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China's Industrial Age Feudalism

What is China's future? I believe it will be similar to Russia's, but with less alcoholism. Both had a centrally planned government that directed fairly obvious investment to move their economies from the agrarian to the industrial age. The move to the industrial age created an enormous amount of wealth in state owned enterprises, which are controlled by the priviliged and powerful few with connections to the state.

Neither nation has a powerful enough middle class, large enough young population, or history of democratic expectations to deliver economic and political power to the people. So this condition will exist for decades, if not centuries. Governments may come and go over that period, but not much will change. Efforts at privatization will merely solidify ownership by the privileged few, or will be mere shell games that hide the concentration of wealth.

With the obvious high return investments made and growth stagnating, China's elite will reap their rewards by systematically depleting every resource available, starting by absconding with foreign investment and continuing with the rape of natural resources. Unlike Russia, China does not have a surplus of petrochemical energy resources to export, so it will export the human energy (labor) of its people. To do that, it will practice wage repression, which may mean that investments to automation and robots in production lines are retarded from the natural flow of economic progression. 

Similar to Russia, China will rattle its saber in foreign policy, but its elite are more interested in accumulating personal wealth than expanding a sovereign empire. As it becomes more apparent that China's growth is stagnating, their wealthy will increasingly put their money in asset purchases outside of China (real estate in North America rather than China). Similar to Russian oligarchs in London, the Chinese elite will buy property and hide assets in Canada, the US (particularly on the west coast of each) and Australia - because they never know when they might fall out of favor with the current regime. Their children will increasingly live outside of China, where their family assets are.

ps: Hopefully I'm wrong.

Think the Unthinkable

It used to be unthinkable that the Euro would break-up. Now the common question is not if, but when and how much. 

Another unthinkable is that China's economy will not only slow, but will shrink significantly. Even more unthinkable is that the Politboro's power will be challenged. The economic news from China looks to have turned into a vicious negative cycle. Yes, there is still hope by many that the government will manage a recovery, but I doubt that hope will survive the year. When hope is lost, it is difficult to regain and most stimulus projects become impotent because consumers don't consume and investors don't invest no matter how big the government incentives are. My crystal ball isn't clear enough to see if China's political system is overthrown; I doubt it, but again, it is thinking the unthinkable.

And so two of the largest economies in the world will retreat for a decade or two. Perhaps the US will become like Japan and have 25+ years of zero growth, zero inflation, and constant deficits. And who knows what will become of Japan - can they borrow forever? We study Greece too much and Japan too little.

Looking back, we will ask why it happened, and how it could have been avoided. The old self rightous vices of debt and sloth will be trotted out, with perhaps a bit of avarice and gluttony too.

But it was all avoidable, if we followed a few simple rules:

1. Bad debts are the responsibility of the lender more than the borrower, and are not the unlimited liability of the government or society. Our bailouts to date have benefitted the creditor more than the debtor, and in so doing create lenders with money who won't lend, borrowers who can't consume, and businesses who won't invest. Gradually liquidate insolvent lenders, and encourage new capital to new lenders.
2. Never give up your currency. It is your sovereignty. Don't share or peg currencies because it creates long-term inbalances that end in distaster.
3. Corruption destroys the state. It creates terrible investment decisions and breeds contempt and hopelessness. Corruption is obvious in Greece and China, but more shadowy in the West; particularly in the US where Congress spends most of its time asking for campaign contributions.

In the past decade the world has made many bad investment decisions. In almost every instance the loss is borne by taxpayers, the creditors are indirectly bailed out, and the debtors are slowly destroyed. This will be exacerbated in the future by global deflation.

Here in North Carolina, a recent vote on banning same-sex marriage brought guidance from this Leviticus 20 scripture, "If a man lies with a man as one lies with a woman, both of them has done what is detestable. They must be put to death, their blood will be on their own heads."

