thecomingchinacrisis 10-06-2011 (1)

7/31/2019 TheComingChinaCrisis 10-06-2011 (1)

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The Coming China Crisis | By Bert Dohmen

www.dohmencapital.com | E-mail: [email protected] | 1

ABOUT THE AUTHOR

Youve probably seen Bert Dohmen on CNBC, or Neil Cavutos

show on FOX News, Louis Rukeyers Wall Street Week or read

his views in Barrons, the Wall Street Journal, Investors BusinessDaily, Business Week, etc. Over the past 33 years, he has been a

favorite speaker at the largest investment conferences. His track

record of accurate and sometimes uncanny forecasts have given

him a world-wide reputation for accuracy and amazing insights.

Bert Dohmen founded the Dohmen Capital Research Group

in 1977. The rms investment advisory services have received

awards of excellence, as well as #1 ratings. Dohmen Capitals onlybusiness is to analyze the major global investment markets for the

best opportunities, and then issue forecasts to its clients. There is

no conict of interest, no axe to grind, and no compulsion to justbe bullish. The words sell or sell short are used frequently.

Over the past 33 years, the forecasts have frequently called

important market tops and bottoms within one or two days. And

that is documented.

Bert Dohmen has forecasted every bear market and every

recession. He has shown his clients how to prot from adversity.

He uses sophisticated technical analysis for his timing. This

discipline measures the change in the supply/demand equation

for an investment or an index over different time periods. Logically,

only a change in supply/demand can change the price of a stock

or the trend of the market.


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The rms eight services include Bert Dohmens WELLINGTON

LETTER, now in its 34th year, SMARTE TRADER for short term

stock

traders, the CURRENCY PRIVATE PORTFOLIO and severalother services for investors and traders which have enabled them

to prot from the markets, whether bull or bear.

He is a member of the NATIONAL ASSOCIATION OF BUSINESSECONOMISTS and the MARKET TECHNICIANS ASSOCIATION.

Bert Dohmen has been warning about the immense future

problems of China while virtually all analysts have been preaching

about the great opportunities of investing in China. Once again,

Bert Dohmen is in the very small minority, just as he was in March

2000 when he wrote that a market crash was ahead, (it was the

exact top of that the internet bubble), and in 2007 when he wrotethe book PRELUDE TO MELTDOWN, predicting that the globe

would see market crashes similar to 1929 the following year.

Now Bert Dohmens work shows that the big surprise for

investors will be when they realize that what was assumed to be

the long term driving force for the global economies, is having

its own economic crisis. China was the locomotive of the global

economies, the nancing mechanism for the immense US debt,

the source of incredible demand for commodities and oil, and theeconomic power of Asia.

Bert Dohmen is not a perma-bear, someone who is always

negative on the markets, predicting the end of the world. In fact,


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most of the time he is an optimist, especially when gloom and

doom hangs over Wall Street. In bull markets he is bullish, but in

bear market he is correctly bearish and shows his clients how to

make money in plunging markets.

His book in 2011, FINANCIAL APOCALYPSE, describeschronologically how his analysis of charts and the credit markets

allowed him to precisely catch the important tops of the major

markets in the 2007-2008 for his clients.

He correctly identied the start of the big recession in December

2007, while Wall Street economists still claimed eight months laterthat it was not a recession. In his Bert Dohmens WELLINGTON

LETTER he called the bull market top within 2 days of the start

on Oct. 13, 2007 while most analysts were very bullish.

And when oil hit $149 per barrel and a major Wall Street rm

predicted $200, he said that crude oil prices had made a peakand would drop to at least $80 and lower later. They actually

plunged below $50.

In 2007 he predicted a crisis of proportions similar to the 1930s

Depression. His time table for the rst sustainable bottom was

2017 using long term cycle analysis. That was ridiculed by someanalysts. However, now other analysts are talking about 2015-

2016 as a potential bottom. He made these predictions as well in

his book, written in 2007, PRELUDE TO MELTODOWN.

While virtually no analyst agreed with Bert Dohmen in 2007

that the country would go into the severest nancial crisis since


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the 1930s, the attitude is now similar in regard to China. Most

analysts point to China as the never-ending growth engine for the

world. But that makes the world so much more vulnerable when

China goes into crisis.

Bert Dohmen says that China has had a credit bubble the past

two years, not genuine growth. The GDP growth numbers are

totally false as China does not correct for the very large price

increases. What they count as growth, is nothing more thanination.

Reading this book, may save you, or make you a fortune. Itsthe most important read of the year.


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TABLE OF CONTENTS

ABOUT THE AUTHOR 1

TABLE OF CONTENTS 5

INTRODUCTION 7

COMMODITY PRICES WILL TUMBLE 11

THE REAL ESTATE BUBBLE 14

EMERGING COUNTRIES:SHARP SLOWDOWN! 17

THE BATTLE AGAINST INFLATION 18BEWARE OF CHINESE IPOs 22

A BRIEF HISTORY OF RECENT U.S. BUBBLES 23

HOUSING DEBT 25

THE FINANCIAL TSUNAMI 26

CHINAS TRADE DEFICIT SOARS 28

UNAFFORDABLE REAL ESTATE 30

NEW ITEM FROM CHINA 33

DOUBLE-DIGIT INTEREST RATES AHEAD 34

A TURN OF THE TIDE 36

TIGHT CREDIT AND A SHARP SLOWDOWN 39

POWER SHORTAGES 40

OVERSUPPLY 41

THE CHINA BUBBLE IS BURSTING 42THE MEDIA TAKES NOTICE 45

CHINA IPO DISASTERS 46

THE COMING REAL ESTATE COLLAPSE 48

THE SQUEEZE 50

WATER SHORTAGES 51

CORRUPTION AT ALL LEVELS 52

THE WEAKENING CHINA ECONOMY 54

DEBT DEFAULTS ARE STARTING 56

A MT. EVEREST OF DEBT 58

SOCIAL UNREST 59


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BIG BROTHER 59

FUTILE INFLATION FIGHTING 60

THE GROWING MANUFACTURING CRISIS 63

IS A SOFT LANDING POSSIBLE? 65

CHINA CAR SALES PLUNGE 67

STEEL PRODUCTION: NOT RELEVANT 69

THE EMERGING MARKETS: CRISIS AHEAD! 72

THE REAL ESTATE BUBBLE BURSTS 74

SIMILARITIES TO JAPAN 76EPILOGUE 81

A NOTE FOR INVESTORS 83

CALLING THE PLUNGE: MID-2011 86

HIGHLIGHTS OF BERT DOHMENS 33-YEAR TRACK RECORD 90

TESTIMONIALS 95

DOHMEN RESEARCH ADVISORY SERVICES 100

AND SUBSCRIPTIONS 100


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INTRODUCTION

Some of the older stories in this book are from issues of the

award-winning WELLINGTON LETTER where we warned our

clients to prepare for the next phase of the global nancial crisis.However, most of the content of this report is about what is

happening now in China, and what is likely to happen over the

next year or two. I am a big China bear now just as I warned of

the U.S. meltdown in my book, written in 2007, PRELUDE TOMELTDOWN.

China has had remarkable economic growth. But it had

a lot of catching up to do. China was about 100 years behindthe industrialized nations of the world. And much of the

catching-up was due to the technology of the west. Look at this

parabolic growth.


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Many people think that Chinese ingenuity has produced the

strong economic growth in China. The facts are different. It was

cheap labor that allowed China to be the export king, with hugeforeign cash reserves building up for the government.

