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Friday May 14, 2010 - 14:04:18 GMT
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China: That dog won’t hunt!

Key News
  • New Zealand retail sales rose at the slowest pace in a year and house prices fell, weakening the case for central bank Governor Alan Bollard to raise interest rates next month.  (Bloomberg)
  • Spain’s underlying inflation rate turned negative in April for the first time on record. (Bloomberg)
“Every dog has its day.”                

FX Trading – China: That dog won’t hunt!  

I have two dogs; a very big Rottweiler (for protection from Chi-Coms when I pen pieces like this) and a mutt.  Usually they sit here in the office each day, just hanging out watching the market with me.  They always seem to agree with my assessments--another reason I love them so.  

I share this to explain why I was, as your average 13-year old girl is prone to say, “Grossed out!” when I read that Chinese astronauts were fed dog while in space.  Supposedly dog meat gives the average Chinese astronaut more energy.  Because the China National Space Administration is headquartered in Beijing, it helps explain why during three very long days I spent in the city, a couple of years ago, I didn’t see one of our canine friends, at least in any shape or form I recognized (deep gulp).

China does some very strange things, from my perspective.  I am sure they might say the same about me from theirs.  Heck two healthy tasty morsels and you just let them sit there all day so they can watch the currency market with you?  Idiot!

But there is one thing China is doing we can all understand; it is creating for itself the mother of all credit bubbles.  We keep hearing how smart the Chinese are.   We are told by Charles Murray of The Bell Curve fame, a book that examines human intelligence, Asians are at the top of the intellectual food chain.  Well, if that’s the case, why is China placing its economy into the same type of box that left-side of the curve Western countries has proven so good at?  

Same reason, different day—it is still a lot easier to drive exports, with effective zero cost credit to targeted industries and government owned institutions, than it is to develop a vibrant domestic market.  

But how can I say that, since China is booming?  Well, that is true, China is booming.  But, let’s turn to the Master, Ludwig von Mises, for some simple guidance here [our emphasis]:

The erroneous belief that the essential feature of the boom is overinvestment and not malinvestment is due to the habit of judging conditions merely according to what is perceptible and tangible.  The observer notices only the malinvestments which are visible and fails to recognize that these establishments are malinvestments only because of the fact that other plants—those required for production of the complementary factors of production and those required for the production of consumers’ good more urgently demanded by the public—are lacking.  

…the events which resulted in the crisis amounted to an undue conversion of “circulation” capital into “fixed” capital…However, raw materials, primary commodities, half-finished manufactures and foodstuffs are not lacking at the turning point at which the upswing turns into the depression.  On the contrary, the crisis is precisely characterized by the fact that these goods are offered in such quantities as to make their prices drop sharply.

The forgoing statements explain why an expansion in the production facilities and the production of heavy industries, and the production of durable producers’ goods, is the most conspicuous mark of the boom.

One thing to keep in mind, it is easy go broke putting real money behind a belief China is going to crater because of too much debt and bad loans.  But because of the precarious position of global demand i.e. the entire continent of Europe basically entering into a savings binge, and US consumers still not close to their former drunken sailor spending selves, China’s massive export needs are in trouble.  It is this relative lack of growth that will make bad loans in China become a real problem this time.  The last time bad lending was seen to be a problem, the globe was growing, China grew right through the so-called bad loan problem.  

This from Michael Pettis, Professor at Beijing University [our emphasis]:

What really matters if we want to stop the speculative frenzy is to find ways of raising interest rates and removing domestic liquidity.  But both of these are tough to do.  Raising lending rates, if it is done enough to suppress real estate speculation, will put unbearable pressure on Chinese borrowers – many of who can only manage the debt because it is virtually free – and will make it impossible to revalue the currency in any serious way.  The fact that it would prevent currency revaluation shouldn’t matter because, as I have pointed out many times, low interest rates may have as much or more to do with China’s trade surplus as the undervalued RMB, but unfortunately the RMB has become so politicized that a failure to move will simply fan foreign anger at China and lead to increasing trade tensions – and China is terribly vulnerable to trade war.

But putting pressure on borrowers is a real problem.  After so many years of being able to invest with almost no concern for the return on investment, raising funding costs will force real financial distress onto borrowers.  Either they ignore it, and government debt levels rise serenely ever higher (and remember, as I discussed in a previous post, government debt must be paid for by reducing future household consumption), or they respond by cutting borrowing.  Less borrowing means that investment slows dramatically, and in an economy so dependent on increased investment for its growth, anything that slows investment slows growth.

It is even tougher to contract domestic liquidity.  As long as China maintains the currency regime it is hard to control the domestic money supply, and the one powerful tool Beijing does have – too powerful to be wielded smoothly – is the lending quota.  The problem here of course, to repeat, is that Chinese growth is so heavily dependent on additional investment, which is itself heavily dependent on new lending, that Beijing can’t really force down loan growth without seeing GDP growth drop sharply.

Maybe the performance of the Chinese stock market is just profit taking, or maybe it really is telling us something:

DJ Shanghai Index vs. Copper vs. Oil Weekly: [Chart not available in text format.]

At least the Chinese government can’t be too upset their stock portfolio is sinking for now; they are holding a great hedge—the soaring US dollar and US Treasury bonds…Sweet!

Shanghai Stock Index vs. US$ Index vs. US Treasury Bond Futures Daily: : [Chart not available in text format.]

We continue to hear the Chinese cheerleaders telling us the US dollar and Treasury market is very close to collapsing.  They imply that all things China is the only place to be.  

My response: That dog won’t hunt!  

Jack Crooks
Black Swan Capital

Currencies are another asset class …

David Newman here… “Investing vs. Trading”

How many times have you seen pictures of people sitting on the beach with their laptop in hand in those “Trade Forex, Commission-Free!” advertisements?  “Open an FX account, quit your real job, sit on the beach and get rich” is the implicit message.  It’s ridiculous!  But unfortunately that is what sells.  

It doesn’t have to be that way.  You don’t have to buy into the hype ... and you don’t have to take that much risk in order to get involved in currencies.  Trading can be profitable; but it requires extreme focus and discipline.  There is another way if you want to “invest” in currencies.

 Investing in currencies for the long haul means using currencies as another asset class in your portfolio.  An asset class that will stand along stocks and bonds and hopefully provide some much needed diversification.  

There are plenty of low leveraged long-term investment choices available to you so you can make real money in currencies.  They are called Currency Exchange Traded Funds (ETFs).  

An ETF is a simple straightforward currency product that you can buy and sell in your standard equity brokerage account.  It’s the same as buying any other fund traded on the exchange.  We offer recommendations on Currency ETFs in our month Currency Investor newsletter.  We don’t recommend trading them; we do recommend investing in them using a long-term buy and hold strategy.  

To sum it up: Our monthly Currency Investor newsletter is geared toward newcomers and experienced investors who are looking for a conservative approach to the foreign exchange market, and learning more about how the global economy works.

In plain language we deliver global macroeconomic analysis and actionable ideas geared toward exchange rate fluctuations over time.

Our analysis is comprehensible and our recommendations consist of ETFs, as I said. So don’t get turned off by buzz words like “exchange rates” or “foreign exchange” – this investing strategy is as easy to implement as buying and selling stocks.

Plus, at $39 per year it’s a deal you’d be hard-pressed to find anywhere else.

Thorough global analysis plus complete investment guidance ... and all for only $39 per year?  You can become a Member of our Currency Investor service at our homepage via credit card or PayPal.

Thank you.

All the best,

David Newman
Director of Sales and Marketing
Black Swan Capital
[email protected]  
Phone: 866-846-2672


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