More On The China Bubble

I have posted on China a few times in the past few weeks.

tradersutra.blogspot.com/2009/08/chinese-market-tickticktick.html

tradersutra.blogspot.com/2009/08/more-on-usd-and-china-decoupling.html

tradersutra.blogspot.com/2009/08/global-rebalancing-is-happening.html

Continuing on with this theme, China is in a bit of a quandary. Their entire economy is based off of selling cheap goods to US Consumers that are debt leveraged to the hilt. Something needs to break or budge, and China knows this, so they have already tried to diversify away from USD assets. They are on a tremendous commodity buying binge using their sovereign wealth funds via Goldman Sachs doing the bidding.

The Chinese economy currently suffers from overcapacity, as most of its growth is from domestic lending, real estate values in Shanghai have sky rocketed as there has been forced lending by the government. But forced lending is always bad lending, and China will pay the price.

In the bigger picture, its all about interest rates. China sells goods to America, and receives USD in exchange for the goods. Instead of immediately swapping USD into Chinese Renminbi, which is the most obvious thing to do, they instead take USD and buy US Treasuries. The reason they didn't exchange USD to their currency is that doing so would kill USD, increase Renminbi values, make cheap Chinese goods not so cheap, kill exports, thus their economy wouldn't grow as fast. All of this was fine and dandy for both parties involved. So they artificially kept USD afloat all of these years to the tune of $2.2T in USD reserves.

At the moment their economy is humming along at around 8%. Soon or later, lending will go bad in China, Real Estate down the hatch, China will again have to re stimulate their economy. Here is the great delicate balancing act. They need more and more money to finance their internal growth, how to do it with no US Consumer Spending? You got it! Sell Treasuries and or USD. If this base case happens, we are in serious trouble, as USD drops badly, Inflation flies uncontrollably, Long term interest rates rise to the level where US debt issuance is no longer feasible or desirable. Also what will happen is Chinese currency will appreciate in tandem, which basically screws up their competitive balance, both economies go into the toilet.

The reason why China is so desperate to diversify away from USD is for this reason. They know that the party cant last forever. Its not going to be easy or painless.

The Black Swan event here is that as the US continues to issue debt at a vulgarly alarming pace, when will China say enough is enough? We cant buy anymore.

I sure hope I am working from home the day China stops buying treasuries.
Financial gravity cant last forever...just ask the US Home Owner.

tradersutra.blogspot.com/2009/06/black-swans-and-unthinkable-stuff.html