I don't want to live in a theocracy, but I wish equal attention was given to Leviticus 25, in particular: "If any of your fellow Israelites become poor and are unable to support themselves among you, help them as you would a foreigner and stranger, so they can continue to live among you. Do not take interest or any profit from them, but fear your God, so that they may continue to live among you. You must not lend them money at interest or sell them food at a profit." 

It sounds to me like the Bible directs an interest free work-out on hardship borrowers (read the whole chapter and you will see details on foreclosure and redemption rules). Maybe we should pay more attention to the passages that direct us to help each other, and less on the those that direct us to stone each other. Let's think the unthinkable.

Shipping Volume

Just a quick link on something disturbing. The Baltic Dry Index measures the cost of ocean shipping. When the Great Recssion hit, shippers has too much capacity and mothballed part of their fleet. Now there is a huge and sudden drop in shipping prices. As the graph shows, part of that is due to the Chinese New Year. But there is something bigger. Part of it is probably due to a slow down in Europe; I saw earlier that shipping costs to from China to Europe had plummeted. Probably a bigger part is a drop in Chinese imports of raw materials.

A signal of falling international trade.

China's Greatest Asset

The article's title says it all, Shanghai Homeowners Smash Showroom Over Falling Prices. I don't know what is really going on with house prices in China. They have many market segments (speculative, occupational, luxury, middle, and low) that probably don't move together. Chinese home financing requires much more equity than the US. It defies a clear comparison to the US.

Nevertheless, Chinese have come to expect house prices to only go up, and believe that the government will not allow prices to fall. As I've tried to explain here, speculative assets tend to act like Giffen goods in that demand actually increases with price because there is an expectation of future appreciation. But once that expectation is gone, then the price reverts to a normal equilibrium - which means that prices fall a lot. No one pays a speculative price for an asset just to hold its value. And if the asset was purchased with debt, then forced liquidations increase supply and the price falls even more. Empty Chinese commercial real estate is more leveraged and has less utilitarian benefits, so its price will fall more. Speculation never lands softly. 

But real estate prices are a symptom of a greater problem in China. The paradox is that China is saving too much money - not just by their people, but particularly by their government. Excessive savings leads to bad lending decisions. And a bad investment is being made by the People's Bank of China by confiscating US dollars from their exporters and purchasing US Treasuries. China is over reliant on US trade and debt.

Someday US relations with China will sour, or the US will find a cheaper provider of imports, or the US will manufacture the goods domestically using state of the art automation. The value of China's foreign reserves may decline due to inflation, or due to a fall in the dollar caused by reduced Chinese demand for Treasuries. Or maybe the value of China's portfolio increases. It doesn't matter because to the Chinese people the foreign reserves are worthless.

Real wealth isn't something that you can deposit in a bank (regardless of the currency); real wealth is goods and services that you produce for each other. Foreign reserves can't buy Chinese people more jobs, healthcare, education, retirement, or anything else that is really important. All of these things can only be provided by the Chinese people themselves. China's greatest asset is not their $3.1 trillion foreign reserve holdings, it is their 1.0 billion people.

China's planned economy has  made rapid progress from the agricutural to industrial age. Machines displaced the farm workers and now they will displace the factory workers. Investments made in infrastructure and export facilities are approaching their capacity. Now the investments need to be in the people themselves, so that they are productive by serving each other in education, healthcare, and recreation. Then China's greatest asset will consume more, create more (as opposed to just produce more), and be more valuable.

Euro Bailout Failure

Have so many ever been so enthusiastic over a plan to beg, borrow, and steal $1.5 trillion?

• Beg - Weaker European banks will have to raise over $100 billion in capital.
• Borrow - Eurozone will borrow $1.4 trillion to bailout future sovereign and bank defaults.
• Steal - Private investors lose 50% of their Greek bonds' face value (ok, "steal" is a bit strong).

Begging, borrowing, and stealing doesn't usually instill confidence. And it shouldn't. Piece by piece, here's why...

