China raises rates and why the Chinese economy is a paper tiger.
While nobody was surprised by China's move to tame it's inflation via a rate hike yesterday, I think it provides a great opportunity to demonstrate a contrary view to China's strength. There are two "facts" that are currently being accepted and discussed in the main stream that deserve some mention.
First, everyone is convinced that China is deliberately suppressing the value of their currency, the Renminbi (RMB), in order to achieve superior exporting results. Secondly, everyone is convinced that the Chinese "miracle" will turn into an economy that will overtake that of the United States.
Even though I once subscribed to the former, I see no evidence to suggest it is actually true and in fact there is a very good possibility that most people are wrong. In terms of the latter, I think there is ample evidence to suggest that the exact same financial problems we are experiencing in the United States are happening in China and a crashing halt is a far more likely outcome than anything else.
Regarding the RMB. People's conviction and obsession with the undervalued Renminbi is now reaching a boiling point, there was even a piece of legislation in Congress to punish China with trade penalties if they do not comply. This is rather interesting, because the way the system works, at least from a logical standpoint suggests that the RMB is probably over not under valued! Keep in mind please that unlike the dollar, the Chinese currency is not freely traded on the markets and whose value is manipulated by a central authority.
As you know, the RMB is pegged to the US dollar. You may also know that our Central bank is busy making dollars. So one would assume that for as many extra US Dollars that get created, there will have to be a multiplier effect in China. As it stands one US dollar fetches you 6.6 RMB and thus for every dollar created for the silly purpose of battling deflation Bernanke not only creates one extra dollar chasing fewer goods in America he is most likely creating 6.6 extra Renminbi. China has to respond, what choice do they have? If they do not print more RMB then for every dollar Bernanke creates the peg would drop and that is not allowed to happen. This part is logical.
Obviously the peg is whatever the Chinese Central Bank says it is and the actual value is yet to be determined, indeed China can continue making money irrespective of what happens in the US. For instance American money supply grows primarily through lending, but as we have seen through QE1 the supply can grow even as lending stagnates.
Observe the chart of the money supply in China and United States.
Even though M2 is a poor measurement of the total money supply (MZM is better for example) this chart speaks volumes. The Chinese supply has been growing at an alarming rate. I ask you then, how is it possible that in the face of 20-30% growth in the supply of money that the value of the RMB is still undervalued? Considering also this crucial fact. From December 2007 to January 2010 the US Dollar lost a great deal of value. In fact the DXY (dollar index) plummeted from around 89 to 76 and this happened with the M2 actually shrinking (this is why the M2 is a joke), what do you suppose happened to the pegged RMB when their M2 exploded? In fact one might wonder how the Chinese M2 clocked such impressive gains and my hunch suggested that it must have been the voracious lending appetite of the Chinese banks.
This chart confirms:
Chinese lending is through the roof. This confirms the notion that a psychotic bubble is brewing in China and this should be no surprise to anyone considering that real estate in China has reached levels of sheer absurdity.
So if the US Dollar lost a great deal value due to all the printing that was happening by our Central Bank despite our virtually non-existent lending then China's currency with the level of lending and printing they are doing should have fallen just the same and then some, yet conventional wisdom suggests that the RMB is still undervalued. How?
Neither logic nor numbers confirm the notion that China is deliberately undervaluing their currency, in fact I would argue they are deliberately over valuing their currency! The peg should not be 6.6 RMB to 1 US Dollar it should be 8 or 9 and this is just a rough guesstimate. That would of course imply that 'made in China' would only escalate, but the cost of Chinese goods should actually be cheaper than they are now today.
Indeed the Chinese CPI is spiking.
Another chart that suggests that there are way too many Renminbis floating around causing immense pressure to prices making our imports of Chinese "goods" more expensive. Yet Congress thinks the answer to this problem is to punish China for "undervaluing" their currency. A potentially devastating legislative approach to a very misunderstood problem.
Ultimately because the Chinese currency is manipulated and badly the inflation is rampant, this causes two behavioral changes in China. First it deprives the Chinese middle class of extra income as food and energy consume their income (a problem plaguing American working classes) and secondly it forces people to chase risky assets. This is the natural consequence of inflation, people try to protect their savings and wealth by placing their money into assets to protect from inflation, but they inadvertently cause speculation and bubbles. More specifically, the central authorities that create the inflation are causing asset bubbles and this was last witnessed during the reign of Greenspan/Bernanke when cheap money policies fueled a gigantic property bubble.
So with this, I make a rather simple and logical conclusion - China is doing exactly what America did, but believe it or not on a much grander scale. The result will then be a crash, but on a much grander scale. It is clear that some in the Chinese leadership have recognized a problem and are trying to stifle the speculation by raising rates and sadly just like any other central planning authority the chance of them overdoing it is high. By applying too much tightening too quickly the Chinese economy will act like a 150 MPH truck barreling down the highway and slamming the brakes. Result? Anything not securely bolted down being propelled through the windshield. Splat.
