Why a Trade War With China Is Bad News and Thoughts on U.S. Financials and Oil

We're in the home stretch of 2010. The favorite, Weak Recovery, is ahead by a nose. QE2 and Falling Dollar are right behind. Toxic Asset and Solid Earnings have been unable to mount a charge.

But two horses -- Man 'o Trade War and Europe's Problem -- are moving on the outside and could decide the race.

There are so many conflicting catalysts, sometimes it seems as though you have to pick your horse, place your bet and see what happens.

I'm sure plenty of Congress-persons are pretty proud of themselves for moving a bill that would label China currency manipulators through the House.

But let's not kid ourselves: this particular strategy for standing up to China is both reckless and hypocritical.

It's reckless because it demands action from China on the yuan.

It's hypocritical because we don't act when the ECB intervened in the currency market to weaken the euro. And we don't cry when Bernanke buys Treasuries to lower interest rates and the U.S. dollar.

(OK, so maybe some investors aren't happy with the Fed, but stocks have certainly responded to the Fed.)

I'm no apologist for China. There are serious trade issues with China - Like intellectual property and patent piracy. Then there's the playing field in China that overtly favors state-run enterprises. And the recent move by China to restrict exports of rare earth elements is a WTO violation.

These are the angles from which we should be attacking the China fair trade issue. Congress is pandering to its constituents when it plays the currency manipulator card.

Does anyone really believe a stronger yuan is the cure-all for the U.S. manufacturing sector? And does anyone think a trade war with China is anything other than the single fastest way to return to recession and push the unemployment rate to 15%?

The real fix is for Americans to take care of business at home. And it would probably be wise to make it more difficult for companies to move operations to China.

Ultimately, a trade war would hurt China worse than the U.S. anyway. China does not have the mature consumer market that the U.S. does. If its export economy dried up, it would be absolutely devastating for China.

Alright, I've spoken my mind on China for today. Let's get back to the stock market...

I said Thursday that we should be expecting a pretty sharp move lower for stocks on either the last day of the third quarter (Thursday) or the first day of Q4 (Friday).

I'm sure we could consider the 200-point swing from highs to lows on Thursday a pretty sharp drop. (Though I will say I was pretty impressed with the rebound.)

And the reason for the declines has nothing to do with the economic data that came out. It had everything to do with the institutional investors.

Mutual funds, hedge funds, pension funds and the rest of the institutional crowd have not been making a lot of money this year. Massive investor redemptions aside, volatility has made profits difficult. So after a nice rally to end the quarter, it should be no surprise that funds wanted to lock in some gains. They pretty much had to.

And I don't think they're done. I expect we'll see a strong rally in the next day or two. The Fed is giving the green light to buy stocks and most institutions will not fight the Fed.

Interesting note from the financials: they led the rally in early September, then lagged the rest of the month. But Thursday, the financials showed relative strength.

It would be fitting for financial stocks to resume a leadership position, especially if this rally is to continue.

Keep an eye on Citigroup (NYSE:C). The Treasury just finished selling around 1.5 billion shares. It will take a break until Citigroup reports earnings on October 18. That could give the stock some upside.

I suggested a position in Citi ahead of last quarter's earnings. The stock ran from $3.80 to as high as $4.50 on July 13, three days before it reported. A similar 18% run would push it to $4.60 over the next two weeks.

Bank of America (NYSE:BAC) also made a nice run ahead of earnings.

Speaking of earnings, just a reminder that 3Q reports start a week from today with Alcoa (NYSE: AA). My Wyatt Investment Research colleague Jason Cimpl, thinks yesterday's surprisingly strong Chicago PMI regional manufacturing survey bodes well for a good earnings report from Alcoa.

Finally, I'd be remiss if I didn't note the huge jump for oil prices Thursday. Oil closed just below $80 a barrel, but spent most of the day above that level. Oil is now at a 7-week high.

Oil is an excellent gauge of economic growth expectations. Despite a seemingly conflicting message from stocks, oil's message is pretty clear cut.

About the author: Ian Wyatt

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Geithner's Decision on China

So, the Obama administration is going to toughen up on China, is it? I find this hard to believe. Let’s take a look at the trade picture to figure out the motivations behind this most recent move by the administration. According to the Census Bureau:

Total exports of $153.3 billion and imports of $196.1 billion resulted in a goods and services deficit of $42.8 billion in July, down from $49.8 billion in June, revised.

Also, take into consideration that our trade deficit with China alone decreased only slightly to $25.92 billion in July from $26.15 billion in June. This amounts to basically no change at all. According to the Calculated Risk Blog, there are also some stormy clouds on the trade horizon. This data is from LA Port, which can claim about 40% of the United States’ container port traffic. According to Calculated Risk, loaded inbound traffic increased 24% in August year over year while outbound traffic is down 2.6% over the same time period. Imports have recovered, but exports are still 17% off from two years ago. Exports may have peaked a couple months ago, while imports have continued to rise. This means that the deficit most likely increased in August.

