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All eyes still on China!

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telescope1(Thaler's Corner 05-09-09) While financial markets in the West are behaving pretty much as we might expect, in the context of 0% short-term interest rates, with rising stock and gold markets, it appears counterintuitive for the paranoids of (hyper) inflation that fixed interest rate instruments are also doing so well, the 2-year German bonds sank this morning to a low 1.07%.

But, as has often been the case in recent times, all eyes are on the Middle Kingdom, thus, giving our daily note an increasingly exotic character.

This reminds me of a recurring theme in 2006, which seemed just as strange at the time: the worrisome growth of securitisation, with the terrifying launch of the now defunct CPDOs, which were trading at Libor + 100 in November 2006! I provide you below the study we cited at the time for the nostalgic pleasure of reading Bill Gross on the subject: ‘Reality Check’. 

While, at the time, the explosive growth of securitisation (before its implosion in the summer of 2007) propped up all risky asset classes, today, it is the credit explosion in China which is fuelling a big part of the stock market rally in the past two quarters (along with 0% interest rates in the West, obviously).

We are thus continuing our close tracking of the Chinese credit market, i.e. on banks and the regulatory policy direction mandated by the State.

We must admit that this weekend was rich in news, like the following:

  • Liu Mingkang, China Banking Regulatory Commission Chairman: growth of new yuan loans should stabilize in the second half”.
  • Jiang Dingzhi ,China Banking Regulatory Commission Vice Chairman, Shanghai, 5 September: Regulators are still making changes to the draft rules on subordinated bond holdings. The rules are being implemented to ensure capital quality and improve risk management, after the capital adequacy ratio of Chinese banks fell in the first half”.
  • Su Ning, Deputy Central Bank Governor, Shanghai, le 5 September: China would study the use of "regulatory tools" to adjust bank lending after the nation had a record 7.37 trillion yuan of new loans in the first half”.
  • CBRC official:China's banking regulator is planning to tighten capital adequacy ratio requirements for banks in a move to improve their ability to hedge against risk in the future. He added that they are considering a three-year window before excluding cross-holdings of subordinated debt as part of its calculations of tier-two capital.
  • Jiang Dingzhi, CBRC deputy-director, Shanghai, le 5 September: "The CBRC is working on new regulations on bank capital adequacy ratios, involving the calculation of adequacy ratios and cross-holdings of subordinated debt” because banks need a sounder capital structure.
  • Wang Huaqing, head of disciplinary committee of the CBRC, quoted by the official China Securities Journal as saying: the regulator will take "effective measures" to prevent bank loans from entering the stock and property markets.
  • Zhang Ming, who tracks cross-border capital flows at the Chinese Academy of Social Sciences, quoted in the China Securities Journal: As much as $88 billion in speculative capital is now sitting in China and that amount is set to grow”.

All these comments are, in fact, reassuring, since they show just how aware Chinese leaders are of the Minsky ladder effect from the wave of money injected into the Chinese economy in the first six months of the year.

The most important issue now is to what extend these very important regulatory and technical measures can actually be implemented.

We believe, today as in the past, that each time the stock market declines too fast, a Chinese official will intervene to ‘calm things down’.

Although officials are wary of today’s bubbles, the last thing they would like to see in the current context, where international demand has yet to come to the rescue of the export machine, would be to experience another 73% contraction on the Shanghai exchange, like in October 2007 to November 2008!

One of the most tell-tale signs relating to international demand will be the coming change in the savings rates of US households.

This rate has climbed from 0.80% to 6% with the deleveraging of 2008, before falling back to 4.2% this summer, given the rush to buy new cars fuelled by the Cash for Clunkers programme.

In this respect, we were treated to an interesting declaration of intent from the new US president:

We'll help you save.

Backed by diverse fiscal measures, he wants to bolster the savings rate of US households by encouraging them to pay more into their retirement plans (401 k).

He recognises that this movement could compromise chances of an economic recovery, but says that the change is necessary for long-term balance.

I have left for the end a bit of a polemical article, from ‘Foreign Policy”, which I found on the Pakistani Defence Ministry site. I find it very instructive, but I’ll let you be the judge:

How China Cooks Its Books: It's an open secret that China has doctored its economic and financial statistics since the time of Mao. But could it all go south now? “

- Last October, Vice Premier Li Keqiang said in a speech after inspecting China's Statistics Bureau, "China's foundation for statistics is still very weak, and the quality of statistics is to be further improved" -- a brutally harsh assessment coming from a top state official -

Have a good Labor Day.

Erwan Mahé -OTCexGroup

Asset allocation and option strategy



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