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"I Wonder". . . What Will Happen in China   (February 27, 2007)

Dear Readers: I wrote this last night but wanted to add some further comments, so I didn't post it. Events caught up with me, however, as the China stock market plunged 9% and as I write this, the Dow Jones is down 130 points and Nasdaq is down 45 points. The "correction" I called for Monday has begun, and gold has dropped, also as I suggested it might.

Continuing this week's theme of "I wonder"--I wonder how long the Shanghai stock market can go before it crashes a la the dot-com Nasdaq market in 2000.

This chart (from a story recommended by frequent contributor U. Doran) is the picture of unsustainability. This chart forces us to wonder: when this market rolls over and blows up, will there be any consequences in the U.S. and global markets?

Frequent contributor Albert T. pointed out another potentially hazardous connection between the U.S. and China: China's proported interest in buying risky, high-return mortgage-backed securities:

This is news to me but I was thinking, who is going to hold the bag when the housing market goes bust? I found this and basically started laughing. The article is below...

China's financial clout

Testimony of Brad Setser (Roubini Associates) to USCC

(page 14 of USCC link above gives the breakdown in Chart format... had to get another source to confirm, the excerpts from below where they tout sophistication had me laughing a few months ago)(excerpts below)

"As the pot grows, the secretive and sophisticated portfolio managers at China's central bank are trying gradually to boost their country's returns on its foreign-exchange holdings, at least in part by making somewhat riskier but higher-yielding investments. "

"As China's reserves balloon, markets and many U.S. officials believe it to be buying less U.S. Treasury debt, which is explicitly guaranteed by the U.S. government, and more debt issued by U.S. mortgage lenders Fannie Mae and Freddie Mac, which carries an implicit government guarantee.

China's shopping list also is said to include somewhat riskier but higher-yielding mortgage-backed securities and U.S. corporate debt."
Excellent work, as usual, Albert T.

I wonder if the Chinese fund managers are being pressed to find "alpha," (returns above the benchmark), and are therefore turning to higher return investments like mortgage-backed securities and CDOs without fully understanding the much higher risks.

I wonder if China will mis-allocate its foreign reserves, just as it has largely mis-allocated the billions of foreign investments and its own government spending.

I wonder when American will "get it" that the dollar/yuan level is meaningless because if China gets "too expensive" for manufacturers--say, its factory wages rise to $300 a month--the factories will not be shipped to the U.S. and its $3,000 a month wages and $1,000 a month medical insurance, but to Vietnam, Cambodia, Bangladesh, etc.

For more on this subject and a wide array of other topics, please visit my weblog.


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