Greek bond 50% haircut:

1. Greek bonds held by the ECB and IMF don't get a haircut, so the Greek gov't didn't get half of all of their debt cut - only part of it. They still owe much more than 50%.
2. Greece's economy is still shrinking and it still runs a trade deficit, so they will continue to run a gov't budget deficit. They are going to default again.
3. The bank trade group agreed to the 50% cut as voluntary so that it wouldn't trigger a CDS default, but their decision doesn't bind the actual bond investors, and some probably won't volunteer.
4. The best reason to volunteer now is so that you haven't shot your wad early, before Greece defaults again, when you might get a bigger payout.
5. Nobody knows what the interest rate and term of the restructured bonds will be. Assume it will be very low and very long, so that the present value of the bonds will be much less than 50%. Looking for volunteers? (in truth there isn't that much Greek CDS out there).

 Banks Raise Capital:

1. The rule was created so that it scarcely touches German and French banks, funny how that works since they negotiated the deal.
2. Italian banks have to raise a lot of capital, but do private investors want to put money in banks in a stagnant economy, with a government that probably can't bail them out?
3. The goal is to hit a target capital as a percentage of assets. Instead of raising capital, they could sell assets - particularly the good ones that will sell for a high price, which leaves them with the crummy assets and makes the bank weaker in the long run.
4. A scarcity of bank capital will cause banks to lend less and lend more conservatively, which will contrain economic growth and ultimately make it harder for banks and governments to pay back their debt.
5. If banks sell many of their assets, and lend less, then that will generally lower the price of European assets and further undermine bank solvency.
6. If the value of sovereign bonds is used to determine bank capital adequacy, why would a bank now buy Italian and Spanish bonds that have a greater risk of falling in value? Sovereign bonds are now risky to banks even if they don't default.

Borrow €1.0 trillion ($1.4 trillion):

1. €1 trillion equals 45% of China's foreign reserves, but China's reserves aren't in Euro cash, but mostly in US Treasury and Agency debt. And although these are very liquid assets, you can't sell $1.4 trillion of anything without driving down your price a lot (unless the Fed wants to buy it).
2. No nation will guarantee the €1 trillion debt, Germany explicitly will not. 
3. Germany demanded that the ECB would not guarantee the debt either.
4. The Euro Emergency Stability Fund will take the first loss before any of the €1.0 in debt defaults, but the EFSF is backed by credit risks such as Italy and Spain, who are more likely to default than lend in an emergency.
5. Borrowing €1.0 trillion from China will increase demand for the Euro, causing it to rally and make the Eurozone trade deficit worse.
6. If the money is lent from within the Eurozone, then you are removing money that would otherwise be lent to someone else, which may constrain economic growth.
7. If the €1.0 debt is perceived as safer than some individual Eurozone members, then individual Eurozone members may not be able to sell their own bonds to refinance their debt - which means that they would be forced to tap the leveraged emergency fund.

If I'm China, here's what I think: 

1. If this loan is so important, why won't the borrowing nations' guarantee it?
2. If this loan is so important, why won't they let their own bank guarantee it?
3. If this loan is so important, why did they send the French guy rather than the German?
4. Why should I risk the value of my US investment portfolio?

Then I offer the Frenchman some sage words, some spare change, and a pat on the head. Give them maybe one year's worth of their Eurozone trade surplus - about €140 billion, since it is natural to recycle trade supluses back into the importer's debt.

Euro Solution

Eurozone leaders continue in feeble solutions to the growing menace of sovereign and bank insolvency, but they never get to the heart of the problem - some nations are much less efficient and productive than others. These inefficient nations run trade deficits that accumulate as debts to the trade surplus nations which ultimately cannot be repaid. The Eurozone must solve both the short-term (solvency) and long-term (competitiveness) problems. Here's my stab at it...

1. Authorize the ECB to print Euros and pay all members' sovereign debts down to 75% of GDP.
2. Require all banks to be capitalized to 10% in tangible equity.
3. Implement import tariffs on each nation equal to their previous quarter's trade deficit within the Eurozone. The tariff is paid to the deficit nation's government.

Printing that many Euro's sounds terribly inflationary, and it would be if it were not facing the terribly deflationary act of default. Every time someone defaults on borrowed money, it essentially removes that amount of money from the economy, plus it constrains future bank lending and government spending.