This is the last thing politicians will want to hear heading into the heat of elections. So, with the intervention by Japan yesterday, upcoming elections and the unfortunate current/future state of American exports, it seems like now is the perfect time for Geithner to make a stand. I’ve written about China relations before, and nothing has changed to make me believe Geithner will actually be able to pull off anything more than an empty threat. There are several reasons for this.

Despite the cry of economists across the world (including myself) to garner multilateral support for such a measure, this is still going to be a US versus China issue when Geithner speaks. If China was going to listen to the things we have to say, they would have done so long ago. Mr. Geithner is apparently going to say:

We are concerned, as are many of China’s trading partners, that the pace of appreciation

View the Original article

U.S. / China Trade Imbalance: A Triumph of Hope Over Experience

Between 2005 and 2008 the Chinese yuan appreciated by a bit over 20%. Then when the recession got bad in late 2008, the yuan was (wisely) re-pegged to the dollar. Now Fred Bergsten calls for another round of yuan appreciation:

C. Fred Bergsten, director of the Peterson Institute for International Economics, a leading research organization here, told House lawmakers on Wednesday that a similar increase over the next two to three years would create about 500,000 jobs. He said it would reduce China’s current account surplus by $350 billion to $500 billion, and the American current account deficit by $50 billion to $120 billion.

The United States should seek to mobilize the European Union and countries like Brazil, Russia and India to press China to realign the renminbi, and should seek W.T.O. authorization to impose restrictions on Chinese imports if it does not do so, Mr. Bergsten said.

I’m not opposed to modest yuan appreciation, and indeed I think it will gradually occur over the next three years. But I am opposed to a trade war, which is utter madness in a world struggling to recover from the Great Recession. Here’s what I don’t understand however. Between 2004 and 2008 the Chinese CA surplus rose from about $70 billion to about $430 billion (click on chart to enlarge). Why does Bergsten now expect “a similar

View the Original article

China Backpedals on the Yuan

Last week we drew attention to the strange behaviour of Chinese officials, who pushed the yuan downward against the dollar while their trading partners were calling for the Chinese currency's appreciation. This shift occurs as China is clearly trying to diversify its investments, as exemplified by the hike in its allocation in government debt from the zone: Y1.7 trillion in Japan in the first seven months of 2010, up from just Y255.7bn for all of 2005, and $2.11bn in South Korea. At the same time, China has reduced its investments in US debt by $8.95bn to $844bn. (La Chine diversifie ses réserves de change; The Real Drivers of Diversification in China’s FX Reserves). This also surely explains a big part of the yen's strength vis-à-vis the dollar and the euro. On the basis of the latest statistics published in the China Securities Journal, this is the current breakdown of currency reserves: dollar 65%, euro 26%, pound sterling 5%, yen 3%. The main reason (in their eyes) for these changes in currency reserve allocations is the fear, as expressed on numerous occasions since 2008, but more and more clearly in recent weeks, that the dollar will lose its status as the world's reserve currency (too much of the Fed's QE?), leading to a significant decline in its value. PBOC governor, Ms Hu Xiaolian, has made the latest pronouncement in this vein: “My view is that the Yuan doesn’t have a key role to play in rebalancing bilateral trade between the U.S. and China. I don’t think excessive argument and criticism on this issue will help”. (WSJ 1 Sep 2010) "Once a reserve currency's value becomes unstable, there will be quite large depreciation risks for assets. A diversified international currency system will be more conducive to international economic and financial stability.” (China Finance, 6 Sep 2010). In reality, you can already read the same views in Ms Xialian's speech of 15 July before the PBOC: “Three Characteristics of the Managed Floating Exchange Rate Regime.” However, the yuan's recent depreciation vis-à-vis the dollar hardly went unnoticed in the United States where it sparked an immediate reaction from Robert Hormats, under secretary of State for economic, energy and agricultural affairs: ‘U.S. Official Warns of Backlash Against China’. “A lack of action by the Chinese to address U.S. concerns about currency issues and intellectual-property protections could encourage a more protectionist agenda on Capitol Hill.” "We're likely to see some legislation offered that would be adverse to Chinese interests if more steps aren't taken.” All this in an already tense context, as Larry Summers (Director of the National Economic Council) and Thomas Donilan (Deputy National Security Advisor) travel to China to discuss all these highly sensitive issues. They will not only talk about the yuan, but also about China's anger at US involvement in the South China Sea and US concerns about Iran. ‘Bumpy months ahead for U.S. and China’ So surprise, the yuan's controlled depreciation last week has abruptly moved upward, just in time for Mr Summers' visit. Here is an updated graph comparing the yen and the dollar. Yuan and yen vs the US dollar China back-pedals a bit…

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Private Equity Firms Settling Into China

I have been closely following the growth of private equity in China because I believe it is one of the most important and exciting new markets for the industry. As the country opens up more and more to financial institutions by easing typically stringent regulations, the potential for buyout firms operating in China is huge. This is why you see many firms moving into China even though they may not begin doing large deals for a few years still. It's about getting your foot in the door and setting up offices in the country before your competition.