First, everyone is convinced that China is deliberately suppressing the value of their currency, the Renminbi (RMB), in order to achieve superior exporting results. Secondly, everyone is convinced that the Chinese "miracle" will turn into an economy that will overtake that of the United States.
Even though I once subscribed to the former, I see no evidence to suggest it is actually true and in fact there is a very good possibility that most people are wrong. In terms of the latter, I think there is ample evidence to suggest that the exact same financial problems we are experiencing in the United States are happening in China and a crashing halt is a far more likely outcome than anything else.
Regarding the RMB. People's conviction and obsession with the undervalued Renminbi is now reaching a boiling point, there was even a piece of legislation in Congress to punish China with trade penalties if they do not comply. This is rather interesting, because the way the system works, at least from a logical standpoint suggests that the RMB is probably over not under valued! Keep in mind please that unlike the dollar, the Chinese currency is not freely traded on the markets and whose value is manipulated by a central authority.
As you know, the RMB is pegged to the US dollar. You may also know that our Central bank is busy making dollars. So one would assume that for as many extra US Dollars that get created, there will have to be a multiplier effect in China. As it stands one US dollar fetches you 6.6 RMB and thus for every dollar created for the silly purpose of battling deflation Bernanke not only creates one extra dollar chasing fewer goods in America he is most likely creating 6.6 extra Renminbi. China has to respond, what choice do they have? If they do not print more RMB then for every dollar Bernanke creates the peg would drop and that is not allowed to happen. This part is logical.
Obviously the peg is whatever the Chinese Central Bank says it is and the actual value is yet to be determined, indeed China can continue making money irrespective of what happens in the US. For instance American money supply grows primarily through lending, but as we have seen through QE1 the supply can grow even as lending stagnates.
Observe the chart of the money supply in China and United States.
Even though M2 is a poor measurement of the total money supply (MZM is better for example) this chart speaks volumes. The Chinese supply has been growing at an alarming rate. I ask you then, how is it possible that in the face of 20-30% growth in the supply of money that the value of the RMB is still undervalued? Considering also this crucial fact. From December 2007 to January 2010 the US Dollar lost a great deal of value. In fact the DXY (dollar index) plummeted from around 89 to 76 and this happened with the M2 actually shrinking (this is why the M2 is a joke), what do you suppose happened to the pegged RMB when their M2 exploded? In fact one might wonder how the Chinese M2 clocked such impressive gains and my hunch suggested that it must have been the voracious lending appetite of the Chinese banks.
This chart confirms:
Chinese lending is through the roof. This confirms the notion that a psychotic bubble is brewing in China and this should be no surprise to anyone considering that real estate in China has reached levels of sheer absurdity.
So if the US Dollar lost a great deal value due to all the printing that was happening by our Central Bank despite our virtually non-existent lending then China's currency with the level of lending and printing they are doing should have fallen just the same and then some, yet conventional wisdom suggests that the RMB is still undervalued. How?
Neither logic nor numbers confirm the notion that China is deliberately undervaluing their currency, in fact I would argue they are deliberately over valuing their currency! The peg should not be 6.6 RMB to 1 US Dollar it should be 8 or 9 and this is just a rough guesstimate. That would of course imply that 'made in China' would only escalate, but the cost of Chinese goods should actually be cheaper than they are now today.
Indeed the Chinese CPI is spiking.
Another chart that suggests that there are way too many Renminbis floating around causing immense pressure to prices making our imports of Chinese "goods" more expensive. Yet Congress thinks the answer to this problem is to punish China for "undervaluing" their currency. A potentially devastating legislative approach to a very misunderstood problem.
Ultimately because the Chinese currency is manipulated and badly the inflation is rampant, this causes two behavioral changes in China. First it deprives the Chinese middle class of extra income as food and energy consume their income (a problem plaguing American working classes) and secondly it forces people to chase risky assets. This is the natural consequence of inflation, people try to protect their savings and wealth by placing their money into assets to protect from inflation, but they inadvertently cause speculation and bubbles. More specifically, the central authorities that create the inflation are causing asset bubbles and this was last witnessed during the reign of Greenspan/Bernanke when cheap money policies fueled a gigantic property bubble.
So with this, I make a rather simple and logical conclusion - China is doing exactly what America did, but believe it or not on a much grander scale. The result will then be a crash, but on a much grander scale. It is clear that some in the Chinese leadership have recognized a problem and are trying to stifle the speculation by raising rates and sadly just like any other central planning authority the chance of them overdoing it is high. By applying too much tightening too quickly the Chinese economy will act like a 150 MPH truck barreling down the highway and slamming the brakes. Result? Anything not securely bolted down being propelled through the windshield. Splat.
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