Rebel Traders – Analysis Without The Hype

The U.S. government needs foreign entities to keep purchasing U.S. treasuries in order to fund the government. Many months ago I discussed what would happen if foreign interest in purchasing our treasury notes began to dwindle, or worse yet, began selling them. If this is the start of a new direction for foreign governments, then funding the U.S. government will become increasingly difficult.

China Total holding of US Treasuries: $755.4B v $789.6B prior

Japan Total Holdings of US Treasuries: $768.8B v $757.3B prior 
Oil Exporters total Holdings of US Treasuries: $186.8B v $187.7B prior 
Brazil holdings of US Treasuries $160.6B v $157.1B prior 
Russia holdings of US Treasuries $118.5B v $128.1B prior 
Hong Kong holdings of US Treasuries $152.9B v $146.2B prior 
India holdings of US Treasuries: $29.6B v $31.6B prior

[…] WASHINGTON (AP) — The government said Tuesday that foreign demand for U.S. Treasury securities fell by the largest amount on record in December with China reducing its holdings by $34.2 billion.

The reductions in holdings, if they continue, could force the government to make higher interest payments at a time that it is running record federal deficits.

The Treasury Department reported that foreign holdings of U.S. Treasury securities fell by $53 billion in December, surpassing the previous record of a $44.5 billion drop in April 2009.[…]

[…] The Obama administration on Feb. 1 released a new budget plan which projects that the deficit for this year will total a record $1.56 trillion, surpassing last year’s record of $1.4 trillion deficit. The trillion-dollar-plus deficit have been caused by a deep recession, which has reduced government tax receipts, and the massive spending that has been undertaken to jump-start the economy and stabilize the financial system.

The administration has pledged to begin addressing the huge government deficits with Obama saying he will soon appoint a commission to recommend ways to trim future deficits.

Overall, the Treasury Department said that foreign net purchases of long-term securities totaled $63.3 billion in December, down from $126.4 billion in November. This category covers Treasury securities and private company bonds.[…]

There is only one way out of this record deficit the United States finds itself in, taxes will have to go up and more services will have to be cut. There is simply no way around it. We the taxpayers will be paying for the mistakes of Wall Street and government spending for a very long time.

With so much talk about China of late this is as good a time as any to go over the popular China ETF , symbol FXI.

FXI is a fund that attempts to match (before fees and expenses) the FTSE/Xinhua China 25 Index. It is managed by iShares

Current top holdings (as of January 21 2010):

CHINA MOBILE LTD
9.87%

CHINA CONSTRUCTION BANK-H
9.38%

IND & COMM BK OF CHINA – H
8.16%

CHINA LIFE INSURANCE CO-H
7.10%

BANK OF CHINA LTD – H
6.11%

CHINA PETROLEUM & CHEMICAL-H
4.03%

CHINA MERCHANTS BANK – H
4.01%

PING AN INSURANCE GROUP CO-H
4.00%

PETROCHINA CO LTD-H
3.98%

CNOOC LTD
3.97%

The first chart spans nearly 3 years. Observe that a wide channel (channel 1) has been a dominent technical factor on the chart.

Next we look within the wide channel and find a smaller channel (channel 2). FXI has broken below the smaller internal channel and this raises the potential that FXI will test the lower, wide channel level.

The question is what will happen if FXI does drop to the lower channel line. Like any support level, there will be an attempt to hold the price within the wide channel. I foresee FXI trading in a narrow range (see next chart). The smaller channel will serve as resistance, while the larger channel will serve as support for the short term from my analysis.

If FXI breaks below the wide channel, then a likely initial price target would be in the range of $32 to $34.

OilPrice.com Oil Market – Summary for 01/18/2010 – 01/22/2010

New measures by Chinese authorities to curb bank lending reversed a rally in energy prices early in the week, bringing West Texas Intermediate futures down more than 4% in the second half of the week to below $75 a barrel by Friday.

China continued its efforts to slow down its economy and prevent overheating, and told some banks to stop making certain kinds of loans. The Chinese move on Wednesday hit all commodities across the board, from gold to lead, with the prospect of slower economic growth in the country.

Not even the news that China’s oil imports in December exceeded 5 million barrels of oil a day for the first time could stop the decline.

U.S. data, meanwhile, showed that demand for oil had slipped 1.8% in the four weeks leading to Jan. 15 from the like period a year ago, when the U.S. economy was in the grip of a recession. Crude inventories declined in the week, against expectations, but gasoline inventories rose. Continued milder weather in the Northeast further dampened heating oil prices.

News that utilization of U.S. refinery capacity fell to its lowest levels since the 1980s drove home the point that demand for distillates was lagging. Refinery utilization in the previous week dropped 2.9 percentage points to 78.4% of the 17.6 million barrels per day total capacity, the lowest level in two decades except for periods when hurricanes shut down refinery operations.