The repayment of that much sovereign debt will create a large amount of money looking for an investment, which will hopefully be directed to investing in banks that must raise large amounts of capital, and who will now look like a much better investment since they aren't exposed to sovereign default risk. Bank capital will also absorb some of the otherwise inflationary effect of the Euro printing.

The tariffs are enacted to re-balance chronic trade deficit nations. Their imports will cost more, so consumers will import less in the future and thus prevent an accumulation of public or private debt that is ultimately held by trade surplus nations. Domestic producers will naturally be more competitive in terms of price and will produce more. Hopefully the government collecting tariff revenue will invest the money in education, infrastructure, and whatever make them more competitive in the future. 

There are several downsides to the tariffs. Surplus nations won't be able to export as much, and will lose employment from that activity. Consumers in deficit nations will pay more for some goods and therefore have a lower quality of living. But that's the natural downside that would occur if the nations had different currencies, and which the Euro has artificially suppressed - but that impossibly big bill is now coming due. 

The other downsides of the tariff are that it protects uncompetitive producers in deficit nations, and there is the potential that governments will squander their tariff revenue. It gives producers and governments the opportunity to invest in themselves, but there is no guarantee that they will take advantage of it. If they don't, then that is a shame because it prevents trading nations from fully enjoying their competitive advantages. The people of the deficit nation should demand the investments be made so that they enjoy a higher quality of life.

The tariffs are unfortunate, but we must impose long-term balance in our trade relationships, or else the debts will grow so large that the borrower must either default or inflate. The same idea might work for another relationship where a managed currency has distorted the trade and debt balance - China and the US.

That relationship is quite different since the deficit is due to the Chinese gov't buying up their exporters' dollars and unilaterally imposing a Yuan peg to the dollar. The constant deficits are not due to US inefficiency or a mutually agreed upon currency. Nevertheless, the risks of this contorted trade will create increasingly large risks - particularly to China. Oddly, the greatest contribution of quantitative easing may ultimately be that it is manufacturing enough money to repay the accumulated trade debt, although this money won't be released from bank reserves until economic growth and bank lending resumes.

China's Giffen Investments

"Giffen goods" is a term used for goods where demand increases with price rather than decreases as should normally occur. The textbook example is if income drops and consumers can no longer afford to buy meat, and so buy more inferior bread products - even though the price of bread is increasing due to the higher demand (as long as it is cheaper than meat). This is observed more in theory than in reality.

But could a Giffen good be an inferior investment asset? An inferior asset would be one that produces little to no operating income or utilitarian benefits; its only benefits would be from expected capital gains and as a storage of real value. In normal periods thre are many assets which are a more attractive investment because they produce steady profit margins, rents, or dividends. 

However in periods of recession and/or high inflation the operating income may become operating loss due to falling real profit margins and yields. In these environments the formerly inferior assets will be more sought after. In particular, a period of high uncertainty (fear) and low inflation will create high savings rates, low profit margins, and low interest rates. In such a period, the higher savings and lower supply of assets with positive real operating income will increase demand for Giffen investments.

As demand for Giffen investments increases, so will the price. Because the value of Giffen assets is not tethered to standard asset valuation such as interest yield, dividend yield, or profit margin, the value of a Giffen good can be driven upward by the feedback loop of expected higher future prices. Which is to say that investments without cash flows are more likely to become speculative bubbles.

Below is my attempt to graph a Giffen asset, where the demand curve is 'U' shaped once price rises above a certain point. The danger in a Giffen asset's value is that it is completely dependent on the expectation of higher prices in the future. If this expectation is ever lost, then demand plummets and equilibrium is not reached again until the price falls to where the asset clears in the normal (downward) shaped demand curve (e₂). The asset reverts from Giffen demand to normal demand. Which is to say that once enough uncertainty hits a bubble, the price can't just stay where it is because it was speculative demand that drove the price to its high level. The price of Giffen asset must continue to rise, or it must fall. There is no such thing as a "soft landing" on a Giffen asset.