There are still major obstacles to working in China but the prospects are bright and many firms believe it is worth navigating complicated (and sometimes unfair) regulations. The government is working to make the country more receptive to private equity firms, with actions like this week's announcement that China will allow insurers to invest up to 5% of their total assets in private equity. These types of initiatives are key in developing private equity activity in China.

Yuan-Denominated Funds Dominate

Although there have been some promising private equity funds in China, the industry still lacks the credibility that it has gained in other parts of the world. It is encouraging that private equity firms have started opening funds in the Chinese yuan currency. Having a fund denominated in the local currency has helped these buyout firms attract local investors, which is a key step to working in the country successfully.

David Rubenstein told the audience at a WSJ China Financial Markets Conference, "“For any of the large private-equity firms in the West to be a real player in China, you probably should have a

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China Sky One Drops on Trimmed Guidance

China Sky One Medical (NSDQ: CSKI) reduced its guidance for 2010, blaming the shortfall on the loss of several major distributors. The company said the distributors ended their relationship with China Sky One after they discovered their business information was disclosed in SEC filings. This led to increased scrutiny in China, which was enough for them to stop doing business with China Sky One.

In actual numbers, China Sky One now expects revenues to drop from a forecasted $162 million to around $131 million, a decline of 19%. Net income is now predicted to come in 30% below the previous $40 million at about $28 million. Both sets of numbers exclude the impact of derivative warrant liabilities.

China Sky One says it will replace the distributors with new ones, but the process will take time and will increase the company’s Selling and Marketing costs in 2010.

The news sent the price of China Sky One shares lower by 29% to a 52-week low. It was trading at $6.90, down $2.79 in mid-session. The stock has traded in a range between $6.85 and $25.45 over the past 12 months. China Sky One’s market capitalization now stands at $116 million.

Disclosure: none.

About the author: ChinaBio Today

View the Original article

Geithner's Decision on China

So, the Obama administration is going to toughen up on China, is it? I find this hard to believe. Let’s take a look at the trade picture to figure out the motivations behind this most recent move by the administration. According to the Census Bureau:

Total exports of $153.3 billion and imports of $196.1 billion resulted in a goods and services deficit of $42.8 billion in July, down from $49.8 billion in June, revised.

Also, take into consideration that our trade deficit with China alone decreased only slightly to $25.92 billion in July from $26.15 billion in June. This amounts to basically no change at all. According to the Calculated Risk Blog, there are also some stormy clouds on the trade horizon. This data is from LA Port, which can claim about 40% of the United States’ container port traffic. According to Calculated Risk, loaded inbound traffic increased 24% in August year over year while outbound traffic is down 2.6% over the same time period. Imports have recovered, but exports are still 17% off from two years ago. Exports may have peaked a couple months ago, while imports have continued to rise. This means that the deficit most likely increased in August.

This is the last thing politicians will want to hear heading into the heat of elections. So, with the intervention by Japan yesterday, upcoming elections and the unfortunate current/future state of American exports, it seems like now is the perfect time for Geithner to make a stand. I’ve written about China relations before, and nothing has changed to make me believe Geithner will actually be able to pull off anything more than an empty threat. There are several reasons for this.

Despite the cry of economists across the world (including myself) to garner multilateral support for such a measure, this is still going to be a US versus China issue when Geithner speaks. If China was going to listen to the things we have to say, they would have done so long ago. Mr. Geithner is apparently going to say:

We are concerned, as are many of China’s trading partners, that the pace of appreciation

View the Original article

U.S. / China Trade Imbalance: A Triumph of Hope Over Experience

Between 2005 and 2008 the Chinese yuan appreciated by a bit over 20%. Then when the recession got bad in late 2008, the yuan was (wisely) re-pegged to the dollar. Now Fred Bergsten calls for another round of yuan appreciation:

C. Fred Bergsten, director of the Peterson Institute for International Economics, a leading research organization here, told House lawmakers on Wednesday that a similar increase over the next two to three years would create about 500,000 jobs. He said it would reduce China’s current account surplus by $350 billion to $500 billion, and the American current account deficit by $50 billion to $120 billion.

The United States should seek to mobilize the European Union and countries like Brazil, Russia and India to press China to realign the renminbi, and should seek W.T.O. authorization to impose restrictions on Chinese imports if it does not do so, Mr. Bergsten said.