The U.S. and China are the world’s top two oil-consuming countries, so the signs of weakening demand in both were bearish for energy prices.

As if all that wasn’t enough, the announcement by the White House on Thursday of tough new measures to limit banks’ proprietary trading threw a double whammy in energy markets. There were concerns that Wall Street banks, among the biggest energy traders, would have to cut back their activities. Plus, the news sent equities into a tailspin, and dragged down commodities prices.

The uncertainty about U.S. bank restructuring reversed the dollar’s climb against the euro, which had also weighed on crude oil prices. After dropping below $1.41, the euro bounced back up above that level at the end of the week.

But continuing concerns about Greece’s debt and new uncertainty about whether Ben Bernanke will be confirmed for a second term as Federal Reserve chairman supported the dollar and were likely to dampen any strong rise for the euro, analysts said.

Originally published at: http://www.oilprice.com/article-crude-oil-prices-fall-victim-to-china-syndrome.html

By Darrell Delamaide for OilPrice.com who have recently launched a Free Market Intelligence Report which focuses on unique Geopolitical and Investment News which enables readers to spot trends and events in the marketplace and reduce investment risk. To find out more visit: http://www.oilprice.com

There are numerous reasons being floated in the media today to explain the sharp sell off in the equities market. Some are ridiculous, while others are meaningful. Unfortunately bubble TV pays little attention to the meaningful reasons, so let us briefly list the important ones here.

   Sovereign default concerns continue to grow for Greece and the Eastern European region.

   China has temporarily restricted banks from any further lending to control excesses in the economy. Additionally, a Chinese economist has floated the idea that China should curtail further purchases of U.S. debt.

   The U.S. dollar has risen significantly in response to the items listed above.

   Q4 earnings so far have been met with ‘sell the news’. An indication that stock prices have advanced far too much and earnings don’t substantiate the stock prices.

   Financial firms are still reporting en masse losses on loans and other credit portfolio products.

   The FHA, in an attempt to save itself from complete destruction has tightened lending criteria. A good first step for the FHA, but bad for those who were counting on more ‘easy money’ to keep the housing market afloat.

   Unemployment, unemployment, and unemployment.

   And the biggest one of all today is the Massachusetts senate election that elected Republican Scott Brown last evening.

Famed CNBC windbag Jim Cramer misinterpreted what the election of Scott Brown means. Jim Cramer claimed that the market would rally ‘huge’ today if Scott Brown were elected. The part that Mr. Cramer fails to comprehend is that Scott Brown threatens the normal way of life in Washington and he embraces the ‘tea party’ ideals of ending free money.

The ‘tea party’ movement has had lots of bad press. But that is understandable since the ‘tea party’ represents the idea of fair and balanced taxes, no bailouts for Wall Street firms who dug their own grave, and a government that actually represents the people instead of lobbyists and their interests. Any group of people that threatens the normal way of life in Washington will be singled out and made to look foolish by those who are threatened the most.

Senate elect Scott Brown says he will take to Washington the very concept that threatens the normal way of life, and that has Wall Street worried.

Despite what is habitually said of Chinese stats, some elements seem to indicate that “growth”  is not abating in the Chinese economy. Electricity consumption is generally considered as the most reliable indicator to check the reality of Chinese production.

According to power usage stats, the September rise was the strongest Y/Y, and October and November energy consumption should also rise strongly to 15 and 20 % according to projections.

China’s power consumption in September rose 10 percent year-on-year to 322.4 billion kilowatt hours, the fastest pace of growth since June last year, the China Electricity Council said on its Web site on Oct. 15.

The increase followed 8 percent growth in August and indicated continued economic recovery, it said.

Power generation in August gained 9.3 percent year-on-year to a record 344 billion kWh, as demand from manufacturing plants soared in line with rising consumption fueled by the government’s stimulus spending. The council did not provide output figures for September.

Power consumption in the first nine months rose 1.4 percent year-on-year to 2.7 trillion kWh, it said.

Grid operators sold a combined 2.2 trillion kWh of electricity in the first nine months, up 3.2 percent year-on-year, it said.

A total of 199.7 billion yuan was spent on construction of power plants in the first three quarters, 83.2 billion yuan of which went on coal-fired projects.

China added 49 million kWt of generating capacity in the first nine months, comprising 32.9 million kWt of thermal power, 12.1 million kWt of hydropower and 4 million kWt of wind power, the council said.

A total of 219.2 billion yuan was spent on grid construction and upgrades, it said.

The 10 percent year-on-year growth rate of power consumption in September was “normal” in comparison with a decline in consumption a year earlier, Yang Zhishan, a power analyst with CITIC Securities Co. Ltd., told Caijing.

Year-on-year growth in power use during October and November will likely reach 15 percent and 20 percent, respectively, Yang added.