JGB Example

A corollary to the US is Japan 20 years ago. Japan had bubbles with numerous mal-investments and high debt levels. Since then Japan has slowly de-leveraged, with corporations hoarding cash in the absence of better domestic investment opportunities (consumption is low because wages are low). As the Japanese economy slowed, short interest rates fell to zero by 1996. The realization that the slow down was for the long run caused longer interest rates to gradually follow, with the 10-yr rates staying below zero after 1999.

Seems to me like that is where the US is heading. Some would say that Japan is nothing like the US; their population is older and shrinking, causing their consumer demand to gradually fall. And Japan is an export driven rather than import driven economy. Although the US population isn't shrinking, its growth is slowing as immigration slows (driven by worse job prospects and domestic policies). Japan has a strong currency because their export proceeds are exchanged into Yen for domestic investment. The US will have an increasingly strong currency as fears of Euro defaults drive money to safety.

In the absence of better low-risk investments, global savings will increasingly flow to the US and keep interest rates extremely low. China and developing nations simply don't offer enough liquid bonds an investments to satisfy global demand. The irony of bond experts who rail against debt is that, without debt, they would have no job.

Gold should continue to be a good bet, not for fears of US inflation, but for fears of Chinese inflation due to China's policy of an artificially weak Yuan. And for fears of default in Europe. Defaults in Europe would cause massive immediate bank insolvency in one country, which would then rapidly jump to much of Europe. At some point Europe will have to issue Euro-wide bonds for refinancing debt, which will basically be printing money. That may sound bad, but it beats the alternative of most banks in Germany, France, Italy, and Spain becoming insolvent, and causing the sovereign default of all those nation's bonds.

Someday China will hit a hard recession and the Yuan will no longer seem undervalued. Someday Europe will solve its problems by issuing new shared sovereign bonds. When that happens, gold's day will be done. But that some day isn't today or tomorrow.

12 Reasons Why Inflation Will Fall

Here are a dozen reasons why inflation will be low over the next couple of years. In fact we may flirt with deflation. Correspondingly, interest rates may actually drop from their already low levels.

1. Slow employment growth will create a surplus of labor, which will keep wages (the largest component of most US prices) from increasing significantly.
2. Shelter costs will remain low because of the housing surplus, which is caused by low employment growth and high foreclosure rates.
3. Greece, Portugal, and perhaps other nations will default in one way or another. That will make the dollar rise relative to other currencies, which will make imports cheaper.
4. The end of quantitative easing will cause a stronger dollar, which will make imports cheaper. A stronger dollar may also lead to lower US stock prices.
5. China’s growth will slow or even turn negative as they deal with the consequences of their credit boom in 2008-2009. Lower domestic construction will lower their demand for iron, copper, and petroleum. They will rely more on cheap exports to America for maintaining employment.
6. Speculation in metals will collapse, both precious and industrial. Much of the higher demand was driven by hoarding rather than consumption and lead to a bubble.
7. Reduced government spending worldwide will lower both government and household demand, which will lower employment and general prices.
8. Households and businesses are still deleveraging, which when combined with slower government debt growth means that savings is growing faster than debt. The lower demand for debt will keep interest rate costs low.
9. Higher acreage sowed will lead to higher agricultural production and lower food prices.
10. The curtailment of ethanol subsidies will lower the price of corn and lead to lower prices for livestock and corn oil
11. Better weather in the grain belts of the world will lead to lower food prices, assuming that we don’t have two bad years in a row (and La Nina is over).
12. Baby boomers are nearing retirement, and so are saving more and spending less.

Impossible? See Japan’s inflation and interest rates for the past couple of decades.

The Commodities Bubble

Bubbles start with sound fundamentals. In this case it was the end of the global financial crisis, the rapid growth of China, and a falling dollar. But the global economy isn't growing that quickly,China's growth rate is slowing, and the US dollar only rose about 10% against major currencies. The fundamentals don't support the price moves. The increasingly pervasive speculative use of derivatives and ETF's exacerbates natural price cycles. So we are trapped in a volatility machine of our own design.