Furthermore, the manufactured Chinese goods are really

a product of free, western technology. Imagine, China didnt

have to develop any of the technologies, the patents, the

manufacturing methods, machinery. This was the product of

100 years of effort in the US and Europe. And it was given to

China free of any cost. In fact, its a requirement to give it when a

foreign rm wants to do business in China.

That, combined with ultra-cheap labor, is how China was able

to make the big leap. However, the catch-up phase and the free

use of this technology is now coming to an end. In the future,

China will have to do its own development. Thats costly. It meanspaying labor and especially engineers and other professionals

much more. General wage increases the past two years are about

40%. Those for professionals are much greater.

The cost increases create price pressures, i.e. ination, a squeeze

of prot margins, and the counterforce from the government to

stop ination via a credit crunch.

A credit crunch and economic downturn now will be very painful.

Many companies will close. Unemployment will rise, social unrest

will soar, and the government will become more oppressive.

My work strongly indicates that China is now going through what


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the U.S. did in 2007-2008. The difference is that the over-investment

is in non-productive projects, such as huge construction projects,

shopping malls and entire cities which are empty, over 40 billionsquare feet of commercial space under construction now, most of

which will never nd an occupant.

The crisis will present great opportunities for investors and

traders who are informed and have the best guidance. During

the 2007-2008 crisis in the US, subscribers to our variousadvisory services, from the award-winning WELLINGTON

LETTER, to our almost daily trading services like SMARTE

TRADER, were able to make huge prots as the various

markets tumbled from 50%-60%, or more.

Another such opportunity is around the corner.

Chinas capital investment is over 60% of GDP. Much of that is

in such projects as mentioned above. This compares to 6-8% formost other industrialized countries. Of course, China had a lot

of catching up to do. The problem is that governmentally funded

programs create huge debt and very little return for many years.

The crunch in China has started. We believe it will unleash a

tsunami throughout the nancial world, potentially much stronger

than the 2007-2008 crisis. That one was mostly company-specic,

where many nancial rms went bankrupt or had to be rescued.The next crisis will involve entire countries defaulting. No one is big

enough to bail them out.

An implosion of a credit bubble is always deationary as the


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creditors lose what they thought were their assets. Only when

the central banks engage in a desperate money creation binge

to prevent a depression will we see currencies plunge in valuecompared to assets, things, which have the ability to maintain

their intrinsic value. Currencies will be avoided in favor of hard

assets, like gold, silver, and other commodities.


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COMMODITY PRICES WILL TUMBLE

In November 2010, I wrote that Chinas tightening of creditwas starting to be noticed by the markets. I had been warningabout this for months. The fear of further interest rate hikes in

China roiled the global markets. Anything related to commodities

tumbled in the week of Nov. 15, 2010. That was a preview of whatis ahead when things really get serious.

China may like the lower prices. Commodity prices had soared

over the past several months, increasing the purchasing prices of

raw materials to China. What better way to get lower prices and

ghting ination pressures at home than to promote the idea thatinterest rates will rise, the economy will slow, and commodity

prices will drop? Chinese ofcials said that copper prices wereabout 20% higher than justied. That caused a plunge in copperprices.

Obviously, ination numbers in China were conrming my view

that ination would become a huge problem. Chinas consumer

price index surged 4.4% in October from the year earlier period,much more than generally expected. But we predicted this in Bert

Dohmens WELLINGTON LETTER. The prior month ination was up3% (annualized). You see, my prediction was that the governments

ght against ination, through higher interest rates, would actually

boost ination.

We wrote: China is now on the road to very high rates and

then an eventual plunge into recession. The government will hike

rates on every ination report. That will boost ination pressures,


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producing further interest hikes, which increase the cost of doing

business. It never has a happy ending.

According to Miss Sharmin Mossavar-Rahmani, CIO of

Goldman Sachs Private Wealth Management, since 1993, when

the MSCI-CHINA index came into existence, the U.S. stock markethas outperformed this index by 8% per year, in spite of the tech

bubble burst in 2000, the 9/11 attack, and the credit market

implosion in 2007-2008.

Thats amazing. The popular perception that China is the great

investment story is overhyped. The reason is that many of the

largest companies are owned by the government. If the real estate

bubble bursts, it may produce a rerun of 2008, when the stock

markets crashed around the world.

Is China the next great super power? It could happen. In fact,

many analysts predict that this may happen over the next 20years. But we remember the late 1980s when the same was said

about Japan. At that time, Japan was 18% of world GDP. Today,

Japan and China combined are about 8% of world GDP. AsMr. Michael Pettis, a professor at Beijing University School of

Management, points out:

An article in Sundays [Oct. 17, 2010] New York Times

says:

In 1991, economists were predicting that Japan wouldovertake the United States as the worlds largest economy

by 2010. In fact, Japans economy remains the samesize it was then:a gross domestic product of $5.7 trillion

Th i hi i i | h


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at current exchange rates. During the same period, the

United States economy doubled in size to $14.7 trillion,

and this year China overtook Japan to become the worldsNo. 2 economy.

A lot of things can happen on the path to greatness. China still

has to make the transition to a more democratic system where

people can vote. Will that happen without turmoil?

Th C i Chi C i i | B B t D h


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THE REAL ESTATE BUBBLE

In our December 2010, issue of the Wellington Letter, wenoted that the latest numbers released by China (Dec. 11, 2010)revealed that the economy was continuing to grow strongly in

spite of efforts to tighten money.

Industrial production rose a hefty 13.3% last month (year-over-

year). Consumer prices rose a big 5.1%, the most since July 2008.Thats the ofcial number. Actual ination is probably two to three

times higher, according to business people in China. The GDPdeator, a better measure of ination, is close to 11%.

Vegetable prices in the major cities rose 62% in the rst 10 days

of November. Food prices, which account for one-third of weightin calculating the CPI in China, climbed 10.1% in October. Cotton

prices are skyrocketing. According to the website Cottonchina.org,the cotton price has climbed from about 18,000 yuan (US$2,713)

to 28,500 yuan (US$4,296) per ton since September 1. Thats over

50% in just 2.5 months.

An even bigger problem is that people cant afford these higher

prices. Sales for cotton products have plunged. That means the smallvendors are starving. The high food prices lead to hungry people.

All this creates more unemployment. And historically, hungry and

unemployed people riot in the streets. Thats always the 24/7 fear

of any totalitarian government.

The governments tightening efforts have been much too timid.

In Dec. 2010 I wrote: Next year, they will get more serious about



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battling ination, and that wont stop until the economy stumbles.

There is no soft landing from a bursting credit bubble. The more they

procrastinate now, the greater the credit crunch later. Remember1980-1981 in the U.S.? Well, take that and multiply by 100 for

China.

We made the case that China was heading for one of the largest

real estate disasters since Dubai. The main problem in China

is the huge, speculative real estate bubble that we have beendiscussing. That can go on for several years, and usually does,

before governments get concerned. Remember, in the U.S. some

very smart hedge fund managers started investing for a bursting

of the U.S. bubble in 2005. They were about two years early, but

eventually they made billions of dollars.

Ination is always the limiting factor to any expansion fueled

by excessive credit. Once government becomes worried about

rising ination, you get into the end game. And that always endswith a great amount of pain. Its like a giant hangover: the pain is

proportional to the amount of fun you had at the party.

Instead of looking into the mirror, Chinese ofcials now

blame the Feds quantitative easing for Chinas ination. Thatsridiculous, as the stimulus of the Chinese government has been

three times greater than the one in the U.S. on the basis of the

size of GDP.

In 2009 the money supply in China increased the equivalent

of 40% of GDP, according to Lombard Street Research. In 2010it has increased by $115 billion a month, says Citigroup.



