Posted by Don Martin on Mon, May 14, 2012 @ 05:13 PM
China’s economy is cooling and when it settles down and cools off then there will be a huge drop in the demand for commodities causing the price to drop massively. Since inflation-phobic investors have overpaid for inflation sensitive investments such as commodities and real estate then when these investors are hurt by the very investments that were supposed to protect them then there will be a massive panic sale of those investments when investors realize they were overpriced.
Michael Pettis has an excellent article about the Chinese economy cooling down and the subsequent crash in global commodity prices. A striking article about the world going into deflationary slump because of China’s economic cool down was written by Ambrose Evens-Pritchard.
The main driver of global growth has been China and its global demand for commodities. Once that demand has faded away then there won’t be any major forces driving demand. And once the Eurozone loses its credibility in the fight to save the Eurozone then that will produce a global slump.
"Our feeling is that this commodity super-cycle has ended, and ended really in 2008," said Michael Shaoul, of Marketfield who was quoted by the Wall Street Journal.
The huge tax U.S. increases of 2013, starting in 7.5 months, as well as proposed state government tax increases will create a fiscal drag of 5% reduction of growth from positive 2% to negative 3% and this will also hurt demand.
Massive tax increase coming in 2013 as big as this pile of money
The inflation statistics released on Friday, May 11 show the core crude PPI was negative 1.8% last month and negative 4% in the past 12 months.
The best way to prepare for deflation is to look at the past 22 years of Japanese deflation and see that in Japan that only their Treasury bonds did well; all other investments were a false hope. A similar fate may await the other parts of the developed world, limiting investors to a choice of various investment grade bonds, cash, etc. as they wait for the storm to pass.
I wrote an article “Will China slowdown hurt commodities?”
Investors should seek independent financial advice. 
Posted by Don Martin on Thu, Apr 19, 2012 @ 02:43 PM
China crash to be start of global recession
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Foreign investors have changed their opinion from assuming that China is a source of growth to worrying that publicly traded companies in China will be the next Enron.
Today the FT.com had an article “Bulging Chinese inventories undermine copper” where they said 75% of the world's free copper supplies are in China and that China’s demand this year will be very low. In my opinion this implies a surplus of copper, that will eventually lead to a deflationary sell off. Once China goes into an economic “Hard Landing” the price of commodities worldwide will plunge causing more brokerage bankruptcies like MFGlobal and that will cause investors to lose faith in the theory that commodity investing is a way to diversify against the risk of owning stocks. When bullish investors find they can’t make money in China and can’t make money in commodities that will be enough to trigger a global stock market crash. When some assets go way down very fast this creates margin call for leveraged speculators. However, they can’t sell an asset that is in a free fall so they are forced to sell good assets to pay for the margin call on a bad asset. This explains why good stocks can go way down suddenly for no reason during a “Flash Crash” panic.
Don't waste your money on risky speculations
In October there will be another Congressional budget ceiling dispute which could lead to a risk of a technical default by the U.S. Treasury. In October people will wake up and realize that they need to sell their stocks to avoid higher taxes in 2013 and that since everyone else is selling then they had better sell. Then stock prices will go down and bond prices will go up. There are 8.3 months until 2013 tax increases begin and only 5.3 months until the October federal budget crisis.
I wrote an article “Will China slowdown hurt commodities?” and “MFGlobal crash affects your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Apr 10, 2012 @ 02:46 PM
What does the Purge of Bo Xilai Mean for Investors?
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The new premier-designate of China was to be Bo Xilai but he has been removed from office. Today he has been suspended from his positions and his wife has been arrested as a suspect in the killing of a foreign businessman. The result of the leadership change is that more pragmatic leaders will be in charge and will move towards a more sophisticated, more balanced way of running the economy. Unfortunately this will mean that the leaders will order an economic cool down to stop excessive capital projects. This is needed to rebalance the economy, but it will result in a hard landing for China and its trading partners such as commodity exporting countries like Australia and Brazil.