I’m not opposed to modest yuan appreciation, and indeed I think it will gradually occur over the next three years. But I am opposed to a trade war, which is utter madness in a world struggling to recover from the Great Recession. Here’s what I don’t understand however. Between 2004 and 2008 the Chinese CA surplus rose from about $70 billion to about $430 billion (click on chart to enlarge). Why does Bergsten now expect “a similar

View the Original article

China Backpedals on the Yuan

Last week we drew attention to the strange behaviour of Chinese officials, who pushed the yuan downward against the dollar while their trading partners were calling for the Chinese currency's appreciation. This shift occurs as China is clearly trying to diversify its investments, as exemplified by the hike in its allocation in government debt from the zone: Y1.7 trillion in Japan in the first seven months of 2010, up from just Y255.7bn for all of 2005, and $2.11bn in South Korea. At the same time, China has reduced its investments in US debt by $8.95bn to $844bn. (La Chine diversifie ses réserves de change; The Real Drivers of Diversification in China’s FX Reserves). This also surely explains a big part of the yen's strength vis-à-vis the dollar and the euro. On the basis of the latest statistics published in the China Securities Journal, this is the current breakdown of currency reserves: dollar 65%, euro 26%, pound sterling 5%, yen 3%. The main reason (in their eyes) for these changes in currency reserve allocations is the fear, as expressed on numerous occasions since 2008, but more and more clearly in recent weeks, that the dollar will lose its status as the world's reserve currency (too much of the Fed's QE?), leading to a significant decline in its value. PBOC governor, Ms Hu Xiaolian, has made the latest pronouncement in this vein: “My view is that the Yuan doesn’t have a key role to play in rebalancing bilateral trade between the U.S. and China. I don’t think excessive argument and criticism on this issue will help”. (WSJ 1 Sep 2010) "Once a reserve currency's value becomes unstable, there will be quite large depreciation risks for assets. A diversified international currency system will be more conducive to international economic and financial stability.” (China Finance, 6 Sep 2010). In reality, you can already read the same views in Ms Xialian's speech of 15 July before the PBOC: “Three Characteristics of the Managed Floating Exchange Rate Regime.” However, the yuan's recent depreciation vis-à-vis the dollar hardly went unnoticed in the United States where it sparked an immediate reaction from Robert Hormats, under secretary of State for economic, energy and agricultural affairs: ‘U.S. Official Warns of Backlash Against China’. “A lack of action by the Chinese to address U.S. concerns about currency issues and intellectual-property protections could encourage a more protectionist agenda on Capitol Hill.” "We're likely to see some legislation offered that would be adverse to Chinese interests if more steps aren't taken.” All this in an already tense context, as Larry Summers (Director of the National Economic Council) and Thomas Donilan (Deputy National Security Advisor) travel to China to discuss all these highly sensitive issues. They will not only talk about the yuan, but also about China's anger at US involvement in the South China Sea and US concerns about Iran. ‘Bumpy months ahead for U.S. and China’ So surprise, the yuan's controlled depreciation last week has abruptly moved upward, just in time for Mr Summers' visit. Here is an updated graph comparing the yen and the dollar. Yuan and yen vs the US dollar China back-pedals a bit…

View the Original article

China Distance Education CEO Discusses F3Q2010 Results - Earnings Call Transcript

Oppenheimer

China Distance Education Holdings Limited (DL) F3Q2010 Earnings Call Transcript August 19, 2010 8:00 am ET

Operator

Good evening and thank you for standing by for the China Distance Education Holdings Limited third quarter fiscal 2010 earnings conference call. Today, you will hear from Mr. Zhu, Chairman and CEO of the company; and Ms. Ping Wei, the CFO. During the prepared remarks, all participants will be in listen-only mode. After that, the company management will be available to answer your questions.

Before we start, we would like to remind listeners that this conference contains forward-looking statements. These statements are made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Among other things, the outlook for the fourth quarter of fiscal year 2010 and oral statements from management on this call, as well as the company's strategic and operational plans, contain forward-looking statements.

Forward-looking statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in any forward-looking statements. Further information regarding these and other risks is included in the company's annual report on Form 20-F and other documents of the company as filed with the Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

As a reminder, this conference call is being recorded. A summarized presentation can be downloaded from the company's IR website and which we will be referring during the course of the call. In addition, a webcast of this conference call is available on the company's Investor Relations website at ir.cdeledu.com.

I will now turn the call over to Mr. Zhu to discuss the operational highlights. Mr. Zhu, please go ahead.

Zhengdong Zhu

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China Looks to Finish Off Post-WWII Reign. Better Learn Mandarin

The world’s greatest economies have always competed fiercely to reign supreme. From Egypt to the Iberian Peninsula, to Great Britain and the United States: when a King of the Hill got sloppy-drunk on power, a more hungry rival was ready to pounce.

Over the past decade, China has made huge strides toward the economic throne of the world. They’ve joined the WTO, repurposed their entire country into the greatest manufacturing machine in history, embraced as good a derivative of capitalism as any, and, most importantly, been on the right side of the wealth transfer pipeline.

Now, in recent months, China has pressed their heel into the throat of their debtors. They have sharply pared back purchases of US Treasuries, they have further diversified into Gold, and they are helping foreign companies such as McDonald’s (MCD) offer hordes of yuan-denominated bonds.

What does this mean for the US Dollar? A guaranteed near-death-experience.

While we’re all sitting here using prayer as an economic policy, China is using all the wealth we’ve exported to them. How much wealth is that? Take a look (click to enlarge) at the Trade Deficit:

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China Looks to Finish Off Post-WWII Reign. Better Learn Mandarin

The world’s greatest economies have always competed fiercely to reign supreme. From Egypt to the Iberian Peninsula, to Great Britain and the United States: when a King of the Hill got sloppy-drunk on power, a more hungry rival was ready to pounce.