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Compare that to the Feds QE2 which is $75 billion per month.

Chinas GDP is only about 30% of the U.S.s. Chinas money

supply M2 is now double the size of Chinas GDP. In the U.S.its a little more than 60% of GDP.

Chinas government is ghting ination as all central banksdo, i.e. with totally ineffective measures. They raise interest rates,

they raise bank reserve requirements, and they set limits on total

loans outstanding. Historically, such measures dont work untilinterest rates get so high that the entire speculative pyramid

crumbles. Only then does ination decline.

In my view, Chinas credit bubble of the past 18 months is

much larger than the one that burst in 2007 in the U.S., Europe,

and Asia. The consequences could be worse as well. But it willtake time to materialize.



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EMERGING COUNTRIES:SHARP SLOWDOWN!

In late 2010, we wrote:

The popular perception is that the emerging markets are

still booming. Well, real (ination-adjusted) GDP contractedsequentially in the third quarter (2010) in Singapore, Malaysia,

the Philippines and Thailand. In Hong Kong, Taiwan, Korea andMalaysia there was basically no growth.

The OECD Composite Leading Indicators (CLI) indicates that

the ve major economies of Asia, including China, are, in fact,slowing faster than those in the OECD. China is slowing the

fastest with the CLI declining 3.9% year-over-year in September.This explains the poor performance of China stocks in spite of

every analyst in the media recommending China.

Then look at the countries outside of the OECD: The LEI inBrazil has gone from nearly22% year-over-year in early 2010

to just below 3%, India from 15% to 6% and China from 27%to 10% in late 2010.

We could call that a screeching slowdown. If you extrapolatethose trends, you see recessions next year.



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THE BATTLE AGAINST INFLATION

In Dec. 2010 we wrote:

On December 24, the Peoples Bank of China raised thebenchmark one-year lending rate by 25 basis points to 5.81%.

The one-year deposit rate will go to 2.75%, effective immediately.

The bank is raising rates now because usually rates on loans are

adjusted at the beginning of the year. This means that credit foreveryone will be adjusted upward in January.

As we have been pointing out all year, China is now on that part

of the credit cycle that eventually always ends in a credit implosion.

There is no painless way to get off it, although they certainly will

try. China has had the greatest credit bubble in modern history.The broadest measure of money supply, M2, has surged by 55%

over the past two years, and loans have climbed 60% to 47.4 trillionyuan (about $6.8 trillion). Considering that Chinas economy is less

than one-third the size of the U.S. that would be like $20 trillion in

loan creation in the U.S. where the size of the GDP is about $14

trillion per year.

In Jan. 2011 we wrote that analysts had the opinion thatinterest rates in China would rise another 100 basis points (one

percentage point). We strongly disagree! That was much too low.

In the late 1970s in the U.S. economists were equally wrong. They

said the prime rate would peak out at 12.5%. We predicted inthe Wellington Letter that the U.S. prime rate would hit 20%.

Economists called that ludicrous. But it happened in 1980.



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We will now go out on a limb: we predict that the one-year

lending rate in China will eventually rise to at least 12%. And it

wont stop there.

When the government recognizes that all its efforts to control

ination are too tepid and thus futile, it will eventually instituteprice and wage controls. Imagine what that will do to the

international commodity and nancial markets.

Chinas central bank will have to reduce speculation. But

current measures are too mild. When interest rates rise strongly

and ination along with it, and further increases are expected inboth, speculation is the only way to keep up. People are only

getting 2.7% on their bank deposits. Prices in the big cities are

rising at 10%-30%. That forces people to speculate.

Governments always make the same mistake; it tries to control

ination by raising interest rates instead of strong measures tocurb lending. It considers the latter method too painful. But it is

the only thing that works. Ask Paul Volcker. Thats what he did

in 1980.

In China, the situation is similar. Governmental ofcials atthe national and the local levels proted beautifully from the

property bubble. Therefore, it was allowed. But now that property

has become totally unaffordable for the average person, the

government has to act if it doesnt want 200 million people riotingin the streets. The end of the bubble is near.

In late 2010 early 2011 China started to accelerate its tightening



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moves. It raised bank reserve requirements three times, but

in ridiculously small amounts. The last move came on Dec. 11

when it added 0.5% to the reserve requirements. Such moves didnothing to curb rampant bank lending for more construction of

buildings that will be empty.

China then limited the purchase of property by foreign rms

to property used for their own businesses. Just about every week

there was another rule change aimed at reducing speculation.

China has embarked on the traditional central bank cycle. First,

they fuel excessive growth through massive money injections; this

creates speculative bubbles that produce rising ination, which

is then fought by the government through tightening measures

and sometimes price and wage controls. The cycle continues untilthe back of the economy nally breaks. Only an implosion of the

speculative bubble stops the cycle. There is no happy ending.

The economy is already slowing rapidly, but the numbers are

being disguised as the government always quotes year-over-

year numbers. That doesnt tell you anything about the last fourmonths.

Governmental statistics in China are considered unreliable.

So, to see what the economy is doing, a good proxy is electrical

output consumption. After all, it takes electricity to run factory,

light ofces and homes, and keep the economy going. Here is achart up to Oct. 2010 of electrical output in China.



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The graph has plunged to the lowest percentage change, i.e.,

shrinkage, on the chart that goes back to 1988. This is a hugecanary in the mine.

My forecast is that when the China bubble bursts it will be like

a tsunami through the global nancial world. Will you be ready?



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BEWARE OF CHINESE IPOs

There is a big boom in the U.S. of Chinese companies goingpublic (IPOs). So far, 24 IPOs have been done in the U.S. of Chinese

rms, which, according to Herb Greenberg of CNBC, is twice lastyears rate and 21% of all IPOs done in the U.S. this year. Some

large mutual funds in the U.S. are buying them. Should you?

The problem is that these are very small rms, less than$100 million in sales. Another problem: can you really believe

their nancial statements? To us this smacks of a late-stagephenomenon. In the U.S., when the cat and dog stocks run,

you know its time to look for the exit. Remember the China stock

boom in 2007? We had about 200 Chinese stocks trading in the

U.S. on our computer screen. Most traded actively.

Now, there are only about 30 of them that trade more than10,000 shares per day. The majority of the stocks have no quotes

at all, apparently having gone out of business. Obviously, a great

deal of money was lost by investors. There is a long-standing rule:

when you see many IPOs, it means that the smart insiders areselling their shares to the uninformed public. Guess who wins?

We ask who will the mutual funds that are buying these stocks

sell to when they want to get out? One IPO is LE GAGA, symbolGAGA. Can it get more blatant? The company is a produce

wholesaler. Another high ying Chinese IPO, RINO, was delistedfor accounting irregularities. Other Chinese IPO stocks havealso been delisted or have stopped trading because of accounting

problems.



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A BRIEF HISTORY OFRECENT U.S. BUBBLES

All credit bubbles are produced by a government and its central

bank. A good example is the late 1970s in the U.S. The Fed made

it clear it would not tighten money availability, just make it more

expensive. For us, that was the signal that a speculative inationbubble would be created. We forecasted that the prime rate would

rise to 20%, and we became big bulls on gold.

That episode ended with the prime rate at 21.5% in 1980, 30

T-bonds collapsing to yield 15.75%, and ination in the double

digits. Paul Volcker nally came in and crunched credit. As aresult, commodities and the stock market plunged. We started

selling gold related assets short when gold broke down through$694. The back of ination was broken, but with severe pain.

The bubble in the U.S. stock market in 1999-2000 occurredbecause the Fed did not raise margin requirements for stocks and

supplied all the credit possible. Excessive money growth always

goes into speculation. And that created the internet stock bubble

that then collapsed.