When you subtract out China, Australia and Brazil from the world economy what do you have except a group of nations that have slow economic growth propped up by excessive Central Bank stimulus and saddled with an unprecedented and almost unserviceable amount of debt. Couple this with the job-killing U.S. tax increase of 2013 and you have a recipe for a global economic slowdown in 2013, leading to a global stock market crash.
On April 6 Marc Faber said on FinancialSense.com that there will be a hard landing in China in six to 24 months. My opinion is that there have been a lot of news stories about excessive unneeded projects in China such as airports, high rise office towers in rural areas, empty shopping centers, etc. Western based investment advisors who favor investing in China’s booming economy tried to brush off these criticisms and claim that the excess capital improvements were a minor fluke that would serve the needs of the growing population. However most Chinese are very poor and thus can’t pay to use these new capital projects such as high speed rail or airports. But now the evidence is clear that China has created an economic misunderstanding that resulted in the production of an excessive amount of unusable capital stock. This will lead to deflation in China and the deflation will be exported overseas. The excessively easy money lending policies in China created an unsustainable economic boom that ultimately will result in a slowdown. Lending in China is based on the government’s orders to stimulate the economy and is not based on meeting a bank’s standards of creditworthiness. In 2008 the massive lending increase was forced on businesses who were required to accept the loan and spend the funds, resulting in spending on speculation rather than investment.
Open the vault to investment secrets
In the FT today Andy Xie said “The government’s obsession with investment creates overcapacity everywhere…When one is loaded with debts in an oversupplied business, manufacturing fakes is an attractive way out.”
Global stock market bulls like to imagine that China is a magic country that can somehow continue to grow at a much more rapid than normal pace with almost no slowdown. They imagine this boom will justify investing in global stocks and U.S. stock even though the U.S. SP500 market has a 10 year PE ratio of 22, which implies the market is 50% overpriced. When the truth comes out about a slowdown in China this will affect the global economy and global stocks. Remember the unsustainable debt fueled "boom" in Japan in the 1980's its subsequent crash resulted in deflationary markets.
I wrote an article “Will China slowdown hurt commodities?”
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Apr 03, 2012 @ 06:24 PM
China leadership change hints at end of extreme growth leading to a decline in commodities
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Since the global financial crisis began five years ago the only places that escaped the crisis were the Emerging Markets and the one country that did the best to escape it with high growth is China. Some experts think that China’s growth is due to artificially low interest rates and artificially easy lending policies that produce a tremendous stimulus for China’s economy.
This year China’s leadership will change, which is scheduled to occur every ten years. The new premier was to be Bo Xilai but he has been removed from office. See the article in Foreign Policy magazine. His opponent Premier Wen is known for a more liberal attitude towards moving to global financial standards. Bo was known as an old-fashioned Maoist hardliner who was opposed to modernizing China’s economy. The implications of Bo running the country is that he might have been less sympathetic to market forces and more sympathetic to the continual use of excessive loan growth by state owned banks that would be ordered by the government to loan money without regard for creditworthiness. In much of the world outside of North America the banking system is often ordered by the government to loan in a reckless manner to uncreditworthy businesses. This can and did create a tremendous boom but will lead to a crash.
Too much easy lending has occurred
One reason for China’s rapid and long term growth rate has been the excessively easy granting of bank credit to businesses. As China moves away from naïve Maoist ways of running an economy and towards modern global standards of a professionally run banking system then less credit will be granted. This will lead to a slowdown. Since China is the main source of the world’s growth then the world economy will cool down when the China lending machine is recalibrated to a more balanced way of lending. This will result in less demand for commodities and may force speculators to sell off their hoard of commodities leading to dramatic price declines in commodities.
This will upset the plans of speculators worldwide who are obsessed with the incorrect theory that commodities provide diversification from stocks or that commodities protect investors from inflation. This will also hurt worldwide stock prices.
I have written an article about stocks “China’s hidden loan bubble” and “Copper bubble explained”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Mar 02, 2012 @ 02:16 PM
China is selling its dollars and investing elsewhere. Will the dollar collapse?