Over the past decade, China has made huge strides toward the economic throne of the world. They’ve joined the WTO, repurposed their entire country into the greatest manufacturing machine in history, embraced as good a derivative of capitalism as any, and, most importantly, been on the right side of the wealth transfer pipeline.

Now, in recent months, China has pressed their heel into the throat of their debtors. They have sharply pared back purchases of US Treasuries, they have further diversified into Gold, and they are helping foreign companies such as McDonald’s (MCD) offer hordes of yuan-denominated bonds.

What does this mean for the US Dollar? A guaranteed near-death-experience.

While we’re all sitting here using prayer as an economic policy, China is using all the wealth we’ve exported to them. How much wealth is that? Take a look (click to enlarge) at the Trade Deficit:

View the Original article

China Is Not a Currency Manipulator

… at least not according to the U.S. Treasury (see the Treasury’s Interim Report on Exchange Rate Policy).

According to the Treasury’s report:

China’s continued foreign reserve accumulation, the limited appreciation of China’s real effective exchange rate relative to rapid productivity growth in the traded goods sector, and the persistence of current account surpluses even during a period when China’s trading partners were in deep recession together suggest that the renminbi remains undervalued.

It was easy to overlook the recently released Treasury report in the wake of the G20 summit, where much of the debate centered on austerity versus stimulus rather than China’s mercantilist policies (see Agreeing to Disagree).

In this sense then, China’s strategy of publicly announcing a more flexible yuan policy in the days leading up to the G20 summit effectively deflected the debate away from the yuan. What’s more, China’s announcement was seemingly rewarded by a Treasury now more reticent to label it a currency manipulator. And the timing of the report’s release (after months of delay) seemed rather coincidental: It was released after the conclusion of the G20 meetings, and only after China seemed to mollify critics with its announced policy shift.

The interesting thing to me about the whole thing is that the yuan has barely budged since the announcement, rising less than 1% since late June. For a currency that some claim is undervalued by as much as 40%, that’s not likely to make much of a dent in persistent trade imbalances.

Now I’m as much a proponent of free trade as anyone (see Globalization Revisited and Globalization Discontents), but my view is that trade should be allowed to take place in an environment in which economies adjust as a consequence. Explicit policies that prevent such adjustment can be damaging to all parties.

With my bias now laid bare, it seems to me that China is simply paying lip service. It wants to appear accommodating, publicly declaring its intention to allow the yuan to strengthen against the dollar, while continuing to rely on exports to the US as its main growth engine.

Given the recent turmoil in Europe (China’s second largest trading partner), maintaining its exports to the U.S. has taken an even heightened importance (see Revaluation Postponed and Revaluation and Euro Weakness). And in a world where everyone suddenly wants to play beggar-thy-neighbor (China, Japan, and now even Europe), the U.S. is now everyone’s neighbor (for a brilliant treatment of the issues see Capital Tsunami).

This cannot continue indefinitely.

Against that backdrop, don’t be surprised if the trade deficit and cries of unfair trade practices begin to occupy a more prominent place in political discourse.

About the author: Robert Salomon

View the Original article

China Is Not a Currency Manipulator

… at least not according to the U.S. Treasury (see the Treasury’s Interim Report on Exchange Rate Policy).

According to the Treasury’s report:

China’s continued foreign reserve accumulation, the limited appreciation of China’s real effective exchange rate relative to rapid productivity growth in the traded goods sector, and the persistence of current account surpluses even during a period when China’s trading partners were in deep recession together suggest that the renminbi remains undervalued.

It was easy to overlook the recently released Treasury report in the wake of the G20 summit, where much of the debate centered on austerity versus stimulus rather than China’s mercantilist policies (see Agreeing to Disagree).

In this sense then, China’s strategy of publicly announcing a more flexible yuan policy in the days leading up to the G20 summit effectively deflected the debate away from the yuan. What’s more, China’s announcement was seemingly rewarded by a Treasury now more reticent to label it a currency manipulator. And the timing of the report’s release (after months of delay) seemed rather coincidental: It was released after the conclusion of the G20 meetings, and only after China seemed to mollify critics with its announced policy shift.

The interesting thing to me about the whole thing is that the yuan has barely budged since the announcement, rising less than 1% since late June. For a currency that some claim is undervalued by as much as 40%, that’s not likely to make much of a dent in persistent trade imbalances.

Now I’m as much a proponent of free trade as anyone (see Globalization Revisited and Globalization Discontents), but my view is that trade should be allowed to take place in an environment in which economies adjust as a consequence. Explicit policies that prevent such adjustment can be damaging to all parties.

With my bias now laid bare, it seems to me that China is simply paying lip service. It wants to appear accommodating, publicly declaring its intention to allow the yuan to strengthen against the dollar, while continuing to rely on exports to the US as its main growth engine.