From 2003 to 2007 the Fed once again blew up a huge bubble,this one in housing, and the derivatives linked to that. The Fed

and other regulators not only allowed that speculative bubble to

grow, they encouraged it.

The SEC agreed to the requests of major Wall Street rms to

allow the leverage ratio of debt to capital to go to 34 from 12. At



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the higher number, it only took a 3% decline in the value of the

investments for the rms equity to be wiped out. And thats why

Bear Stearns and Lehman Brothers failed.

Each period of excessive stimulation by the Fed ended in

a market crash and a deep recession. This is the reason that

no small group of non-elected people should try to control the

behavior of 300 million people via monetary policy. They only

make things worse.



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HOUSING DEBT

The US home mortgage market is valued at some $10.6 trillion.Foreclosures and past-due loans amount to some 14% of the

market, or about $1.5 trillion.

Of this staggering gure, the loans delinquent or in foreclosure

to which the top three banks (Bank of America, Wells Fargo and

JP Morgan) are exposed amount to more than $600 billion.

Those bad loans must be handled by the banks. The banks

hope that they will be bailed out by a housing recovery. But there

is no recovery.

When the U.S. economy goes into a recession again, and thengets hit by the European crisis, and then by the China crisis, all

these bad loans on the books of U.S. banks will have no chance of

recovering their value. And that is why the stocks of the big banks

are behaving so poorly.



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THE FINANCIAL TSUNAMI

In our WELLINGTON LETTER of February 2011, we wrote:

China will be the source of a tsunami heard around the

world. It may occur as soon as later this year or perhaps not until

one to two years from now. But it will happen. Once you get on this

roller coaster, you cant get off without severe pain.

However, for investors the early phase of such ination can beprotable, especially if you concentrate on strong countries that

have lower ination. And that means the U.S. Once the global

investment capital ows recognize that the U.S. has become the

safe haven, money will ow out of the emerging markets into

the US. And that will produce an awakening of all the emergingmarkets investors.

We would shun those markets now. The risk is high and the

potential reward is too low. Realize of course that this is denitelya minority view.

If your broker talks you out of selling that area, ask him if heis aware of the big declines in the emerging markets during 2008.

Brazil is seeing rising ination, which is now 6.7% (June 2011),versus the 4.5% target for last year. Food prices are rising at

10.4%. As we all know, governmental statistics usually err onthe side of painting the news better than it is. The government is

getting concerned. Prices in Brazils department stores for normal

goods like jeans, shirts, sweaters, etc. are three to four times



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higher than in the U.S.

Brazil is now preparing for World Cup Soccer and the Olympics.Imagine how the huge construction for these events will boost

ination.

CONCLUSION: The emerging countries are now caught in a

trap. They have sharply rising ination and people are getting

restless. If they ght ination harshly with tight money, it meansrecession, even more economic pain, and riots in many countries.

If they dont, it means much higher ination later and an evenstronger recession. There is never an easy way out of a speculative

bubble.



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CHINAS TRADE DEFICIT SOARS

In March 2011 Chinas latest trade numbers showed a surprisingtrade decit of $7.3 billion, with imports exceeding exports. It

was the largest decit in seven years. That means China is nowimporting more than they are exporting.

Much of Chinas growth has been based on exports. Its easy

to gure out what a decline in business for this industry will doto Chinas economy. Building large buildings that remain empty

has also been a signicant contributor to Chinas GDP growth.Chinas period of accelerating troubles is starting.

In spite of the eight increases in reserve requirement for banks,

loan growth had not slowed in March 2011. And thats the key.When the government nally gets serious, it will be very painful.

Furthermore, there is disagreement among policy makers

about further tightening. Li Lihui, governor of the Bank of China,

said reserve requirements cannot be raised further. However, Su

Ning, a former deputy governor of the Peoples Bank of Chinaand now a member of the Chinese Peoples Political Consultative

Conference, said that the ratio could be raised further without

compromising economic growth.

The loan growth for February suggests that a sharp slowdown

is occurring, as loan growth was down 40% from the prior month(600 billion from 1 trillion yuan), according to China Daily. Thats a

screeching halt. Credit growth has always been our best indicator

for what is happening in the economy. Note that this is a growth



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slowdown, not a nominal change. But it is a solid sign that the

Chinese economy is decelerating sharply, no matter what the

governmentally produced statistics say.

Chinese Premier Wen Jiabao said in an online discussion

Sunday (Feb. 27) that the government will reduce its annual GDPgrowth target between 2011 and 2015 to 7% to raise the quality of

growth and improve living standards. Wen also pledged to reduce

energy consumption per unit of GDP during the period of thetwelfth ve-year plan.

CONCLUSION: Our work shows that Chinas economy will slow

noticeably this year. Judging by the market reaction to the trade

decit, such a slow-down will shock the global markets.



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UNAFFORDABLE REAL ESTATE

In the April 2011, issue of the Wellington Letter we wrote:

The bursting of the China property bubble is inevitable in ourview. Only 10% of the people can afford the median priced home. In

California at the top of the housing bubble we think it was around

15%. When most people cant afford the real estate, where will the

buyers come from when the speculators try to sell? There wont beany buyers.

In February 2011, real estate prices in China dropped 4%,

ofcially. To us that means they dropped much more. Furthermore,price declines after a multi-year speculative real estate bubble is

usually very negative. It brings more supply to the market as thesmarter speculators sell. But then they cant nd buyers, andprices drop further. Its usually the end of the bubble.

The government is trying property sales tax in two cities,

Shanghai and Chongqing, to slow real estate speculation.

In Shanghai, the property tax applies to only new housing,including villas, purchased after March 27. The overall tax burden

will be heavier in Chongqing than in Shanghai. There are three

tax rates in Chongqing: 0.5%, 1% and 1.2%, while they rangefrom 0.4% to 0.6% in Shanghai. These are ridiculously low.

These very low penalty tax rates are certainly insufcient toreduce property speculation. Put that together with the mild efforts

to raise interest rates, and you can easily see that the government



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is behind the curve. That means ination will continue to climb,

and the day of reckoning is pushed out into the future. But when

it comes, it will be that much more painful.

A colleague, Simon Hunt, just visited China again. He points

out what we have said in the past, that the ofcial ination ratedoesnt come close to the actual rate. Instead of 5%, business

people tell him its at least 20%. Credit has become tight, if you

can even get it. And that is the ultimate stopper for the economy.

Using the GDP deator, a better measure of actual ination,gives you much lower real GDP growth numbers. He says this:

Using the GDP deator to get a good handle on actual changes

in the economy provides a much better t to what one heard onthe ground in recent years, namely that in the second half of 2008

business tanked and remained very soft through the rst half of

2009. On this count, real GDP rose by 7.8% in 2008, not 12.6%,and actually fell by 0.6% in 2009, not increasing by 7.7% in 2009

as the CPI deator would show.

And last year, real GDP rose by 6%, not the 13.6% deated

by the CPI data.

We can see that half of economic growth comes from

ination!

Simon Hunt found the huge built up inventories in the supply

channels:



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For instance, during 2010 car makers increased their inventories

by an average of 21%, but by118% for cars of 1 liter or below

and by 125% for those between 2.5-3.0 liters. Other examplesare:

Refrigerators 33%, air conditioners 44%, washing

machines 30%, mobile phones 30%, computers 34% and

color TVs 13%.