Power consumption began falling year-on-year last October amid the global downturn. It began to grow again in June, when it expanded 4.3 percent. Growth rose further to 6 percent in July and 8.22 percent in August.

Another sign of the Chinese muddling in commodities has emerged when it was known that Chinese imports of Iron ore exceeds the demand by 50 million tons for this year.  Speculation (and accumulation of commodities) both by Chinese State authorities and Chinese private actors trying to front-run the expected recovery has brought up an excess of iron ore on the market, thus allowing no room for further upward evolution in iron ore prices.

China’s iron ore imports have exceeded actual demand by about 50 million tonnes so far this year and the oversupply leaves no room for further price rises, a senior official of the China Iron and Steel Association (CISA) said on Monday.

“We believe the Chinese iron ore price is largely influenced by speculation on the market,” CISA’s Vice Chairman Luo Bingsheng told reporters at the sideline of an industry conference in Beijing.

China imported 405 million tonnes of iron ore in the first eight months of this year, up 32 percent from a year earlier, to feed its rapidly growing steel output.

The country’s annual capacity is expected to top 700 million tonnes by the end of this year, with production of around 600 million tonnes of crude steel in 2009, hefty growth of 20 percent from the all-time high of 500 million tonnes in 2008.

The benchmark price of Indian origin ore with 63/63.5 percent iron in China has stabilised at about $90 per tonne, below the year’s peak of $115 hit in early August, but still above the contract price of about $75 cost and freight.

Additionally, Luo called for a revision of ongoing annual price talks, which he said would benefit both steel mills and miners, but gave no details.

“The traditional negotiation system no longer matches the current market situation. We think it is necessary to make some changes and adjustments, but they should be decided by both the buy side and the sell side,” Luo told reporters.

China broke the rule this year by agreeing to a 35 percent cut from 2008/09 prices with Australian upstart miner Fortescue Metals Group, despite the top miners’ “take or leave it” approach to the 33 percent price cut first reached by Rio Tinto and Japanese steel mills.

The annual conference involving CISA and the steel industry, led by top producer Baosteel, is traditionally seen as a warmup for annual term talks.

CISA Secretary General Shan Shanghua told Reuters earlier that his group would seek to change contract terms to the calendar year instead of the April-to-March fiscal year.

Shan also said talks over 2009/10 prices were continuing with Brazil’s Vale and Australia’s BHP Billiton six months into the contract year, but added that China was not in talks with Rio Tinto.

As regards overall steel production, whereas steel production fell all over the world Y/Y, in China the production beat its 2008 output (see below graph, courtesy of Steel Grips)

On the whole, the seel production alone would indicate a recovery if there wasn’t a serious issue of overcapacity in China. This overcapacity is forcing some Chinese steel mills to cut prices up to 58 $ per ton.

Despite this, the Chinese stimulus may provide for some nice results in Asian steelmakers.

Asia’s big steelmakers likely saw their earnings exceed expectations in the latest quarter on unexpected strength in China’s economy, though the spectre of oversupply looms as a key threat in the year ahead.

The sector is pulling out of the worst slump in decades thanks to stimulus measures by governments around the world, including China’s near $600 billion package focused on infrastructure that prompted a spurt in exports by JFE (5411.T), Nippon Steel (5401.T) and POSCO (005490.KS) to capture demand.

However, the issue that lies ahead, as previously mentioned is the Chinese oversupply… And there is not going to be a market sufficiently vigorous to catch up all that supply.

But the threat of oversupply from China clouds the outlook at a time when manufacturers are still cautious about spending for new plants, and housing and building starts remain in the doldrums.

Steel output at China has been growing at a rapid clip. The country’s annual capacity is expected to top 700 million tonnes by the end of this year, with production of around 600 million tonnes of crude steel in 2009, a hefty growth of 20 percent from the all-time high of 500 million tonnes in 2008.

Lakshmi Mittal, chairman of the world’s largest steelmaker, Arcelormittal, told the Financial
Times in a recent interview that prospects for a world steel industry rebound could be blown off course by a strong rise in exports from China.

As the recovery (or at least the first signs of one) confirms, the focus of the attention moved from checking whether the stimulus would be enough to kick-start the economic activity to checking how to pull it “out of the system” without killing the economy in the process.

Andy Xie thus proposes an analysis of the pitfalls of pulling out the stimulus. In essence, his argument runs that the excess liquidity is liable to create inflation, as that is the only acceptable alternative to deleveraging by bankruptcy.

(…)

Financial markets had been chattering about economic stimuli exits for about a month before Canberra’s move. The consensus was that central banks would keep rates extremely low through 2010, and possibly beyond, on grounds that the economic recovery is still shaky.