Given the recent turmoil in Europe (China’s second largest trading partner), maintaining its exports to the U.S. has taken an even heightened importance (see Revaluation Postponed and Revaluation and Euro Weakness). And in a world where everyone suddenly wants to play beggar-thy-neighbor (China, Japan, and now even Europe), the U.S. is now everyone’s neighbor (for a brilliant treatment of the issues see Capital Tsunami).

This cannot continue indefinitely.

Against that backdrop, don’t be surprised if the trade deficit and cries of unfair trade practices begin to occupy a more prominent place in political discourse.

About the author: Robert Salomon

View the Original article

China, The Mother of All Grey Swans

I gave a presentation last week at the Value Investment Seminar in Trani, Italy (here is a link to the PDF). I strongly suggest you visit their website in a few weeks, as it will have presentations and videos. It was a terrific event; I learned a lot.

I spoke about China, Japan, and our favorite stock idea: eBay (EBAY). I changed the title of the China presentation to “” (instead of “Black Swans”). A while back, when I shared this presentation with my readers, I was corrected: China is not a black swan, because a black swan is a rare, significant, and unpredictable event. However, the consequences of what is transpiring in China and Japan are for the most part predictable (especially if I am writing about it). We don't know when they will play out, but they are predictable.

Nassim Taleb, one of my favorite thinkers, who brought the black Swan to life in his books Fooled by Randomness and The Black Swan (I like both books, but Fooled by Randomness is my favorite, plus, it is by far an easier read than Black Swan), solved my dilemma with China by creating a new swan: "grey" -- a rare, significant, but predictable event (though the timing is still unknown, or perfectly known only with the benefit of hindsight.)

I spent a few days at the seminar discussing and debating China with some very smart folks, who stirred up some random thoughts.

What really amazes me is how people who would not trust the US or European governments to do their laundry, have unconditional faith in Chinese government involvement in its very complex economy.

The Chinese government brainwashes its people the same way the Russians and Soviets brainwashed theirs: by controlling and censuring media. So I understand when Chinese people who live in China speak highly of their leaders – they are brainwashed (I have experienced this first-hand). However, I am amazed that the Chinese government has been able to brainwash people who reside outside of China.

No, an economy in large part controlled by the state is not superior to ours. Greater control over their economy allows the Chinese government to pull the economy out of recession a lot faster than in the democratic countries, but there is no free lunch. Their actions will just lead to greater excesses and imbalances down the road.

It seems that as Westerners we have an inferiority complex when it comes to Asian cultures. Chinese uniqueness is praised today the same way Japanese superiority was in the 1980s. I even remember reading Russian newspapers in Russia, in 1989, praising the Japanese work ethic and their unique culture and spouting predictions of the continuance of Japanese dominance. I can only imagine how the mainstream press in the US was caressing Japanese uniqueness in the late ’80s, especially as the Japanese were invading (buying) Times Square and the State of California.

What is very interesting about it is that today all those Japanese cultural advantages are looked upon as disadvantages. For instance, “saving face” did not allow Japan to deal sufficiently with failed companies; their economy was full of semi-dead, zombie companies, which did not allow the healthy ones to prosper. Their employment-for-life system that was praised to the heavens during the Japanese golden age is now killing productivity of their economy. I recently read that 12-17 million people in Japan are employed who should not be employed (for an economy of 120 million people, these are huge numbers). In other words 12-17 million Japanese show up for work every day and receive a paycheck, but add little or no value to their employers.

Back to China. Even if the Chinese are harder-working and more entrepreneurial than Americans and Europeans, that doesn't mean the laws of economics are somehow suspended in China – they are not. The Chinese economy was geared for high global growth, while now much lower growth is in the cards. The excesses created by 14% of GDP being “stimulated” into the economy through a fire hose have led to significant overcapacity. It will take time for these excesses to be dealt with, even in a country full of super-hard-working people.

A friend asked, “But what about Singapore; its government plays a significant role in the economy, and Singapore is thriving.” The clear answer: government can only succeed in running very small and relatively simple economies. Let me give you this example. I have a game on my iPad called Flight Controller – my kids love it. The point of the game is simple: you are an air-traffic controller and your job is to land planes. Planes come in three colors, red, yellow, and blue, and each plane has to be landed on the runway matching its color. The objective is not to have mid-air collisions. I can land ten planes no problem, twenty gets more difficult, and forty I cannot handle (Okay, I played the game a few times). The same is true for economies: the more complex the economy the more difficult it is to be centrally planned.

Government is not and never will be an efficient allocator of capital. It empowers bureaucrats, which in turn leads to corruption, which further misallocates capital. The size of the bribe or strength of the personal relationship decides the flows of capital instead of the invisible hand that funnels capital from low to high uses. (A side point: Singapore is one of the most uncorrupt countries in the world; this may explain in part the government’s success. China is not Singapore; it is infested with corruption).

I often hear that you have to go to China to understand it. But tourists who go to China don't see the real China, the same way that tourists who go to Moscow don't see the real Moscow. I was in Moscow a few years ago, and I was impressed by how clean and beautiful it looked; in fact it didn’t look much different from the center of Brussels. Of course, I was only in the center of the city, where you see fancy restaurants, gift shops, museums, theaters, etc.

