I see the only sustainable rally in USD happening for the following reason. Higher short rates enacted by the FBR to fight inflation. All static coming from Bernanke is that rates will be kept low for the foreseeable future. Whats happening at the moment is Bernanke and the FRB is denying the inflation risk in the system. This is what happened in the 70's. The longer the wait, the more inflation risk will be apparent. There are definitely other aspects to this equation. Trillions of HELOC/ARM Mortgages are pegged to LIBOR, any move in US short rates will ratchet up LIBOR. So there are many many moving parts at play here.
But when inflation starts to accelerate, it will cause panic in financial markets in the form of higher long rates. The inversion will cause great pain in credit markets world wide. To calm the markets, the Fed has to tighten aggressively, probably too excessively, which would lead to a massive dollar rally.
This would be the worst possible situation:
A strong dollar and a weak US economy coupled with higher treasury yields.
China’s asset markets and their economy would almost surely go into a hard landing as will Asia.
Everyone knows China is in a bubble. When will that pop? It all depends on the US government’s liquidity policy. The current bubble wave is very much driven by the government encouraging banks to lend and the super low interbank interest rate. As the Fed’s interest rate is zero, the dollar is weak, China’s foreign exchange reserves are high, and the loan deposit ratio is low, China could increase liquidity, which would expand the bubble further.
Where Are The Bullets?
If the government pumps all the liquidity it can, it wouldn’t have any ammunition left to revive it when it comes down. If the global economy has revived by then, Chinese economy may have a soft landing with strong exports. The asset markets will certainly have a hard landing. However, if the global economy remains weak then, which is my view, both asset markets and the economy would have a hard landing.
The other way of putting on the brakes is the stop and go approach. Turn on the liquidity, then stop it.
Markets will run out of steam when its stopped, then more liquidity is pumped back in.
The entire Chinese Economic Policy is built on the premise of a weaker dollar. maybe China is going through an asset boom instead of a bubble?
World markets have reflated because the dollar has been weak, reviving exports.
But one thing is certain. China real estate is just as out of control as it was for US in 2005-2007.
Just take a look at price to income ratio and price per meter. China’s average price per square meter nationwide is quite close to the average in the US. The US’s per capita income is seven times China’s urban per capita income. The nationwide average price is about three months of salary per square meter, probably the highest in the world.
Remember China Real Estate and property values dropped badly when the USD was rallying from 1995-2002.
Everyone in China is saying that Chinese government officials wont let the stock market drop. Same static we heard here in this country when Greenspan was running monetary policy.
It looks to me that the average mainstream Chinese citizen is not interested in real jobs, just market appreciation and speculation. They basically set their entire day on watching stock prices. Kind of like the out of work citizen trading stocks in their bedroom here in the states.
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