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Monday August 29, 2005 - 11:10:25 GMT
Black Swan Capital -

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China syndrome...


“A man may know what to do and lose money if he doesn’t do it quickly enough.”

Jesse Livermore

FX Trading

In Nineteen Eighty-Four, George Orwell wrote: “Who controls the past controls the future: who controls the present controls the past.” Control is the mother’s milk for governments everywhere. Problem is human nature and the quasi-free flow of information, a necessary ingredient for an effective pricing system to allocate resources, tend to eat away at the semblance of control over time—no matter how tightly or how brutally said control is enforced.

From 26 Aug 2005 [our emphasis]:

“Hong Kong's Chengming magazine reports that some $28.8 billion was converted into yuan in the 90 minutes between the final decision to change the yuan value and the actual announcement -- a report that, if true, implicates officials at the highest levels in what is effectively an insider-trading scheme to profit off the currency revaluation. That this comes from government officials -- and their associates at various state-owned enterprises -- presents a troubling problem for Beijing.

“China's central leadership already has enough trouble keeping local party and government officials in line. Beijing's inability to control local leaders, coupled with a pervasive culture of corruption and nepotism, has left an indelible taint on the government structure that reaches from the lowest levels to the highest. Although Beijing regularly makes examples of officials at many levels, the system of relationships offers protection to the senior cadre and their associates.”

Many inside and outside China, public and private, continue to believe Chinese growth numbers. Or should we say, they want to believe Chinese growth numbers because their wealth and prestige are predicated on such.

One of our major themes for while—yet to play out, but we think it will, is a hard landing scenario in China. Or at least a lot harder than what is now expected by the financial market nomenklatura. If we see a hard landing in China, we think it will lead to another sharp leg-up in the dollar as much of the hot money throughout Asia, not just China, reported to be in the $700 billion area, will come rushing back on shore. We are finally starting to see some fraying around the edges among the global market elite—some strategists are straying from the reservation.

Below are excerpts form an interview with Mr. Frank Veneroso, a seasoned market strategist with RCM, the equity money management platform of Alianz Dresdner Group. He spoke with Kathryn Welling, of Welling @ Weeden:

“A friend of mine says that the marketplace now generates synthetic realities, and I feel that that’s very true. That was certainly true about the tech bubble. Anyhow, my view is that this story of unending growth in China is one of those synthetic realities that the market has embraced.

“The data on China is rubbish. It is an economy that has a very high share of fixed investment in GDP, a very high share of industry; it should be very cyclical. It has growth rates and credit oscillating hugely—depending upon what data series you use and whether you look year-over-year or sequentially and over what time period—between zero and 30%. So you should expect variability in GDP. I mean, even developed countries, which are quite a bit more stable, have fairly variable real GDP growth, quarter to quarter. You’ll get up 6, up 3, even if the country’s growing at a fairly steady rate. But in China now, you’ve seen 9.4% real growth reported, give or take a couple of tenths of a percentage point, virtually every quarter over the last three years.

“I basically will say the Chinese hard landing will be similar to the ’90s experience. A multi-year affair in which the reported growth rate falls to 7% and the real growth rate falls to 3%— but that’s a political statement on my part.

“This time around, we’re on the verge of deflation. China is going to go into the deflation as the economy softens—outright price deflation, and with the debt-to-income ratio not at 100%, like at the peak of the last cycle, but at maybe 170%. We all know that the debt and deflation are a nasty combination—that is what we are staring in the face, in China.”

The newsletter crowd has built a virtual industry touting China. It seems they have become mind numbed robots—twisting any shred of news to support the view that commodities have to go up because China will continue to grow no matter what.

What’s interesting is this same newsletter crowd prides itself on the virtues of hard money economics—primarily the Austrian School. Yet, they fail to mention to their subscribers that China, as far as we can see, is a real time test case for validation of von Mises boom-bust credit cycle analysis.

“However, raw materials, primarily commodities, half-finished manufacturers and foodstuffs are not lacking at the turning point at which the upswing turns into depression. On the contrary, the crisis is precisely characterized by the fact that these goods are offered in such quantities to make their prices drop sharply,” said von Mises, in his most brilliant book Human Action.

We’re not sure how long China can keep the music playing. But when it stops, we don’t want to be long commodities or short the dollar.

Jack Crooks
Black Swan Capital


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