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NEW ITEM FROM CHINA

We read many publications and articles out of China. We ndimportant facts you cannot nd in the US media. Here is one item

from April 2011:

The Chinese government accused Google along with three of

its afliate companies oftax evasion. Currently Google is under

investigation. Three companies afliated with the search engineGoogle are being investigated for tax fraud in China...

The companies have been found using fake invoices. Accounting

and business tax irregularities involving more than 40 million yuan

(US$6.06 million) were also discovered, the newspaper said.

Remember in early 2010 Google moved from China to HongKong over a dispute about censorship. Is this retribution?



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DOUBLE-DIGIT INTERESTRATES AHEAD

In the Wellington Letter of April 2011, we wrote:

Over the weekend of April 16, Chinas central bank hiked bank

reserve requirements again, this time 0.5 points, to 20.5. Thebanks governor said that monetary tightening will continue for

some time. We believe another interest hike will probably comein May from the current 6.3% for one-year money, to 6.8%. But byyear-end, we predict that interest rates in China will be near or

over 10%.

We hear that private companies cannot get credit. The squeeze

is on. Yet the China bulls think that China can engineer a softlanding. Only if you believe the moon is made out of cheese.

So many analysts talk about the strong economic growth of

China. However, my view is that most of the growth which shows

up in economic statistics like production, sales, etc. is actually an

increase in prices, i.e. ination.

Here is the example above as applied to China. In 2010, GDP

in China grew at 9.8%. Thats after adjusting for ination. But

ofcial ination was said to have been 3.3%. Business peoplein China say its at least 10%-20%. Lets just say ination is

understated by 10%. That means that GDP growth, after ination,would actually be near zero. In other words, all the GDP growthis actually ination.



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Or if you assume that perhaps the understatement is 5%, then

actual GDP growth is 4.8%, certainly a lot less than advertised.

Ination is causing many rms to close up as they can no

longer pay the rising costs. Do we hear that in the U.S. media?

Export growth and real estate construction is the largest

contributor to economic growth in China. They are growing. They

continue to build buildings, cities, and shopping centers whichstay empty. Its counted in GDP. But is that productive economic

growth?

Obviously, there must be a lot of shrinkage in other sectors

to produce the anemic GDP growth when we adjust it for actual

ination. When it comes to governmental statistics anywhere,things are not always what they seem.

Now think of what will happen when the global economies

have a sudden slowdown, as they will. The Middle East is on re.Japans catastrophe has not only sharply reduced that countrys

growth, but because of supply-chain disruptions, it is affectinggrowth in other countries. Just imagine if Chinas exports are

now reduced because of slower global growth! It will be painfulas it comes just at a time of tightening credit and sharply rising

interest rates in China.

China will be the source for the next global crisis.



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A TURN OF THE TIDE

In the May 9th issue of Bert Dohmens Wellington Letter, wewrote:

The Chinese economy is now starting its long-term correction of

the credit and speculative excesses. It will soon become clear that

the alleged great economic growth of at least the past two years

was merely a credit bubble, not genuine growth.

Entire cities are empty of people. But the construction counts

as part of Chinas GDP. The worlds largest shopping mall,

the South China Mall, has virtually no occupied shops and noshoppers.

At the same time, the average Chinese person lives in a

one-room shack, many of which are destined for destruction in

order to build more huge highrise apartment buildings, which willalso remain empty. The housing glut of unaffordable homes and

apartment in China continues to grow. One analyst stated that

there is about 30 billion sq.ft. of new construction in progressright now. With the new efforts to curb speculation, its a cinch

that most of this will never be sold or occupied.

This is the type of stuff revolutions are made of. And the

government knows it. Therefore, the real estate developers, in spite

of the excellent political connections, will eventually be sacriced.

We remember when in 1990, Japan announced their intention

to kill real estate speculation with tight money. Their stated goal



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was to get real estate prices down by 30%. A Finance Ministry

ofcial was asked by a journalist if that wouldnt bankrupt many

developers. The reply: Easy come, easy go. Thats when wepredicted a ten-year period of recession and disination for Japan.

No one believed it. But it happened and even lasted much longer.

Capital investment in China makes up more than 60% of

GDP. Thats a number never seen before anywhere. For other

industrialized countries, its less than 10%. The consumer isonly about 34% of GDP vs. about 70% in the U.S. Interestingly,

about six years ago when the Chinese government made its goal

to increase the consumer portion of GDP, it was over 45%.

You see, the command economy is not that controllable. In

fact, lots of it is just a group of party ofcials making up numbers.Its similar to some of the nancial statement of Chinese rms.

In its ght against ination, Chinas central bank said it willcontinue using price control measures including interest rates

to curb ination. Well, that doesnt work. Price controls just

distort the markets. President Nixon tried that in the early 1970sand it led to a horror show. What started as a program printed on

fewer than 100 pages ended being thousands of pages.

And using interest rates to ght ination only enhances

ination as companies raise prices to offset the higher cost of

money. Only tight credit restrictions can stop ination, but thathurts. Therefore, politicians usually avoid that.

Now we are seeing an avalanche of new IPOs of Chinese



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companies on the NYSE. In years past, such stock could never have

been listed on the NYSE. But the exchange needs the business.

History shows that when any group of insiders sells their stockto the public, its an effort to exit, i.e. get out while the getting

is possible. This is a sure sign that there is a big trouble brewing

in China.

CONCLUSION: If you want to speculate in China, do it by selling

short in a conservative manner. China is once again where it wasin 2007, before the big implosion, except that the current bubble

is probably 10 times larger.



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TIGHT CREDIT AND A SHARP SLOWDOWN

The MNI China Business Sentiment Survey of May 27 fell to61.22 in May 2011 from 69.28 in April. The index was at 78.46 in

May last year. Thats signicant deterioration, but China is stillone of the favorite markets of the bulls in the media.

Credit conditions remain very tight. In April, the index for

credit availability hit the lowest level in the surveys six-yearhistory. As long-time subscribers know, according to our Theory

of Liquidity and Credit, credit availability is the most signicantdeterminant for economic growth.

Tight credit is the boom killer. We dont understand why hardly

anyone talks about this. When credit becomes so tight that nobusiness can get a loan, which is the case now, the highly inatedcredit bubble implodes. Thats extremely painful and produces

more than just a slow-down or recession.

We have been saying for over one year that when the speculative

real estate bubble in China is nally popped by the government,a soft landing becomes impossible. This is very serious and

will produce the next global nancial crisis. And thats where

we were in early summer of 2011, although virtually no one

in the west seemed to be aware of it.



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POWER SHORTAGES

Eastern China, where all the manufacturing is located, is facingthe greatest power shortages since 2004. Part of the problem isthat the government had been encouraging people to buy electrical

appliances to improve their way of life. Now they have all the

gadgets, but dont have the power.

Many companies report that they dont have power one out ofthree days. So they install diesel generators to make their own

power. But that takes diesel fuel, and now there are shortages of

diesel fuel.

In eastern China where all the production is, there is a projected

shortfall of around 19 million kilowatts of power during thepeak summer season, according to the East China Power Grid.

Households will get priority over industry. Yes, people can riot in

the street, companies dont.

On another note, entrepreneurism is blossoming in China.

The Beijing Business Today journal reported that more than1,100 rms in Beijing alone are getting ready to list their stock

on Chinas stock exchanges. That includes more than 800 newhigh-tech rms.

Developed capital markets are necessary for long-term growth.

Thats an advantage Britain and the U.S. had for more than 100years. We wonder how many rms will have accurate nancialstatements.


OVERSUPPLY


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OVERSUPPLY

There are some things which are not in short supply in China.The head of Chinas Baosteel Group recently predicted the

imminent collapse of iron ore prices.

