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China Must Stimulate Economy Or Risk Political Unrest.

The Financial Times last week reads: “The benchmark one-year lending rate was cut by 27 basis points to 5.31 per cent, while the one-year deposit rate was lowered by the same amount to 2.25 per cent.”

That’s not surprising news, plus it shows some originality - China doesn’t want to end up like the US. So it cut interest rates in a multiple of 27 basis points, not in boring multiples of 25 basis points.

“The government estimates more than 10m migrant workers have lost their jobs so far, while 6.5m university students will enter the workforce next year.”

China is unlikely to escape the fate of developing countries, and facing higher unemployment, a question is raised: Will this lead to political unrest? High unemployment in China is very different than high unemployment in the US or Europe. Unlike in the developed world, there isn't much of a social net in China.

If you lose your job in the U.S, you may be forced to shop at Wal-Mart (WMT) instead of Target (TGT) and downgrade to basic cable (only 50 channels, sorry). Of course I'm oversimplifying, but the point is in the U.S, they have unemployment benefits and many other government programs aimed at keeping the Yanks from starving. This isn't the case in China.

As China's social net is in its infancy, high unemployment in many cases may mean hunger and, ultimately, political unrest. The Chinese government knows this well. Unless it comes up with social net very quickly, it will need to stimulate the hell out of its economy - far beyond the stimulus announced to date. This means more government spending. But the next bit of news I read revealed that doing so would be difficult:

“China's foreign exchange reserves, the largest in the world, apparently fell in October for the first time in five years, according to an official from the State Administration of Foreign Exchange.”

Published economic numbers are likely not describing the true economic reality in China, as -- despite economic growth for the first time in a long time -- the country feels the need to dip into its piggy bank. But here’s the scary part: That piggy bank is filled with US dollars! The U.S. government is printing a lot of money at the moment to deal with its own problems. It may or may not be inflationary in the short term (although definitely in the long term), as the velocity of money seems to be declining at a fast rate. Banks are barely lending and consumers are deleveraging and are reluctant to borrow.

But if the Chinese economy continues to deteriorate -- a likely scenario as the deterioration just started -- the Chinese government will need to start digging into its US reserves. And since there are no other natural buyers (in size) of the US debt, U.S. interest rates may actually shoot up while the US dollar crashes.

This creates a twofold problem for China: High interest rates mean even lower economic growth in the US, and even less consumption of Chinese-made goods. China can't afford a weak US dollar; that would mean its US dollar reserves will be worth even less while its products become move expensive for US consumers.

Here’s one last thought: All this is taking place while 30-year government bonds are at one of their lowest rates ever. US government bonds are likely the most overpriced asset in the world, period!

Stevie Ray Vaughan - Rivera Paradise.

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Pat Metheny & Anna Maria Jopek - Are you going with me?

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Ave Maria.

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USD Underwater.

Last Tuesday, the Federal Reserve signalled they were hell-bent on pursuing an “inflate or die” approach to rescuing the ailing US economy and fending off the forces of deflation. The Fed is now inflating at a level possibly not seen by a developed nation since Weimar Germany.

Since the credit crisis started intensifying in July, the dollar benefited from a global flight to safety in US Treasuries and a scramble for dollars to repay dollar-denominated debt. The deleveraging process effectively created a huge short position in the greenback.

But more recently, US-specific worries concerned with public debt expansion and the potential inflationary implications of quantitative easing dawned upon battle-weary investors, causing the dollar to reverse the uptrend that had commenced in July.

The US Dollar Index (i.e. a trade-weighted basket) has not only breached its 50-day moving average convincingly, but seems to be forming a top of at least medium-term significance. The fall from grace was brutal with the Index recording its largest six-day decline (from December 10th to 17th) ever, setting up an assault on the key 200-day line (often seen as a crude indicator of the primary trend).

The US currency also suffered its biggest one-day slide against the euro on Tuesday, and plunged to a 13-year low against the Japanese yen.