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The Chinese government has reduced its holding of dollars from 75% of reserves in 2006 to 65% in 2010 and it is now at 54% as of June, 2011, according to the Wall Street Journal.
It may be tempting to think that China will sell off all of its dollars and this will cause U.S. interest rates to rise. But as I have said before, the U.S. is the only deep, liquid, reliable market big enough to accommodate China’s $3 trillion reserves. The only possible exception to that is the Yen or Euro which has lost credibility and become very risky with a significant probability of a breakup. Japan’s economy is reaching a dangerous stage of ever increasing government debt and permanent stagnation so it would be risky to invest in Yen. Buying gold bullion or Swiss Francs is not possible because those markets are too small for China to invest in without disrupting the market. The Chinese government won’t buy U.S. stocks to diversify because Central Banks have a tradition of only owning foreign currency and precious metals, and there is the risk that a stock crash could occur. The dollar, in the form of U.S. Treasuries, is the only game in town, for gigantic investors like China. It is in China’s best interest to put its holdings into the dollar (in Treasuries) while camouflaging its intention by pretending to diversify elsewhere.
A lot of money is stake
The big picture is that China’s economy is very similar to the U.S. during the real estate and mortgage bubble of 1997-2007 and eventually it will end in a similar manner. When it does then China will sell foreign currency reserves to raise funds to rebuild the economy. This could hurt the dollar but a way for the U.S. Federal Reserve to reduce this problem would be for the Fed to give China a margin loan against China’s US. Treasury holdings and thus the Treasuries would not have to be sold. During a world recession the dollar usually goes up in value because it is a safe haven. Assuming we will soon go into a world recession because of the 2013 tax increases and because of China’s problems then the dollar will go up and the world’s Central Banks will send their reserve funds into the dollar.
I have written an article “Will the Dollar Collapse” and “Albert Edwards Warns of China’s Bubble Bursting”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Aug 10, 2011 @ 02:47 PM
If China is a bubble that crashes will Asian currencies go down?
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Bearish investors like Jim Chanos say China is a bubble and thus the Chinese economy will go into recession. This would affect the neighboring Asian countries. But if it does happen, how will it affect the Asian currencies?
The Asian countries were badly hurt by the regional crash of 1997. They learned from this and have established excellent sovereign debt standards and sovereign financial health. They have far less debt than the developed countries. They continue to offer exports at lower prices than developed countries. They are superior to the developed world in terms of sovereign fiscal management and control and this superiority may last for decades.
The Chinese financial system is fire-walled off from the world. They have very little debt that has been issued to foreigners and they have currency controls to keep the Renminbi from leaving China.
When a corporation suffers from a recession and has a temporary loss of profit that does not mean it will go bankrupt and be unable to pay its debts, because the corporation can draw on its savings to make debt payments. By analogy when a country suffers from a recession it can use its reserves to keep its economy healthy without having to use borrowed money. In China’s case they don’t have to worry about inability to pay debts to foreigners since they don’t have foreign debt, except for a few Renminbi loans issued out of Hong Kong.
Open up to new ideas
So if the West can’t afford to buy anything from China then China will simply find new markets selling things to local consumers.
If China needs to spend money to recover from a recession it will sell U.S. T-Bills and then sell dollars in exchange for Renminbi and then use the funds to stimulate their economy. So when that happens that will put selling pressure on the dollar as a result of economic weakness in China.
I have written “Foreign currency investments” and “Two things you must know about the Renminbi”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jul 20, 2011 @ 08:55 AM
Is the Renminbi going to crash?
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People wonder where is a safe place to invest. Should they buy gold, foreign currency or something else? Looking at foreign currencies the old paradigm is that when the world goes into a recession then the rest of the world suffers more than the U.S. so the dollar goes up in value and the other currencies go down in value.
However, time has come for a paradigm shift. The Asian Emerging Markets countries have lower levels of debt and are more solvent than the developed countries.