Central banks also have been discussing the subject. Their messages are, first, that they know how to exit and will exit before inflation becomes a problem and, second, that they don’t see the need to exit anytime soon. They try to assure bond inventors not to worry about their holdings, despite low bond yields, while trying to persuade stock investors they need not worry about high stock prices, as liquidity will remain strong for the foreseeable future. So far, central banks have made both groups happy. But Australia’s action is likely to raise concern among financial investors who hold expensive stocks and bonds.

Each economy will exit at its own pace, according to local conditions. First, the United States and Britain, where property bubbles have burst and could not be revived through low interest rates, will increase rates next year at a pace in line with the speed of inflation expectation. Their goal is to keep real interest rates as low as possible to support financial institutions still sitting on mountains of bad assets. They don’t want to stop inflation, but want to limit the pace of its increase. Through low real interest rates, their economies could decrease debt leverage. I think the Fed would raise interest rate by 100 bps in 2010, 150 bps in 2011, and 200 bps in 2012. The United States could be stuck with an inflation rate of 4 to 5 percent by 2012 – and for years to come.

As Andy Xie stresses, the stimulus exit will be a combined effort of all the central banks and it will not be exempt of risks: one central bank alone could derail the whole process.

My central point is that the global economy is cruising toward mild stagflation with a 2 percent growth rate and 4 percent inflation rate. This scenario is the best that the central banks can hope to achieve; it combines an acceptable combination of financial stability, growth and inflation. But this equilibrium is balanced on a pinhead. It requires central banks to constantly manage expectations. The world could easily fall into hyperinflation or deflation if one major central bank makes a significant mistake.

In modern economics, monetary stimulus is considered an effective tool to soften the economic cycle. While there are many theories about why monetary policy works, the dirty little secret is that it works by inflating asset markets. By inflating risk asset valuation, it leads to more demand for debt that turns into demand growth. In other words, monetary policy works by creating asset bubbles.

It is difficult to reverse this kind of stimulus. A complete reversal requires that household, business and government sectors decrease debts to pre-stimulus levels. This is why national ratios of indebtedness-debt to GDP have been rising over the past three decades while central bankers smoothed economic cycles through monetary policy. It led to a massive debt bubble that burst, leading to the ongoing slump.

Of course, the bailouts have brought in essence to transfer the non-performing debt from private actors (where it could be cleansed through bankruptcy) to government actors and central banks. The issue being here that it would be impossible to call these loans in without bankrupting the originators.

By some estimates, US$ 9 trillion has been spent to shore up failing financial institutions. A big chunk of that money was borrowed against illiquid and problematic assets on bank balance sheets. As the debt market refused to accept that collateral, governments and central banks stepped in. Today, it is impossible for banks to liquidate such assets without huge paper losses. Hence, if central banks call the loans, they are likely to go bankrupt.

Of course, central banks can suck in money from elsewhere to substitute money that’s tied up in non-performing loans. They are unlikely to do so, however, as it would depress a good part of the economy in order to support the bad. And that could easily lead to another recession.

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

What Andy Xie shows is that while the originating issue is the same, the exit strategies will have to be quite different according to each country or zone, each having its own specificity.

Some may argue that Britain is not expensive anymore. The problem is that being less expensive is not good enough. Prices have to be low enough to attract non-financial economic activities despite a rising tax burden. The pound’s value must be very low to achieve that goal. Five years ago, I predicted the pound and euro would reach parity. It seems the day is finally here. But I’m not sure parity would be enough; the pound may have to be cheaper.

Of course, the euro zone is a mess, too. With high unemployment rates, a stagnant economy and imploding property markets in southern Europe, shouldn’t the euro’s value decline, too? Yes, it should. But it won’t. The European Central Bank was structured solely to maintain price stability. With so many governments and one central bank, ECB is unlikely to change anytime soon. (…)

At some point, euro zone monetary policy may change. It would require governments in the zone’s major economies come together and change the ECB. That may come in three years, but not now. The trigger could be one country threatening to exit the euro. Italy and Spain come to mind.

Meanwhile, Japan is an enigma. It has been locked in a vicious cycle of economic decline with a strong yen and deflation. Most Japanese people have a strong yen psychology. (…)  But I think various theories that explain Japan’s behavior are not good enough. The best explanation is that Japan is run by incompetents, and some are downright stupid. They have locked Japan in an icebox and refuse to come out.

Japan is a giant debt bubble. Its zero interest rate, supported by a strong yen and deflation, has turned the debt bubble into an iceberg. You don’t have to worry — until it melts. Unfortunately, when the temperature reaches a critical point, the iceberg will melt suddenly, all at once. That turning point will come when Japan begins to run a significant current account deficit. The day may be near.

For Japan to avoid calamity, it should deal with deflation and skyrocketing government debt now. The only way forward is for the central bank to monetize Japanese Government Bonds. That would lead to yen devaluation and inflation. Pensioners will complain, but it’s better than a complete meltdown later.