Commodities are a bubble because demand does not equal consumption. Proof is that stockpiles of commodities are soaring. Wall St. dealers are buying metal warehousing firms. China has stockpiled astronomical amounts of copper (perhaps 550,000 metric tons), and used it as collateral for loans. Now China is exporting copper, which it earlier imported, to other nations for storage. It is crazy, it is destructive, and it is bull.

Beijing Denies Fannie Mae Losses

From an odd little article that I found last month in the Hong Kong newspaper South China Morning Post (registration required).  Apparently an economist at a Chinese bank issued a report advising the government to slash its (reported) $500 billion of Fannie & Freddie securities ahead of losses.  That led to many Chinese ranting and raving in online chat rooms about the losses that their foreign reserve holdings would take.

To quiet the storm, China's State Administration of Foreign Exchange (SAFE) issued the following statement, "The reports that China would lose up to US$450 billion on the investments in the two companies were totally groundless."  

I don't think the Chinese economist who issued the warning knows something that we don't.  But it is kind of amusing to see a bunch of Chinese incensed that their government may lose money to Fannie & Freddie, while we in the US quietly watch as our government definitely loses money to Fannie and Freddie.  Although if they stopped making payments to Chinese investors, I guess that would preclude losses to US taxpayers.  Maybe the economist is afraid we will put that idea to a vote.  What would US taxpayers say?

Real Star Wars

We are moving closer to Star Wars, but it probably won't involve lasers, a missile shield, or The Force.  Yesterday the Air Force launched  another test of its X-37B Space Plane.  This plane looks like a small (29'), unmanned Space Shuttle.  Development used to be headed by NASA, but in 2004 it was taken over by the Defense Advanced Research Projects Agency.

The Air Force won't say much about the X-37's mission or capabilities.  Amateur astronomers have tracked it and noted that it has the same type of orbit as reconnaissance satellites.  Its low earth orbit means it travels at at least Mach 25, and circles the globe every 90 minutes.  A serpentine orbital path regularly puts it over most of the globe on a regular basis.  Like the Space Shuttle, the X-37 lifts off from a rocket, but returns to earth like a plane.  Unlike the Space Shuttle, it can stay in space for 270 straight days.

It is easy to speculate about many military applications that such a space plane could undertake.  Very specialized reconnaissance is obvious, but what else?  The payload potential would allow it to release smaller, less detectable, temporary drone satellites for separate missions.  Or the X-37 could be used to knock out satellites in a number of ways; such as the most obvious of firing a projectile, or less traceable ways such as leaving debris in the path of a satellite, using magnetic waves or particles, or sending a substance that harms solar panel absorption.  

Another military application of a mini-space shuttle could be to launch scramjet missiles.  Scramjets are incredibly fast; they won't even work below Mach 3, have been tested to Mach 10, and in theory would work to Mach 25 (19k mph).  A scramjet has few moving parts and needs to carry little fuel because as much as 90% of the fuel comes from the air and oxygen in the environment that is compressed as it is shoved down the engine throat at Mach >3.

The downside of a scramjet is that you can't get enough atmospheric oxygen to power it until it is going at least Mach 3.  Going that fast isn't easy.  The last test flight required a turbojet B-52 to fire a rocket that contained a scramjet plane - in other words, 3 kinds of propulsion systems were needed.  But with the X-37 already going Mach 25, getting a scramjet started shouldn't be nearly as difficult (though still complicated).

Why is going Mach 10 or 20 so important in a weapon?  It isn't just that speed makes it hard to track or engage countermeasures.  It is that Force = Mass times Velocity^{2 (squared).} At Mach 20, you scarcely need an explosive charge because every 1 pound of the projectile has the force of 400 pounds at Mach 1, but is focused in a smaller area.  At Mach 20, a few pounds of metal would pierce any armor or sink any ship, and a few hundred pounds would penetrate bunkers. 