He said that the production of iron ore has far exceeded

demand due to the uncontrolled expansion of production capacity

by the worlds mining companies. The bubble is about to burst,he said.

Another thing in oversupply is commercial real estate.

Reportedly, there is now 30 billion sq. ft. of commercial real

estate under construction. The optimists might say that even

if there is an oversupply, high economic growth will eventuallyabsorb it. The problem is that the shoddy construction starts to

show after two to three years. Who will want these after ve to tenyears?

The real estate bubble in China is imploding as we speak, yet

it seems to be widely ignored. The head of one major developer inBeijing, Miss Zhang Xin, said that sales in Beijing dropped 50%.

In all of China, sales are down 27% in April, and prices haveplunged 21%.

This is the tsunami that will go around the world. You cant

be nave and think that just because its a dictatorship theycan produce a soft landing. But it will present some great

opportunities for short sellers. All of Asia will be a short-sale.


THE CHINA BUBBLE IS BURSTING


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THE CHINA BUBBLE IS BURSTING

In the June 2011, we said:

Asias huge, speculative real estate bubble is bursting like

a hot bottle of champagne.

Hong Kong real estate has had a huge bubble which is now

cooling according to local real estate people. Well, what they callcooling is the start of what will be an immense implosion.

The central bank of China in April warned of the risk of a

credit-fueled property bubble. Really! They just noticed that?

Barclays Capital warns that Hong Kong home prices could fall as

much as 20% in 2012. In my view, that will be just the start.

The Hong Kong Monetary Authority has tightened rules on

mortgage lending four times since Oct. 2009. Down paymentshave been increased on locals, and more on foreigners.

Singapore is also a very hot real estate market. Notice that HongKong and Singapore are considered safe havens for internationalcapital ows. Money goes to where it is welcome. Its primarily the

foreigners who are still the big buyers. But the bubble has been

blown up even more in these safe havens, which means that

they will also experience an implosion.

The Singapore government in January (2011) raised the downpayment on second mortgages and extended the sales tax for

home sales to four years from three as it added more rules to curb


speculation


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speculation.

The reality is that the efforts to cool speculation are still amatter of too little, too late. In other words, the central banks are

behind the curve. It still pays speculators to speculate in spite ofthe higher taxes and higher down payments. However, eventually

the central banks will catch up. And that is when the real pain for

the markets starts.

India is another place where a sizable correction is ahead. The

central bank has raised rates ten times since March last year.

That has resulted in home prices in Mumbai declining 20%.Developers are reducing prices to move the inventory. History

shows that once developers start lowering prices, the game is

over. The speculators want to sell but cant nd buyers. Thatmakes other potential buyers stand on the sidelines. And thus,

prices implode.

Australia has had a huge property price bubble, fueled by the

commodity boom and demand from China. Its obvious that with

all the Asian central banks tightening credit in order to choke offreal estate speculation, that the Australian economy will have its

problems.

Additionally, Australias central bank has been very aggressive

in tightening. It has hiked rates seven times since Oct. 2009.

As a result, Australia now has the highest benchmark interestrate in the developed world. Home prices are falling at the fastest

pace since the crisis. Amazingly, we dont hear analysts even

mentioning this very important canary in the mine.


South Korea actually started the new real estate recession


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South Korea actually started the new real estate recession

in 2010. At the end of the year, prices were already down 20%

from the recovery peak. Very large projects have been cancelledor lost nancial partners. Household debt is an enormous 140%

of disposable income. They cant get credit to buy property.


THE MEDIA TAKES NOTICE


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THE MEDIA TAKES NOTICE

On June 9, 2011, the Wall Street Journal carried a storyheadlined The Great Property Bubble of China May Be

Popping.

Well, you read it here rst, about eight months ago.

The yield curve just inverted in India and in Brazil. An invertedyield curve is always the beginning of the big squeeze which

eventually ends in a very tight credit and a recession...or worse.

Chinas yield curve is very close to inverting.

Investors have very little time to nd the exits, or nd ways to

prot from the coming disaster, which is something we specializein with our investor services.


CHINA IPO DISASTERS


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CHINA IPO DISASTERS

On the New York Stock Exchange, there has been an avalancheof offerings of Chinese stocks. These stocks IPOd with greatfanfare.

Renren Inc, one of the largest social networking websites in

China, had its IPO on May 4 with the price soaring 29%. It raised

$855 million. The stock is now down about 75% from the high of theday of the IPO. There are accounting questions.

Netqin Mobile Inc, a Chinese mobile security company, declined

about 50% from the high of the IPO day.

On May 19, trading was halted for Longtop Financial, a recentIPO, because of accounting questions. It has not been able topublish nancial results. This IPO was launched with the help

of some of Wall Streets largest rms, like Morgan Stanley andDeutsche Bank. Several big hedge funds were buyers. Where is

the due diligence?

Of the 11 Chinese IPOs in recent weeks, ten are down from theoffering price. Six have declines of over 50%. We warned against

these IPOs from the beginning.

More than 150 Chinese companies, worth US$12.8bn at market

value, have entered US markets through reverse mergers since2007, with only about 50 ling IPOs.

The Bloomberg Chinese Reverse Mergers Index, which tracks


78 shares listed in the United States, has dropped 44% this year.


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, pp y

In China, we now see the rst attempted IPOs of rms failing.We see headlines: Chinese IPO fails as investors bust myth. Auto

parts producer Nanning Baling failed to attract sufcient demandfor its offering

This is like 2007 when suddenly IPOs had to be withdrawn in

the U.S. That was a great warning signal.


THE COMING REAL ESTATE COLLAPSE


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In Beijing, May real estate sales hit the lowest rate in 28 months,when the world was at the depth of the nancial crisis. Now pricesare declining again, just as we forecast.

The ofcial estimate is that real estate prices will decline about

10% this year. Thats wishful thinking. To us that forecast signals

an eventual decline of 50% or more over the next several years.

In 1990 in Japan, the government said it wanted to get prices

down by 30%. They fell by 50%-70%. This has produced a 20-

year period of economic stagnation. Its a roadmap for China andthe U.S.

The Oriental Morning Postreports that over the next three years,

a new highrise (skyscraper) building will begin constructionevery ve days. Over ve years, the number of skyscrapers will

top 800. Thats four times what we have in the U.S.

Granted, it is a populous nation, but most of the people will notbe working in those buildings once completed.

Furthermore, in the U.S. most skyscrapers were built by

companies who occupied them as headquarters. They didnt have

to depend on leasing the space out to others. In China, most of the

buildings have to depend on lessees to occupy the space. Wherewill the lessees come from when the economy is in recession?

According to the Economic Observer, the worlds second, third,


fourth, seventh and ninth highest buildings are located in Taipei,


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Shanghai, Hong Kong, Nanjing and Guangzhou, respectively. The

worlds tallest building is located in Dubai and stands 828 meterstall.

Put that together with all the other evidence that Chinas

property bubble is now bursting, and you have a prescription for

some very difcult times. There is an old truism that at the peak

of every bubble, the tallest buildings are built. In 2007, it wasin Dubai, the worlds tallest building. We know how precise that

was. In China, it will not be just one skyscraper marking the top,

but 500.

On August 2, 2011, Saudi billionaire Prince Alwaleed bin Talal

signed a $1.23 billion contract with Bin Laden Group for whatwill be the tallest building in the world. It will be completed in ve

years. The 1,000 meter plus (3,280 foot plus) tower would replace

Gulf neighbor Dubais 828 meter (2,716 foot) Burj Khalifa as thetallest tower in the world.

My view is that it will not be completed in a decade, or ever.

