Tuesday, September 11, 2007

Shanghai Index And The People's Bank of China Update

I thought I'd continue the China theme over the past week as I believe a Shanghai market crash, protectionism and nationalism are all very large risk factors to global stability and confidence. Factors not being taken into account by the investment community or multi-national corporations as many shovel significant monetary investments into China without any regard for risk. In the last fifty two weeks the Shanghai Index is now up about 240% and we are fast approaching another key resistance level in the index. Has there ever been such a rapidly rising bubble in the last few hundred years? I remain very negative on the emerging markets supplying China as an investment theme. As we've discussed before, tis better to buy European, Japanese, U.S., Canadian and Australian investments benefiting from exports to China.

Today we see inflation out of China is out of control and has reached a ten year high. We can therefore expect the People's Bank of China to institute its fifth rate increase in 2007 some time soon. In addition, late last week China upped the banking reserve requirements again in an attempt to gain some control over the banking system and astonishing credit creation rates. This is the seventh such move in 2007 if that is possible to believe. The last time the US changed reserve requirements? The 1980 credit crunch. So, what will burst the bubble? I see two possible leading candidates. One, the global supply chain backs up and it starts a severe inventory correction out of China and two, the PBC will bust it as the Federal Reserve did in 1929. Therefore, I vote for history repeating itself with some potential twist. I don't believe the global supply chain will move fast enough to be the exogenous shock starting China's asset decline but being that their boom is heavily focused in the industrial economy, the outcome has the potential to be catastrophic and exacerbated by a significant and lengthy inventory correction, massive business washouts and by a nearly nonexistent consumer economy to cushion an industrial crash.

The global supply chain has a significant lag effect and it is circular. In other words, it starts in the U.S. and ends in the U.S. with global production ramped up to serve America's perceived never ending demand. If you want to read more on that and the ramifications for a supply chain bust, I would encourage you to go back and read The Illusion of Wealth I posted in July of last year.

posted by TimingLogic at 9:09 AM

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