All of these applications are speculation by me, and I have no experience or education in defense or aerospace.  But some of the potential is obvious, which is why the Chinese have expressed concern that the X-37 is starting an arms space race (China Daily), and the Chinese and Russians are talking about starting their own space plane projects.

China's Economic Dissent

Via Financial Times, a couple of fascinating opinion pieces by a former member of the People's Bank of China's monetary committee, Yu Yongding.  The man isn't a crank .  He has often written opinions in the past, but "A Different Road Forward" is more negative and outspoken.  It is also well written and worth a read.  It appeared in the state controlled China Daily, which suggests that Yongding's views may be controversial, but they aren't heretical.  

He gives a litany of problems facing China:

Chinese Inflation and Banking

Lots of interesting news on China lately.

Beijing City to Raise Minimum Wage 21%  - Beijing will raise the minimum wage by 21%, which follows a 20% rise in June.  Every province and municipality has raised its minimum wage by at least 12% in the past year.  The official inflation rate is 5.1%, with food at 11.7%.

Many stories of China raising its benchmark interest rate on Christmas Day, the second increase in two months.  Perhaps more important is that China has increased the deposit reserve requirements for banks six times last year.  Banks have to hold more money, and are a bit strapped for cash right now.  Here's an interesting summary, Cash Squeeze Forces Banks to Pay Double Government Fund Rate.

Two dramatic quotes on the topic from China Daily.  "Money market rates have now reached levels similar to usury, although we expect them to fall in January when year-end fund demand eases," said a dealer at a bank in Shanghai.  And "This is something no one in the market had ever expected until the last two or three weeks. More surprises are possible as many institutions are now so alarmed that they may tend to hoard more money in the future."

At the same time as the increase in reserve requirements, the growth of Yuan deposits in Chinese banks has started to slow, probably because the higher inflation coupled with very low deposit interest rates has resulted in negative real interest rates for consumers.  The result of this bank cash crunch is that two Chinese government bond auctions failed last month.

This doesn't mean that either the Chinese banks or government are in peril.  But it does signal that the government's attempt to reign in booming lending will probably work.  And that should create lower growth, as is becoming increasingly feared.

China's Housing Bubble

China's economy is booming; workers are getting paid more and moving to larger cities.  Housing construction and prices should increase dramatically.  Unfortunately much of the housing boom is driven by wealthy individuals buying luxury flats as a store of wealth.  They aren't buying houses to flip in the short run, or even to rent out - only to store money.  And China's housing boom isn't fed by sloppy credit to homebuyers, but by sloppy credit to state owned enterprises and local governments who buy land and develop large residential and commercial buildings.  

China's Inflation Problem

China has several sources of inflation.  First, some background.  China's currency policy means that when they buy dollars from their exporters, they pay too many RMB (Yuan).  Paying too much in this case makes their currency relatively cheap.  All those RBM running around should cause inflation.  But China keeps a lot of the RMB from circulating by having high bank reserve requirements, restricting lending volume, and putting money in illiquid bonds.  

October Employment

Everyone's talking about it, so why not me too?  As usual there was steady growth in the healthcare sector.  Also growth in Temporary Help, Retail, Food & Drink Places, Education, and Personal/Laundry Services.  Except for health care and education, I doubt that most of the new jobs have the level or steadiness of income to qualify for a mortgage.

Renminbi Me!

Should China raise its exchange rate?  I think a better question is, “Should China let its businesses hold on to more dollars?”  Because right now, the People's Bank of China takes the dollars that Chinese exporters earn and pays them in Renminbi (aka "Yuan", its principle unit).  Then the People's Bank of China uses those dollars to buy (among other things) US debt.  But what if Chinese businesses still had the dollars to spend?  Then they could buy more goods and services from the US.  That would employ more Americans, and Chinese consumers would enjoy a wider variety of goods and services.

Trade Deficit = Debt Surplus

There is a lot of argument about China’s exchange rate of its currency (the Renminbi, which is measured in units called Yuan) to the dollar.  But what does that mean and how does it work?  Here's one explanation.