Japan’s new ruling party DPJ has no vision like that. It doesn’t have the guts to go against popular preference for a strong yen. Without a growing economy, though, the DPJ has little to play with. The whole country has sworn to debt, led by a government with a massive fiscal deficit. The DPJ may only reallocate some spending, which would make no difference for the economy. It seems Japan will remain in the icebox until the day of reckoning.

These snapshots of Britain, the euro zone and Japan suggest everyone needs a weak currency. Those that don’t have one simply don’t know yet. They’ll come around eventually. One outcome could be rotating devaluations and high inflation for the global economy.

Developing countries with healthy banks have a different problem on their hands. By responding to falling imports with stimuli, they inflated their property markets. China, India, South Korea and Hong Kong have inflated property bubbles in spite of slower economic growth rates. The contradictions between a property bubble and a weak economy can lead to zigzags in policymaking.

As China is one-third of the emerging economy bloc — and exerts a great deal of influence over commodity prices that other emerging economies depend upon — its monetary policy has a big impact on global financial markets. Its monetary stimulus in the first half of 2009 went disproportionately into property, stock and commodity markets. As profitability for the businesses that serve the real economy remain weak, little monetary stimulus went into private sector capital formation.

It seems limiting credit growth is the current policy focus. But if the economy shows further signs of weakness in the fourth quarter 2009 and first quarter 2010, the policy may revert to loose bank lending again. The zigzagging will stop when China’s loan deposit ratio is high enough, i.e. when increased lending increases interest rates. As the yuan is pegged to the dollar, China’s monetary policy would become much less flexible after excess liquidity in the banking system is gone.

And so, for Andy Xie, the big challenge ahead is creating sufficient income to favor deleveraging, while holding inflation under control (easier said than done). While it transpires from his writings that inflation is the final outcome he sees looming, it can be noticed that Andy Xie took a more cautious tone in this latter piece. As of today, nobody can really predict with certainty the outcome within a few months.

Could it be that, after the “Black Swan”, we may have the “Black Butterfly” effect ?

Chinese stats (as collected by a Private actor, the bank HSBC, for those who don’t believe any government stats, whether US or Chinese), continue keeping up a strong front, despite the plateauing that could be observed in the US, where new orders met with some pullback in September.

The Chinese purchasing managers index kept above 50 %, thus indicating a continued expansion in the month of September, even if the number fell by 0.1 %. The greatest challenge to be observed so far for China has been its excessive reliance on exports as a motor for its economy. However, despite these issues, it would appear that the majority of the rise in new orders came from internal demand. And this is a factor worth noticing, as the big challenge for the Chinese is managing to develop an internal market. So far, it would appear that this has been done mainly thanks to stimulus and directive instructions to buy or spend (very efficient in a dictatorship).

As the HSBC analysts seem to indicate, the operation by the Chinese government may have pushed up consumption via the gigantic infrastructure spending (which also pulled up employment, in a textbook illustration of traditional keynesianism).

China’s purchasing managers’ index fell by 0.1 percentage points to 55 points in September, the sixth consecutive month the indicator has been above 50, HSBC said in an email statement on Sept. 30.The 50 point mark is the dividing line between expansion and contraction in purchasing, the statement said. Despite the slight decline, the index still indicates strong growth in factory output, orders and employment.

Factory output has expanded for six months in a row due to an improving economy, while overseas orders have risen for the past four months as demand has rebounded, it said.

The majority of the rise in new orders, however, came from domestic demand, it said.

The growth in sales has helped push employment in the manufacturing sector to a two-year high, the statement said.

Overall product prices have risen slowly but steadily over the past three months, but larger hikes in the prices of corn, iron ore, oil and steel have pushed up overall costs, it said.

“The figures indicate a continued rebound of domestic and overseas demand, and the rise in employment levels in manufacturing shows the massive infrastructure investment has pulled up consumption,” HSBC’s chief China economist Qu Hongbin said.

HSBC began publishing monthly PMI figures on Sept. 1. It collects data from 400 companies.

The other aspect of this massive investment spending has been the overcapacity being developed in China. The Chinese government decided to tackle that too, in order to create what would appear as maybe an attempt to foster penuria in some areas (silicon and wind power among others). While curbing the overcapacity in steel or cement makes sense given the quantities being produced, the curbing of wind power (a “clean” energy source) leaves one wondering if this is not an attempt to keep the coal production buoyant (the greatest part of China’s power comes from extremely polluting coal power generators). A very near-sighted operation if ever there was one, but which translates the worries of Beijing on its social front.

The Cabinet has laid out detailed plans to curb overcapacity in industries such as steel, aluminum, cement and wind power, warning that the country’s economic recovery could otherwise be hampered.

In a reiteration of existing policy targets, the State Council said meeting the government’s long-standing goal of reducing overcapacity was urgent because the result of inaction would be factory closures, job losses and rising bad bank loans.