I went to see my college friend who lives in the real Moscow – I saw a very different picture. The second you veer off the main road, it turns into pothole hell, and the streets are anything but clean. My friend lives in a nine-story apartment building that has not been painted in decades; paint is peeling both inside and outside. Interestingly, most of the sides of the buildings that face large streets in Moscow and in Murmansk (the city where I spent all my Russian life) are usually painted, but the sides that face small streets have not been painted in generations.

My friend – a lawyer – and his wife and kid have to live with his mother, as they cannot afford to live on their own. But you won't see this Russia if you are a tourist visiting Moscow. People who visit China even multiple times harbor an illusion that they understand it – they don’t. In fact they are so overwhelmed by its grandness that they stop being rational in their analysis.

I keep thinking about the possible consequences of the Chinese overcapacity bubble pop. It is relatively easy to understand what will happen in Japan: deflation will quickly turn into hyperinflation as government is forced to print money to service its debt and social obligations. They'll announce and may even execute austerity measures, but those will be a decade or two too late. The Japanese yen will likely decline, though maybe not right away, as Japan owns a lot of US dollars and may be forced to sell them.

The Chinese situation is far more complex. China has tremendous overcapacity, but overcapacity is deflationary. It will drive prices for commodities down, and prices of Chinese-made goods will likely decline as well. Demand for industrial goods will collapse, pushing their prices down. But China will also have to deal with a lot of bad debt and will likely have to print money to do so – which is inflationary.

The popping of both the Chinese and Japanese bubble economies will lead to higher US, and likely global, interest rates.

Japan is past the point of no return. Internal consumption of its debt will likely turn negative very soon. Its post office, (which includes a postal savings system that was historically one of the largest buyers of government debt) announced recently that it will be a net seller this year. The situation is out of the Japanese government’s hands. It will probably not be able to intervene in the economy for much longer, so rates will rise and there will be little they will be able to do about it.

China is different from Japan. Its government is trying to slow down lending, but at the same time we have started seeing news of possibly another multi-hundred-billion-dollar stimulus over the next few months. The Chinese government’s actions are the wild card that will determine the duration and the magnitude of the bubble pop – the longer they intervene, the more dire the consequences will be.

About the author: Vitaliy Katsenelson

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China Surpassing U.S. as Largest Energy Consumer Is the Story of the Past Decade

years, has now been surpassed as the world’s No. 1 energy consumer. IEA Paris, following the BP Statistical Review in June, has decided to call this race in favor of China. However, this is really not a story of today. Rather, it’s a story of the past decade. Only the confluence of several powerful forces could have delivered China to its current position. The press should have been paying closer attention. Moreover, the real story here is in China’s growth in coal consumption–the energy source China drew upon to first match, and then surpass, the United States.

Let’s take a look first at BP’s data assessment for 2009 energy use, vs. IEA Paris. Our unit of account here is the mtoe–million tons oil equivalent. This is a unit of energy, not volume, and measures BTU. Also, a note: IEA Paris apparently is including Hong Kong in their data so I have added Hong Kong also to mainland China from the BP Statistical Review (which tracks them separately). For 2009, BP has China edging the USA by nearly 19 mtoe, and IEA Paris has China exceeding the USA by a more substantial 82 mtoe.

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China Plans for Its Competitive Future With Mining Asset Drive

The Wall Street Journal discovers the new old world of mining development and finance; and the natives of that new old world are smart, well financed, and decidedly unfriendly to competitors from the old new world.

Wednesday's July 21, 2010 Wall Street Journal has an article buried on page A11 entitled “Chinese Firms Snap Up Mining Assets.” The article should be on the front page, but the WSJ’s editors do not seem to realize just how important this article is for predicting the future of the American industrial economy.

I have written frequently over the last several years of the growing global dominance of China in the production of metals. The WSJ has now discovered that China “already consumes one-third of the world’s copper and 40% of its base metals, and produces half of the world’s steel.” In actuality, a little research into the facts would have shown the WSJ’s reporters and fact-finding staff the following: China now produces not only (already) half of the world’s steel but also some 53% of all of the metals produced in the world. By 2012, China will produce more than 60% of the world’s steel, an amount that in 2012, is expected to exceed 700,000,000 metric tons. That's between 7 and 8 times as much steel as the USA is expected to produce in 2012!

Does anyone need to wonder why China is ‘snapping’ up mining assets around the globe?

And does anyone still think this feverish resource acquisition is a plot to control the prices or supplies of the world’s metals and minerals for any other reason than to feed at the lowest cost the gigantic and growing appetite of the Chinese domestic economy for raw materials?

As I keep pointing out, the rare earths monopoly enjoyed by China today is a direct result of the fact that China’s monumental growth in demand for raw materials to feed its domestic economy began with those raw materials that the Chinese had in abundance. Materials such as the rare earths, iron ore, and tungsten. There is no mystery and no conspiracy to control prices; it is demand that is driving both Chinese acquisitions and its domestic growth of the production of industrial raw materials. It is the Chinese desire not to let others control the prices in China that is driving this raw material acquisition and development frenzy.