Point I: The Chinese real estate bubble financing is not as dangerous as in America, Europe or Japan
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People wonder if China’s economy is a bubble that will crash, resulting in the Renminbi currency dropping in value. China’s economy has debt of about 100% of GDP. But roughly half of that could be offset by China’s huge $3 trillion foreign currency holdings, making China’s debts the lowest of any major country in proportion to GDP. Further the Renminbi is a blocked currency and there have been only a few Renminbi denominated bonds issued in Hong Kong that the rest of world can buy. So it is unlikely that there would be a selloff of the Renminbi if China’s economy suffered from a crash.
Many of the debts in China are simply private placement of debts where a wealthy person gave up the ability to spend by lending funds to a business that will spend the funds. So if the debtor fails then a wealthy investor will lose some of the value of his bonds or Notes, but if the investor is not leveraged and does not experience his own crisis then the Chinese economy can keep going despite the loss that the investor suffered. By contrast, in the U.S., the Shadow Banking system often sold bad loans (fraudulently rated by rating agencies) to commercial banks that were highly leveraged, resulting in the bank failing because the bad loans failed. This resulted in banks becoming unable to loan money to new borrowers.
Assuming China’s real estate bubble is only financed by cash buyers then China will not be too badly hurt by the coming China real estate crash. Unfortunately some real estate is financed by debt.
Money from debt is risky
Point II: Cash flow from China's exports is more important than balance sheet items like real estate
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China’s economy has made (and saved) a lot of money exporting things to the developed world. The cash flow from that is a more meaningful economic statistic than a balance sheet item such as debt or assets. If cash flow is the most important analytical tool for investments then it should also be so for looking at a country’s ability to keep its currency strong. Criticism of China has been made that they reinvest too much in building unneeded buildings and are thus wasting money while (giving the appearance of) increasing the GNP. But China makes money from exporting and you can’t export a building. So if even if China’s real estate crashes Chinese businesses can still keep making money in exports and will be able to hire workers at lower wages who lost their jobs in the construction industry.
The imbalance of exports over imports and the lower level of debt are some of the key reasons why a country has a good currency. The whole world has a lot of debt and the part of the world that has the least amount of net debt when counting foreign currency reserves, is China.
I do not expect the Renminbi to be devalued if China suffers a hard real estate crash.
I wrote a blog post “China’s hidden loan bubble” and “China crash what are the risks?”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jun 09, 2011 @ 01:03 PM
China real estate bubble popping
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WSJ had an article today that China’s real estate bubble may be popping. In 2006 condo prices in Beijing were 32 times average annual income, now they are 57 times. By contrast in developed countries like London or Paris they are roughly 8 times income and in the U.S. about four times income. This is important because the value of an asset is best calculated by comparing the annual yield or rent in proportion to its price. In Shanghai condo sales in units are down 37% in the past quarter.
The implication of a Chinese real estate bubble cooling down is that there will be less global demand for commodities and less global inflation. This could cause a severe deflation in commodity countries like Australia. The Shanghai stock market is down 15% in the past year from its peak.
My concern is that the Chinese real estate bubble has warped the statistics about commodities demand causing bullish developed world forecasters to assume that a new economic boom and inflation are underway.
I discussed this in "China economy cooling".
In the long run China will be better off after the real bubble has cooled down because their resources can be used to build factories, etc.
White House response seems to be one of grudging acceptance (of the weak economy)
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In Yahoo! Finance there was an article today “The White House View: The Grind-It-Out Economy” by Daniel Gross. “The response at 1600 Pennsylvania Avenue seems to be one of grudging acceptance: The U.S. economy is methodically plowing its way through the post-bust mess, grinding out economic growth one job, one export order, one modified mortgage at a time. And for political and temperamental reasons, the administration isn't going to freak out and roll out a bunch of initiatives that could radically speed that process anytime soon.”
My opinion is that Obama has ended up accepting the Republican-“Austerian’s” strategy of minimal government intervention and subsidies. This is very deflationary. There is nothing left to stimulate the world’s economy except a few tech toys in Silicon Valley. So what if everyone buys an Ipad, will that be enough to make the economy recover? And if China cools off that will add to the odds of a deflationary outcome.