In a notice posted on the Internet it said, “What especially requires our attention is that it is not only traditional industries such as steel and cement that suffer from productive overcapacity and are still blindly expanding.”

While highlighting overcapacity in sectors such as steel and cement — both energy-guzzling and polluting — it also aimed at new industries such as wind power equipment and silicon.

The Cabinet said it would no longer approve or support any new steel projects or any expansion in existing projects.

Shenzhen Daily also reports that the wind power industry was mentioned which is, perhaps, surprising. It said that in 2010 Chinese companies would produce equipment equivalent to 20 million kilowatts of capacity, but that the country would install only 10 million kilowatts of actual capacity.

To tackle this oversupply, the Cabinet said it would in principle refuse approval the construction of complete wind-power equipment factories. It also banned investors in the sector from using locally produced equipment, aiming to prevent local governments from building their own equipment plants.

First of all my apologies to all the readers on RT and to Chuck. My company was in upheaval for the beginning of the week with the meeting of several members of our foreign establishments and my colleagues and me were swamped under work. Some personal aspects have also been involved.

Today, it is interesting to put in parallel two readings of the bubble theory (actually three).  We know that our favorite Chinese economist, Andy Xie, maintains the existence of a renewed bubble that should burst by 2010 for the Chinese markets (and probably also for the US markets in his view). Today, we can put in opposition his views with a fellow economist who finds that there is not yet a bubble in Asia.

Andy, in a nicely illustrated economical discussion argues that while it is very difficult to regulate financial excesses, all the money spent into saving the system has produced few tangible effects. In a way, he argues, saving the financial institutions rewarded “bad” behavior:

It is extremely difficult for an established regulatory regime to stop such a spiral. Usually new financial institutions or products come on the scene, and then a new leverage game begins. It would be impossible for an existing regime to be comprehensive enough to anticipate future institutions and products. Governments may need to install principle-based, not just rule-based, regulatory agencies that could take action to control new financial creations.

The U.S. government is proposing a consumer protection agency for financial products. Such an agency could at least respond to new financial products sold to consumers and, therefore, could be an effective mechanism for stopping some future bubbles. The proposal has met vehement opposition from the financial industry. It may not get through.

What can we speak for after spending trillions of dollars? Not much. Few major players went to jail. The U.S. government sent many more to prison in the 1980s after the junk bond bubble burst. This bubble is 10 times bigger. Yet, apart from the most obvious criminals such as Bernie Madoff and Allen Stanford, who ran multibillion-dollar Ponzi schemes, none of the big shots have landed behind bars. Indeed, a lot of the big shots who brought down the world are still out there running things. The lesson from the Lehman collapse seems to be, “Take whatever you can and, when it crashes, you get to keep it.” How governments and central banks have dealt with this bubble will encourage more people to join bubble making in the future.

For Andy, the stimulus pushed forward by the government, without a restructuration of supply and demand will only bring about short-lived inflation bubbles. For him, the current market is simply playing a strong and vigorous recovery, whereas none shall come out, thus provoking inflation by a self-realizing prediction (an argument often used by Andy).

Because no meaningful financial reforms have occurred, bubble-making rapidly came back in fashion. The drivers are faith in an ever-depreciating dollar and, later, inflation. Stocks, commodities, and even property values in some cities have skyrocketed this year. It is happening amid a synchronous global recession.

Of course, bulls would argue the market recovery is forecasting a strong global economy ahead. I seriously doubt it. With savings and unemployment rising, the OECD bloc is unlikely to stage a strong recovery from the recession. This view is not the market’s consensus, which assumes all stimuli will lead to a strong and sustained recovery. As I have argued before, supply and demand become misaligned during a big bubble. When it bursts, the economy must restructure supply and demand before the economy can be fully employed. Government stimulus can’t solve the problem. Realignment will take time.

The other author, Jonathan Anderson, points out that there seems to be a flow of low-interest cash  flowing and that the potential for a “carry trade” that would be long the emerging markets and short the US market is present. However, for him, the risk is present but the bubble is not yet here. For him, the necessary precondition for this would be confidence in a real recovery.

And in this environment, the Asian region is almost guaranteed to show significantly higher inflation, interest rates and earnings growth than its higher income counterparts. So why wouldn’t we see investors everywhere borrow heavily in low-yield, low growth markets (where, again, liquidity is super-ample) and invest heavily in high-growth, high-yield Asia?

In our view, these arguments make a great deal of sense. However, the bad news is that we’re probably not there yet. To be sure, global interest rates are at absolute rock bottom, liquidity levels are extremely high, and Asian economies are already recovering at a much faster pace. The problem, though, is that we don’t have the visibility we need on future growth and liquidity conditions.