The devaluation of the US dollar (de facto exports deflation and depression) raises the question of how long it will take before other countries retaliate and embark on a “beggar thy neighbor” currency debasement.

China is already in the process of “managing” the renminbi lower, Russia’s central bank has signaled it would step up devaluation, and the Bank of Japan and others might also consider intervention.

Either the U.S. is going to pay for their policy sins via higher interest rates or via a weaker dollar. And for an economy as levered as the one in the US, the former choice is not an option. So a weaker dollar is the natural valve.

US creditors -- such as China -- with large hoards of dollars are growing increasingly nervous, and the dollar is likely to come under additional pressure if foreigners stop finding dollar assets an attractive proposition. The only way the US can attract foreign capital is by offering a higher interest rate or making its assets cheaper through a weaker currency.

Jim Rogers commented:

“The dollar is a terribly flawed currency... I don't like to do it, but I'm going to sell all the rest of my dollars sometime in the next few days, weeks, or months… "Again, I don't like saying it, but I'm afraid the dollar is going to go the way the pound sterling went."

The speed of the dollar's decline has been such that it's quite likely to see a relief rally before the downtrend resumes.

Arguing for a temporary hiatus from a fundamental viewpoint, right now, real competition in this ugly contest [is coming] from the currencies of the European Union and the United Kingdom, and that will probably persist for a while... But they're in pretty bad shape, and they're a little bit behind the curve relative to the U.S.

Lastly, a sustained break in the uptrends of the US dollar and the Japanese yen -- low-yielding currencies previously used for funding risky investments -- should indicate that forced selling due to deleveraging is starting to subside. As this situation plays itself out, we should see a return of confidence and a calmer period for stock markets in general, and also some support for precious metals and commodities.

The dollar may be down for the count, but could herald a sense of normalcy in broader markets.

Rome Wasn't Burned In One Day!

Uncle Sam’s “investment ” in the nation’s banks is shaping up to be a really terrible move, at least in the short-term.

An analysis by the Associated Press finds the government’s purchase of stock in large and small banks has lost about $9 billion, or a third of its value, in just a month.

Shares of virtually all the banks that have received bailout bucks are below the prices negotiated by the government. The Treasury says it’s no day trader, and is instead taking the long view.

That view includes the continuing health of the nation’s banking system. Major banks haven’t collapsed, and the Federal Deposit Insurance Corporation has lined up buyers for those local or regional banks it closed, averting Depression-era runs on financial institutions.

No one would want Uncle Sam as a portfolio manager, but a 1929-style catastrophe appears to have been avoided this time by pumping massive amounts of cash into the system. If so, it’s money well spent - regardless of the one-month negative return.

But there may be more trouble ahead. Citigroup has been pounded, JPMorgan is beleaguered, and the housing market looks like it’s years away from shaking off the shenanigans of Fannie Mae and Freddie Mac.

Federal intervention is risky - but they can hope a few hardy souls at the Treasury Department know what’s going on. However, the Treasury’s $700 billion rescue package is only part of what could become the taxpayers’ future liability.

So far, the FDIC has guaranteed about $1.4 trillion in debt issued by banks. Some estimate that the cost for the government’s effort to ease the pain in the credit crunch could go as high as $7 trillion, including guarantees of certain debts.

The danger: Uncle Sam ends up artificially propping up banks in the long-term. In short, Federal guarantees could become a crutch for poor management. Somewhere along the line, someone needs to say that weaker financial institutions need to fail to assure the overall strength of the nation’s banking system.

It remains to be seen if Uncle Sam has made the right decisions. An exit strategy would be helpful - but so far, no one in Congress has presented a detailed plan for getting government out of the financial sector.

Anyone?

O Fortuna.

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The Matthias' Prophecy.

This is probably the most gutsiest prediction on the Malaysia economy by the former aid to Tun Dr Mahathir, Matthias Chang.

Matthias Chang,18 November 2008

"Let´s put some money in our mouths. In the past I have challenged those who disagreed with me, that if they can prove me wrong, I would> gladly pay them a RM5,000 cash reward. There were no takers. None could prove me wrong!

