stimulus for an economy poised to become the world’s second-biggest this year, seeking to reduce the danger of asset-price inflation after a record surge in credit. The People’s Bank of China yesterday sold three-month bills at a higher interest rate for the first time in 19 weeks." Ah the benefits of a planned economy: controlling the supply and the demand at the same time. And further, being pegged to the dollar, China receives all the secondary benefits of the Chairman's endless dollar printing. Ain't life grand in Beijing...

“It’s a signal toward the commercial banks, because the commercial banks allocate their lending at the start of the year -- it’s a signal not to overindulge,” said Alaistair Chan, an economist with Moody’s in Sydney. “They’re going to tighten in various ways,” including using the benchmark rate and required capital reserve ratio for banks, he said.

After in 2009 the Chinese Central Bank was on route to lend over 10 trillion yuan, this year the institution is expecting to tighten credit by 25% to 7.5 trillion yuan.

The PBOC offered 60 billion yuan of three-month bills at a yield of 1.3684 percent, 4 basis points higher than at last week’s sale, it said in a statement yesterday. The central bank is set to withdraw 137 billion yuan from the financial market this week, the most since the week ended on Oct. 23, according to data compiled by Bloomberg News.

“The move is best seen as an early stage of interest-rate increases,” Barclays Capital economists Peng Wensheng and Jian Chang wrote in a note to clients today. Higher bill rates will influence the cost of credit between banks, and “help to prevent a rebound in bank lending, expected in the first few months of 2010, from becoming ‘excessive,’” they wrote.

The PBOC move will likely not be welcomed by equities, as a trend toward tightening always, without exception, ends up in a substantial pullback in equity prices courtesy of an increase in the cost of capital, a brilliantly simple concept which somehow the Fed Chairman in all his excessive studies never managed to quite grasp.

PBOC moves to tighten policy “are likely to cause transient profit-taking pressures on markets occasionally as investors have become hooked on easy and cheap money,” RBC Capital Markets emerging-market analysts, headed by Nick Chamie in Toronto, wrote in a report. “However, given it’s a confirmation of an improving growth outlook, any pullback should be within the context of a typical early cycle policy adjustment phase.”

Amusingly, all this is occurring in the context of a heated debate between domestic pundits about the fate of China, with just today Mark Mobius and Jim Chanos taking on two diametrically opposite views.

On one hand, Templeton's permabullish Mobius had this this to say:

“The Chinese will act rationally and they’re not going to kill the market,” Mobius, who oversees $34 billion of developing-nation assets at Templeton Asset Management Ltd., said in an interview in Singapore. “There’s still a lot of savings in China. Prices are high but I don’t see a crash.”

Being permabullsh, as noted, prevents him somewhat from having a truly objective opinion.

Mobius said he plans to increase holdings in Chinese stocks by purchasing shares that benefit from consumer demand, including developers and raw-material suppliers. Shanghai’s index of property stocks has lost 28 percent in the year through Jan. 7 after reaching a one-year high in July.

On the other hand, the world's most famous short seller and Enron slayer, Jim Chanos, couldn't disagree more.

“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point.

Yet Chanos faces an uphill battle, as ever more of the procyclical long-onlies come out of hiding, forgetting that all the world market is one great big ponzi that came close to fair value a mere year ago.

“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China,” said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. “China is not in a bubble.”

Nonetheless, Chanos is firmly convinced the next bubble will start in Beijing:

“The Chinese,” he warned in an interview in November with, “are in danger of producing huge quantities of goods and products that they will be unable to sell.”

In December, he appeared on CNBC to discuss how he had already begun taking short positions, hoping to profit from a China collapse.

So at the end of the day who is right: the mutual fund-based, index hugging pension funds of the world who are always last in and last out, and actually rely on Goldman and JPM, and even S&P research for their investing decisions, or the Chanoses and, yes even the the PBOC, who seem to have a far more worried approach to the Chinese bubble? Time will tell, and with the world yet to experience a massive central-planning based bubble implosion, the timing of the Chinese bubble collapse could be very quick or painfully prolonged. Our only hope is that Bernanke will actually heed his Chinese colleagues call for monetary prudence and begin raising rates in the US shortly. Of course, with $1.2 trillion in excess reserves sloshing around, we are keenly aware that our hopes are at best pipe dreams.