One more thing the WSJ did not notice is that the Chinese are focusing on acquiring resources in countries that can produce more natural resources than those countries can use internally. This avoids the problem of the Chinese creating their own competitors.

Rare earths are a perfect example of this. Chinese companies are investing in rare earth mining ventures in Australia, Canada, and Southern Africa. Not a single one of those places has a domestic supply chain for processing such ores or for refining them for use in high tech devices or for manufacturing those devices. The enormous cost of financing the development of a rare earth mine today makes it almost impossible for such an operation to be profitable at the ore concentrate stage- the most common stage at which a mining operation stops. Chinese investors can consolidate rare earth mines with existing Chinese ore processing and refining operations and even with rare earth metal and alloy fabricators and end users in China. This way the mining overheads can be distributed among more comprehensive operations and the total operation can be made profitable in China.

This distributed cost is the hope of the forthcoming Molycorp IPO. The intention is to create a total mine-to-magnet supply chain with the profit coming from magnet production, not from the mining. I think that the Chinese recognize that there is a good chance that Molycorp’s plan could result in a competitor. Therefore they are concentrating on investing in country’s rich in resources but with much less population and wealth then the USA so that there is no danger in those other countries of igniting competition to Chinese exports.

Those countries have neither the skills nor the domestic market that would encourage local investors to take the risk of creating an industry that would only work with massive exports to China as a goal. The Chinese clearly plan to reverse several centuries of tradition by making China the 21st century’s preeminent industrial manufacturing center. The focus is on creating a flow of raw materials from lesser economies into China and having the entire world as a well to soak up excess production. (And thus stimulate Chinese growth.) Wasn’t that the exact system that the British Empire achieved in the nineteenth and early twentieth century? Didn't that make Britain the richest and most powerful nation in the world for a while?

It looks like that system is working again, doesn’t it? Creating wealth beats consuming wealth without creating it every time.

In summary:

The WSJ's reporters now know what everyone in the mining world already knows: The Chinese mining industry, in particular, and China’s natural resources sector in general, are aggressively pursuing the acquisition and development of natural resources around the world for the purpose of supplying the Chinese demand for these materials. American finance looking only for short term gain has completely ignored this and has, at this point, marginalized the U.S. as a global competitor for the resources needed by China.

The pattern I see in Chinese overseas resource development is that China seeks resources and resource development in countries that do not and could not use all of the resources domestically. Thus China can pay for the development of the resources in ways that benefit the host country in general, such as infrastructure or the supply of goods and services not available in that country. This is a compensation scheme that is not possible in the U.S., a country today with no defined purpose.

The sun already does not set on mining operations that feed the Chinese industrial economy.

Disclosure: None

About the author: Jack Lifton

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China MediaExpress: The Most Undervalued Stock Poised to Profit From China's Emerging Middle Class

for many Chinese companies. Its rates are low so they get paid quickly. This is unique for a Chinese companies. With CCME there is no fear of further dilution. The company's CFO recently stated, "we have sufficient resources to fund our business expansion plans, including internal growth initiatives as well as potential acquisitions.”

4) CCME has amazing growth. The Net Income target is $71-$75m this year, which would represent 79% growth from 2009. That $71-$75m range seems very conservative by management since the company did $18m Net Income in Q1 ($72m run rate) and it expects higher growth and margins the rest of the year. Management has a huge incentive to make $84m of net income this year in the form of earn out shares.

I believe the Company will make the $84m in net income this year. With approximately 40.5m fully diluted shares, EPS could range from the $1.85 guidance to over $2 if they hit the earn out target. FMCN, which is the best comparable in this sector, currently trades at a P/E of 17 based on the 2010 estimates of $0.94 EPS. To give CCME a P/E of 17, it would have a share price of $34 right now. This research report gives the company a $35 target and said CCME is discounted 68% to its peers.

This stock is incredibly undervalued given the above 4 discussion points. CCME, being a new listing, has yet to receive analyst coverage. The Company stated it has met with many analysts and institutions, so I personally expect coverage soon. Analysts typically assign P/E ratios anywhere from 10-30, depending on the Company. Because of the above discussion points I think CCME qualifies for a higher multiple. Lastly, CCME was recently selected to be added to the Russell Global Select fund.

CCME is the most undervalued stock poised to profit from China's emerging middle class.

Disclosure: I am long CCME.

About the author: super-trades.com

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Interview with Daryl Guppy

Daryl is a frequent featured speaker in CNBCAsia and he is known as "The Chart Man". In the interview Guppy talks about the Chinese economy, in conjunction with the global economic crisis. He also holds an insight view in relation to the recent soaring of USD against most of the major currencies while the US economy is collapsing.

I don't think you want to miss this!!!

Interview with Guppy (Part 1)



Interview with Guppy (Part 2)