What if the U.S. economy stages an unexpectedly rapid recovery next year, with the Fed hiking rates faster than expected and the dollar surging upward against emerging currencies? This could kill relative investment returns to a long-emerging market, short-U.S. “carry trade” very quickly indeed. And what if European banks or governments start to wobble next year, leading to a renewed credit crunch and a collapse of market liquidity conditions? Once again, investors playing the emerging Asian trade could be significantly hurt.

In other words, we have nearly all the preconditions in place today. But what we really need to complete the deal is greater confidence in a slow but steady global recovery scenario. And this may not occur for a few quarters down the road.

At any rate, even Jonathan Anderson sees alarming signals (notably a drop since August in the short-term commercial lending), which may even question the creation of an asset bubble. For Andy Xie, while the current bubble avoids the collapse of the financial system, it will not lead to a substantial demand creation.

A slightly different view here is that of Roland Laskine, a French trader, who finds that while the economic situation is getting better, the risk is that the economists are constantly revising upwards their expectations… And thus expose themselves to being cruelly disappointed come 2010. For him, while the risk for a total breakdown of the markets is limited, there is going to be some serious disappointment as we advance towards the end of the year, simply because the markets are factoring in a vigorous recovery that will more likely be a “U” recovery.

Needless to say, the views of Laskine and those of Andy Xie can only be conciliated with much difficulty. On the one hand, we are expecting an asset bubble by virtue of “inflation expectation” of economic actors; on the other, we see rather a deflationary scenario because of a slower recovery. What to make of these predictions? They testify only to the difficult situation in the months ahead both, for the economy and the markets. While not totally discounting a bullish outcome (should the Americans relapse in an orgy of unreasoned spending) the likelihood of a bearish scenario seems confirmed by the forward economic indicators. As the economy gears towards an “unaided” recovery, and cash hoarding seems the rule, the slower pace of recovery is going to bring everybody “back to reality”. In that respect, Q4 seems more than ever to hold the keys to the future.

Japan is one of the world economies that relies heavily on having great exports to compensate the costs it faces with having had to cope with a high public and corporate debt during the “lost decade”.

It is also often a bellwether of the global economy, as many of its high-end technological products need a buoyant market for people to consent those types of investment.

And after a transient effect, due mainly to stimuluses, the recession seems to be catching up with the economy in Japan as everywhere else. In August, Japan’s exports fell by 36 %, while the imports also sharply contracted. As the crisis deepens, layoffs have also picked up pace in Japan, thus compounding the issue in some measure.

The ill tidings from Japan bode ill for China, whose economy is largely dependent on exports and who dedicated a great part of its stimulus to increase its capacity and infrastructures. A Chinese slump can be indirectly predicted to be soon in the books by the fall by 27.6 % of Japanese exports to China.

As the effect of the aids start to dissipate, the woobly global economy is now obliged to “walk on its own feet”, and the hope of the Keynesian policies adopted so far, is that the extra government spending will allow the economy to feel new economic “blood” flow into its veins.

So far, that seems uncertain, as a number of structural issues have not been addressed, among others the “hidden debt” in the books of the US banks.

Japan’s exports tumbled 36 percent in August — with car shipments falling by half — and imports also contracted sharply, the government said Thursday, showing the world’s No. 2 economy remains mired in a deep slump.

Declines in automobile and steel exports were especially pronounced, the Ministry of Finance said. Exports fell for the 11th straight month to 4.5 trillion yen ($49 billion).

“We are not seeing an improvement in exports due to a continued slump in global demand,” said Hiroshi Watanabe, an economist at Daiwa Institute of Research. “Japan’s exports were particularly hit hard by stagnant demand in Asia and China.”

Imports, meanwhile, dropped 41.3 percent from a year earlier to 4.3 trillion yen, reflecting weak consumption within Japan, where the jobless rate is at a record high as companies shed workers. Consumer finance company Aiful Corp. said Thursday it will cut 2,000 jobs, or about 44 percent of its work force.

The incoming government of Prime Minister Yukio Hatoyama is seeking to boost consumption and help households with a range of consumer-oriented proposals, including cutting tolls on highways and giving families with children $275 a month through junior high.

But critics say the Democrats, who unseated the long-ruling conservatives in last month’s election, don’t have any clear strategy to achieve long-term economic growth.

Japan’s economy managed to climb out of a yearlong recession in the April-June quarter, growing at an annual pace of 2.3 percent. But with the jobless rate at a record 5.7 percent, growth prospects look murky.

The trade figures showed that the monthly trade surplus, or the amount exports exceeded imports, came to 190 billion yen.

Auto exports in August plunged a staggering 50 percent, while shipments of steel products dropped 43.3 percent, the ministry said. Exports of light oil products fell 59.9 percent due to faltering demand in China and Vietnam, it said.

Japan’s U.S.-bound shipments declined 34.4 percent to 713.1 billion yen, marking the 24th straight month of year-on-year decline. Among exported goods to the U.S., metal products nose-dived 82.2 percent.