CONCLUSION: the frenzy over everything Chinese has reached

the pinnacle. Its like 2007, when leaders in the nancial world

told investors that it was a new paradigm. In 1929, the leading

economist said the economy is on a permanently high plateau.

He said there could not be another recession. My work suggests

that the Chinese markets will lead the global bear markets to

the downside.


THE SQUEEZE


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Credit for businesses is now almost unavailable in China.And credit from a supplier of raw materials to a producer has

also disappeared. Instead of giving the buyer a 90-day term forpayment, cash on delivery is required for most transactions.

However, the manufacturers must fulll the contracts to the

foreign buyers. They have no choice but to borrow at very highinterest rates.

Manufacturers are encountering big price increases in the

materials they buy, but their foreign buyers are resisting price

increases. That results in a signicant prot squeeze, or no prot

at all.

Huang, owner of Wai Pang Knitting Factory in Dongguan, said

his orders have dropped 30% this year, while the higher-than-

expected increase in labor costs has made 30% of its remainingorders unprotable.


WATER SHORTAGES


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If the above is sufcient to cause severe problems, there isan even bigger and more unsolvable problem on the horizon, for

China and the globe: water shortages. I know, I know. Most peopleare probably yawning now. But this problem is severe. In China,

the largest fresh water lake, Poyang Lake, is dry. The boats are

sitting on grass. This is in the Yangtze valley. On many days, dust

storms make the skyscrapers in the big cities invisible. A commonpart of clothing is a face mask.

Furthermore, China has used huge amounts of articial

fertilizers. Over time, these make the soil very acidic and unsuitable

for production.

The growing season in North America last year was shortened

because of all the ash from large volcanic outbreaks, including

those on the Kamchatka peninsula in Russia, just above Japan.

Our view is that in less than 50 years, water, not oil or globalwarming, will be the biggest problem in the world.

If you read history, you will see that major depressions havebeen accompanied by droughts, dust storms, food shortages,

famines, resulting in wars. Dr. Iben Browning spoke about this

chain of events years ago. They are all related to planetary cycles

and sunspot cycles. No, your SUV isnt guilty.

Thats what our children will face. Are they ready for that?


CORRUPTION AT ALL LEVELS


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From a story on BBC News (June 17, 2011):

Chinese ofcials stole $120 billion, ed mainly to US

Thousands of corrupt Chinese government ofcials have stolen

more than $120bn (74bn) and ed overseas, mainly to the U.S.,

according to a report released by Chinas central bank.

Between 16,000 and 18,000 ofcials and employees of

state-owned companies left China with the funds from the

mid-1990s up until 2008.

The ofcials used offshore bank accounts to smuggle the funds,according to the study posted on the Peoples Bank of China websitethis week butwhich has since been removed.

It said the ofcials smuggled about 800 billion yuan into theUS, Australia, Canada and the Netherlands through offshore

bank accounts or investments, like property or collectibles. Thestolen funds were covered up by disguising them as business

transactions by establishing private companies to receive the

money transfers.

The study said corruption inside China was severe enough to

threaten the nations economic and political stability. The Chinesegovernment also revealed that the highspeed train being builtbetween Beijing and Shanghai suffered signicant corruption.

The railways minister has been red on corruption charges.


Allegedly, $28.5million had been stolen by individuals and

construction companies The Chinese media reports that the


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construction companies. The Chinese media reports that the

railways minister is thought to have embezzled $121 million.

The construction was hurried and is shoddy. Already, major

parts of some of the railroad stations have to be rebuilt. One of the

highspeed trains recently derailed, killing a number of passengersand injuring hundreds of others.

Our view is that when such signicant corruption occurs at

high levels in the government, where public ofcials are often

executed for corruption, what can you expect on the nancialstatements of private companies?

China Mobile is the largest telecommunication company inChina. It has been involved in corruption scandals for several

years. The news service, Caixin, writes: Chairman Tian Tao and

CEO Li Yinan of Beijing Wuxian Xunqi Information TechnologyCo., an operator of China Mobiles 12580 service, will resign

following the further investigations into allegations of corruption

at the countrys largest telecom carrier.

Wuxian Xunqi is the exclusive partner and operator of the

12580 operation, an online traveling service. Launched by China

Mobile, it includes hotel and air ticket booking services.

Since late 2009, many senior executives at China Mobile havebeen found to be involved in major corruption scandals, withmany related to behind-the-scenes deals with the companys

service providers.


THE WEAKENING CHINA ECONOMY


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My work shows that Chinas ofcial GDP growth of 9.4% is purection. It consists primarily of price increases, not real growth,

because the ination adjustment is much too low. In fact, I wouldgo as far as saying that the economy is now growing at low single-

digit rates, and will soon go into contraction although the GDP

numbers wont show that.

The manufacturing data out of China on July 1 showed the

weakest numbers in 28 months. In a separate report from HSBC,manufacturing stalled out last month. Does this sound like the

advertised 9% GDP growth?

The real fact is that most of the economic growth has comefrom construction of buildings which remain empty. Imagine 30billion sq.ft. of buildings under construction, much of which will

remain empty when nished.

We are starting to see the effects of the rst phase of the real

estate bubble bursting. Suddenly, there are signs of a surplusof copper. Copper is considered one of the best indicators for

economic activity.

The fact is that there has been a lot of hoarding of construction

materials in China as the prices just continued to rise. Much

of this stockpiling was nanced with borrowed money. As pricesdecline, the borrowers have to sell copper or put up more money.

Earlier this year, the bonded warehouse in China were full. We

have heard that copper exports were eight times the year-earlier


total.


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London Metal Exchange bonded warehouses saw copper

inventories leap 17% in the rst quarter. Furthermore, to

circumvent tight bank lending in China, borrowers are relying

more on available letters of credit to nance copper arbitragetrading and otherwise have the use of the borrowed money with

copper purchases as their collateral. If copper prices continue tofall, those borrowers will have to sell their copper on the market

to prevent further losses, resulting in still lower prices.


DEBT DEFAULTS ARE STARTING


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Shanghai Rainbow, a development company set up by the cityof Shanghai, has failed to repay part of its 1 billion yuan (US$154million) debt that had fallen due.

According to reports, the Shanghai Banking Regulatory Bureau

called the chiefs of local banks for a meeting on June 28 to discuss

the problem and asked them to form two consortiums to offersyndicated loans to Shanghai Rainbow. One of the consortiums

had been asked to arrange a loan of 8.5 billion yuan (US$1.31billion). However, even as a new loan is being arranged, some of

its debts have already become overdue.

In our opinion, we will see an accelerating number of suchproblems. This is similar to the rst problem in 2007, when twofunds of Bear Stearns were insolvent because of huge losses.

That was the canary in the mine. Initially, the authorities will

jump in for the rescue. Eventually, the defaults will overwhelm

the system. That may wait until late 2012 or 2013, although in

todays electronic world, it may come sooner.

Chinese stocks traded in Hong Kong are now a great target ofthe short sellers. The facts are clear. In China and Hong Kong

there are now worries about a hard economic landing. Continued

revelations of false nancial reports by Chinese companies is

increasing the appetite that sells Chinese stocks short on theHong Kong stock market. Hong Kong Exchange and Clearing

statistics show that investors shorted about HK$91.1 billionworth of H shares of four major Chinese banksABC, BoC, CCB


and ICBCbetween January and May.


58/102


Why dont we hear more about this in the U.S.? Wall Street

doesnt want these facts to get out because they have made great

underwriting prots with the Chinese IPOs on the NYSE over thepast few months. Therefore, any analyst who divulges this adverse

information is treated just like the few bears were in 2007 and

2008, i.e. not very kindly. The truth is not very popular today.