In the past few days, the mass media have gone out of the way to interview politicians and the Governor of Bank Negara to project a rosy picture that somehow our economy will overcome the severe pain and disruption from the on-going global financial tsunami.

I am willing to take on anyone from the Badawi regime and Bank Negara that by H1 of 2009, the KLCI will drop below 700. If I am wrong in my analysis, I will pay the first five individuals from the said Badawi regime and or Bank Negara the sum of RM5,000. These five individuals must within a week register at my website that they are willing to take me on in this challenge.

They have to provide their full name and address in accordance with their NRIC/MyKad and their designation.

If they lose to me, they must pay me the same amount!

Fellow citizens, don´t listen to the Badawi regime´s fairy tales. Prepare for the worst and the worst is yet to come. You owe it to your family. The best way to save our family and our country is to be prepared for all eventualities. We must tighten our belts, save for the stormy days that will surely come and not spend, spend as advocated by the Badawi regime´s ministers.

Use common sense. What do you tell your children as responsible parents when the family is going through hard times - spend, spend, spend or be thrifty, thrifty, thrifty?

Remember the flight safety rules when flying - when the oxygen mask falls from the overhead compartment, you are to wear the mask first before attending to your children. If you cannot save yourself, you are not in a position to save anyone. This is a fundamental principle of survival for everyone when a plane is about to crash!

Apply the same principle to economic woes and we will all be saved.

Here are my warnings for 2009:

By 2nd Half of next year, the automobile industry will go into a tailspin and suffer massive losses.

By 2nd Half of next year, credit card debts will soar, credit limits will be drastically reduced (worse than 1997/1998) and interest rates> on outstanding will increase sharply. It is already happening!

By 2nd Half of next year, shipping rates will drop drastically and this is also happening. Our ports and shipping companies will suffer.

By 2nd Half of next year, our housing market bubble will burst notwithstanding all the stimulus and pump-priming. Arab investors will not be coming. Dubai and Abu Dhabi is already in a financial / property gridlock! Why would they come here when they have to save their own asses?

By 2nd Half of next year, our exporters will be in tears, when Letters of Credit (L/Cs) will not be honoured and inventory stacks up at ports and in factory premises. Chinese exporters are already stipulating what LCs from which global banks will only be accepted.

By 2nd Half of next year, FELDA settlers will also be in tears. Having spent their windfall early this year (because of Badawi regime´s false optimism), their savings will be down and they will bleed.

By the 3rd Quarter of next year, corporate NPLs will shoot up! Relaxing mark-to-market rules will not help.

Malaysia will have a huge immigration problem when these hardworking people are thrown out of work and have to compete with the swelling ranks of Malaysian unemployed..

In the meantime capital outflows will continue.

Let´s see whether the statement that Malaysia has more than enough reserves (since according to Bank Negara, we need only have US$30 to US$40 billion reserves) will provide sufficient confidence to foreign investors to continue to invest in Malaysia ..

You can call the above observations - rubbish, pessimism, gloom and doom etc. but that won´t change reality.

Pause and think. In my previous warnings and alerts, I have stated that by the latest - the 1st quarter of 2009, things will get ugly and scary!

If I am not right, why did the leaders of the just concluded G-20 summit in Washington , in their so-called "Action Plan" stipulated that their policies, remedies etc. must be implemented by the end of the 1st Quarter 2009?

My articles were all written BEFORE THE SUMMIT and obviously I have no control over the leaders of G-20.

So ask yourself -"Why Oh Why Must the First Action Plan Be Implemented by the First Quarter of 2009?

This is only the first tentative steps by the G-20 leaders and there is no guarantee that the measures will work. The original Bretton Woods initiatives took almost two years to be formalised and put to work. There is no magic wand to be wielded by the leaders for instant cure. It will be a long hard grind. In the meantime, more shits will hit the ceiling fan. That is a given!

I hope the Badawi Regime and Bank Negara are not accusing the G- 20 leaders and Obama´s financial and economic advisers as being pessimists!

You be the judge!"