A big zero for remaining stimulus funds
Dollar devaluation or dollar collapse during a world economic crash?
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If the world economy crashes or goes into a recession will that cause the dollar to decline? It depends on whether the U.S. government decides to aggressively devalue or avoid devaluing. If the market is left alone then the marketplace will have capital coming in to the U.S. during a severe crash because of the U.S. safe haven status. Further, the major countries want to do competitive devaluations to make their currency the lowest so no one G7 country is likely to have an extreme devaluation.
I mentioned this in "Two things to know about devaluation".
Investors should seek independent financial advice.
Important: Get more information in my free Special Report about emerging market currency investing.
Posted by Don Martin on Tue, May 17, 2011 @ 11:40 AM
Russell Napier forecasts SP dropping to 400
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Russell Napier on was interviewed on Financial Times. He said real rates are negative in most countries and once they go up to normal then that will create deflationary shock, leading to SP 500 plunging to 400 points from the current 1300 range. He favors, as I do Emerging Market currencies.
He said U.S. Treasury rates to go up but the increase could be modest. He likes PE 10 and Q ratio as I do. Fair value in 2009 was 666 for the SP, but it was not a true bottom because no capitulation phase attitude of despair had developed. Negative real interest rates distort equities and when rates are reset up to normal levels that will cause equities to crash. This reminds me of my blog post “U.S. equities are 70% overpriced”.Unstable pyramid?
Shadow banking in China still done by trust companies
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Financial Times ran an article today about non-bank trust lending in China. This is like what I wrote in yesterday’s blog post “7 things about deflation you must know” about shadow banking creating a crack-boom that ultimately leads to a crash. The article said “Traditional trust products surge because of property related products.” So, as in America when the economy booms a borrower tells the lender that based on rising value of collateral the lender should be encouraged to make the loan. This in turn leads to excessive growth and creates statistics that imply strong growth. However some (not all) of the growth would never have happened if it were not for incorrect lending. The ultimate source of the funds are naïve business owners with excess cash who do not understand loan underwriting and merely seek to get a higher rate of return by lending it to a real estate developer. Interest rates of 17% are being paid by developers. This is a symptom of a bubble. It is hard to make a return on assets in excess of 15%, so when someone pays 17% that type of borrower is very risky. This risk implies a crash may follow when the over-idealistic borrower realizes his business can’t produce enough profit to pay the interest he is forced to liquidate, possibly at panic-sale prices, thus leading to downward pressure on asset prices. This in turn would be deflationary or disinflationary especially on commodities since China is using a huge amount of commodities to construct buildings.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Apr 27, 2011 @ 11:00 AM
Today there was an excellent article in the Financial Times about hidden copper bullion stockpiled in China which implied that the price of copper was too high because speculation. Previously I have warned that covert shadow bank margin lending bubbles in China may have aided this speculation. This is important because economists worldwide assume that copper’s price and demand can forecast economic growth. But what if copper has become scarce and expensive only because of covert speculation? Then the world’s economy would not be as robust as it seems. And what if a margin call on these stockpiles of copper caused them to be suddenly sold? Then the shock of the unexpected supply of copper would send the price down, destroying economic models that forecast growth and inflation, thus making equities go down and bonds go up.
The article said 4 million metric tons are “missing”. The world production of copper is about 5.7 million metric tons a year, so that is a huge amount of phony demand. If this demand had never occurred then the price would be a lot lower and a lot of economic indicators would be less bullish.
I have seen this pattern before in America, where people overbuilt the housing market, making GDP bigger because of building an unneeded asset that was falsely labeled as an investment but which was really a losing speculation. The same happened in Ireland.
These commodity bubbles are labeled as proof of inflation and proof that a full employment economy is about to occur, when in fact they are simply bubbles.
I have written “China’s hidden loan bubble” and "Contrarian view of inflation”. These are examples of independent financial advice.