Exports to Asia tumbled 30.6 percent to 2.6 trillion yen. Japan’s exports to China were down 27.6 percent.

Japan’s exports to the European Union dropped 45.9 percent to 514.3 billion yen.

We know that China has been putting a lot of efforts into obtaining cheap iron ore for its steel mills. Hence a surge in industrial production in China, notably of steel.

The problem (again), is that the steel is sold on the market by traders who have entered into future contracts at prices much higher than the current market price (and the market price in itself gives an idea of the tepid recovery taking place, even in China).

As it is, the Steel mills have been charging extremely high prices on their production, while the local demand is weak, and international demand almost non-existing.

As often repeated in these chronicles, Q4 will be the time of truth, for steel as well, as overcapacity is starting to hit the steel production.

Steel traders have urged large mills to cut their prices to reflect the market conditions, Caijing learned from a trader’s conference on Sept. 20.

Steel prices have fallen since August and many traders have lost money on products purchased under contract at higher than current market prices.

The contract price of cold-rolled steel for October delivery from Baosteel, for example, is 6,300 yuan per ton, compared with a market price of about 5,600 yuan per ton, Liu Changqing, chairman of Beijing Lange Baiziwan Steel Market, said.

Liu Yong, general manager of Anhui Huishang Metal Co., said his company bought 90 percent of the steel for a new project though the local markets.

Large steel mills should base their prices on what’s happening in the market or it will be “hard for mills and traders to reach a consensus,” Xu Jianlong, head of Jiangsu’s steel commerce chamber, said.

Meanwhile, steel mills should guarantee traders a discount on the market price, Xu said.

A large proportion of the steel produced by large mills is sold by traders, who resell it on the local markets.

Li Jianshe, marketing manager with steelmaker Magang Group, said steelmakers always consider their own interests first when the market deteriorates.

Meanwhile, the fourth quarter will be the most difficult time of year for domestic steel mills because weak demand will be unable to absorb fast-growing output and inventories, according to the China Iron and Steel Association.

Prime steel output grew for seven consecutive months to August, reaching a record 52.3 million tons in the month, far above the 40.4 million tons in February. In early August, prices stalled abruptly after a four-month rebound as ballooning output began to outpace demand.

Part of the astounding growth in the Chinese stock market has been fueled by an unbound lending by the Chinese banks. In addition, the government stimulus also took the form of loans, which in some case were not required at all, but have been made nonetheless.

Now this unrestricted lending is giving some sleepless nights to the Chinese regulators. The lack of risk management and of controls on the lending brought the Chinese regulators to restrict the rules: Chinese banks will not be allowed to integrate to their capital subordinated bonds issued by other banks (in short: no way for the banks to securitize their loans and sell the problems to other banks), over the next year. The question now is if these changes won’t happen too late as the bad loans have been rising. However, lending has slowed down since the beginning of H2.

Worried that the rapid credit growth this year might aggravate risks for the banking sector, China’s top banking watchdog on Friday reiterated that domestic lenders should enhance their risk management capacity and adhere to regulatory requirements.

“With bank loans growing rapidly, all kinds of risks are rising in the banking industry,” Liu Mingkang, chairman of China Banking Regulatory Commission, said in the statement posted on the regulator’s website.

Chinese banks advanced 8.15 trillion yuan ($1.19 trillion) in new loans in the first eight months, far higher than the 4.91 trillion yuan ($719 billion) it extended during the same period last year, sparking wide concerns of rising default risks at banks and asset bubbles in the capital market.

Liu said the ongoing global financial crisis has triggered a worldwide reflection on overhauling the financial supervision system, which includes revising and improving rules on capital adequacy, provision, leverage ratio, liquidity, as well as corporate governance and compensation system.

Chinese banking industry should strengthen their compliance management and get prepared to follow up the upcoming changes among the global financial institutions, the statement said citing the chairman’s remarks at an annual banking conference on compliance management in Shanghai.

In face of the explosive lending growth this year, CBRC has been urging banks to stick to the regulatory requirement for capital adequacy and be vigilant on signs of rising bad loans.

Earlier this month the regulator announced plans to implement stricter capital requirements for lenders, forcing them to deduct holdings of subordinated bonds issued by other banks from their supplementary capital over the next few years.

Many Chinese banks have promised to slow down lending in the second half. With new loans reaching 410.4 billion yuan in August, the flood of lending has been eased so far, echoing Liu Mingkang’s recent remarks that bank lending would be more stable in the second half.

However, the nation’s top policymakers have pledged to maintain stimulus spending and a “moderately loose” monetary policy as the economy is at a critical phase of recovery. With the effective help of the massive bank lending in the first half, the nation’s economic growth has rebounded to 7.9 percent in the second quarter after dipping to 6.1 percent in the first three months of the year.