A MT. EVEREST OF DEBT


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Premier Wen Jiaboa of China had ordered the rst audit of

local government borrowing in March. The results are in. Local

government debt was 10.7 trillion yuan ($1.7 trillion) at the endof last year. The report warned of repayment risk.

Local governments rely on land sales for more than 80% of their

income. What will happen when the real estate bubble implodesand there are no buyers for the land?

However, a few days later, Moodys came out with a report

which said Chinas local government debt burden may be 3.5

trillion yuan ($540 billion) larger than the ofcial numbers above.

Moodys said it found more potential loans after accounting fordiscrepancies in gures given by various Chinese authorities.Moodys said that as many as three-quarters of the loans couldturn sour. That would push the bad debt ratio for banks to

between 8% and 12% of all loans, up from just over 1% now andworse than Moodys had previously anticipated.


SOCIAL UNREST


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The many riots in different parts of China are becoming more

violent. This is what Futures Magazine writes:

Reports indicate that scary riots in Chinas Guangzhou area

have put leaders of that country on edge as they came on the

heels of several weeks worth of intensication of such unrest.Chinese society currently witnesses untold numbers of protests

and riots each year as the ire over government corruption and

social inequality appears to be boiling at a disturbingly high level.

The global riots and revolts are not a coincidence. And they will

eventually come to the U.S. Are you ready for that?

BIG BROTHER

Here is a news item from WSJ.com: Western companiesincluding Cisco Systems are poised to help build an ambitiousnew

surveillance project in Chinaa citywide network of as many

as 500,000 camerasthat ofcials say will prevent crime but thathuman rights advocates warn could target political dissent.

These cameras will allow a quick response by police when

people are starting to gather for protest. Isnt technology great!


FUTILE INFLATION FIGHTING


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China is having a huge ination problem, which will get worse

as the government tries to ght ination with a method that neverworks, namely hiking interest rates. The rising rates actually

create higher ination. On July 6, the Peoples Bank of China

(PBOC) raised the benchmark 12-month lending rate to 6.56%.Dont you just love the words Peoples Bank? You see, everyone

loves fairy tales. Its like calling members of the U.S. Congress

public servants.

Anyway, the only way rising rates stop ination is by crunching

the economy. The implosion of the credit bubble stops the ination,

not the higher interest rates.

And that is very painful.

Currently, credit in China is almost impossible to get by private

companies. Some companies are paying interest rates of 50% to130% to small nance companies just to nance purchases of

raw materials from their suppliers. How can any analyst thinkthat this can end in a soft landing?

Corruption is a major problem in China. And that will be

exposed in the coming meltdown. As Warren Buffett said years

ago, You see who has been swimming naked when the tide goes

out.

Premier Wen Jiabao said that the countrys efforts to contain

ination have worked and that the pace of consumer price increases


will slow, Bloomberg reported. There is concern as to whether

China can rein in ination andsustain its rapid developmenti h ti W id


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-- my answer is an emphatic yes,Wen said.

China has made capping price rises the priority of

macroeconomic regulations and introduced a host of targeted

policies. These have worked. The overall price level is within a

controllable range and is expected to drop steadily.

Is he right, or is this wishful thinking? Studying many decades

of ination cycles in the world, we cannot nd one instance where

rising ination has been reduced by hiking interest rates whilemaintaining rapid economic growth. Perhaps China will show

the world how it can be done. However, we are doubtful.

However, the government is concerned about the enormous

and growing mountain of bad debt. Beijing may assume up to

RMB3,000 billion (US$463 billion) of debt that banks could never

hope to retrieve, according to WantChinatimes.com.

Dong Tao, Credit Suisses chief Asia economist, said that local

government debt is the biggest problem the country has faced in

his many years as a China watcher. Although Chinas national

debt is about 20% of GDP, if considering all the debt includingthe 70% of stimulus loans to state enterprises, the governments

debt is probably around 80% of GDP. Well, now we see that China

is potentially just another nancial basket case, not much betterthan the U.S. or Greece. They just have the advantage of a closed

nancial system, not subject to market forces. But eventually,that wont save their economy.


All of our information shows that Chinas manufacturing

rms are now basically operating without making a prot. Wage

i 20% th t t t hil th


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increases are over 20% over the past one to two years, while thecost of raw materials is up similar amounts. Yet their Western

customers are not willing to pay higher prices. So they are in a

real cost squeeze.

Local manufacturers cant get nancing from their suppliersany more. Now its cash on delivery. They cant get bank loans

either. So they go to private nancing rms, paying interest that

would make the Maa blush. How long can you keep a business

aoat under those conditions?

Standard & Poors says that perhaps as much as 30% of bank

loans are expected to turn bad. Imagine the kind of bailout thatwill require from the central government!

Local governments are not allowed to borrow from banks. So

they set up nancing vehicles which do make loans. Its estimated

that these loans amount to a hefty $2 trillion. The overdue loans,

according to the ofcial audit, are estimated to be more than 8billion yuan ($1.27 trillion) and growing rapidly. You see, global

governments get most of their revenues to nance expenses fromland sales. Many are now running out of land to sell, while others

that have the land cant nd the buyers as property sales to

speculators are drying up.


THE GROWING MANUFACTURING CRISIS

The next global nancial crisis has started in Europe and will


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The next global nancial crisis has started in Europe and will

eventually be followed by China. These will envelop the markets

of the world. Stress will start building this September.

The July 20, 2011, story from a China news service washeadlined: Southern China sees wave of manufacturingbankruptcies.

The story blamed the rising value of the currency and

unavailability of credit for the bankruptcies of manufacturing

rms, especially in the heavily industrialized areas of Guangdongand Zhejiang. The story states that a wave of bankruptcies with

a severity not seen since the 2008 nancial crisis is sweeping

through the manufacturing industry.

The story didnt mention two other big problems: the 40% risein wages over the past two years, and decreasing orders from

overseas. Industry sources say that they expect a shutdown of 10%

of textile companies in Dongguan, the manufacturing stronghold

of Guangdong Province, and 20% in Zhejiang Province.

The second largest toy manufacturer, Dong-guan Soyea Toys Co

Ltd, closed down unannounced on April 1 after its South Koreanowner went into hiding. Why would the owner go into hiding? You

need permission to close down a company or be arrested. Any hintof problems, and the foreign owner has to forfeit his passport.

In mid June, well-known textile manufacturer Dinkind Knitting


Fashion Co Ltd abruptly went bankrupt. The company employed

more than 2,000 workers in Dongguan.


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The president of the Dongguan Textile and Garments Trade

Association said the second half of the year is usually a boom

season for the textile and toy industries, but that business willnot recover unless credit is eased and labor and commodity

prices are reined in.

The China Economic Weekly quoted business leaders in

Zhejiang as predicting that nearly 20% of small and medium-

sized enterprises in the eastern province would close down

within the next three years, for the same reasons that Mr Chen

listed. The three years is probably a political statement. You can

change that to one year.

The president of the Dongguan Taiwan Business Association

predicts that over 10% of the members of his association wouldclose their businesses before October. The owners are probably

already packing and planning their escape. Remember when the

airport parking lot in Dubai was full of abandoned cars? These

people were also escaping, fearing arrest for abandoning their

business enterprises.

The above conrms our forecast of a China Crisis-Phase I

having started.


IS A SOFT LANDING POSSIBLE?

In spite of the facts governmental ofcials in China are no


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In spite of the facts, governmental ofcials in China are no

different from those in the U.S. They are experts at putting lipstick

on a pig just to make it look better. But its still a pig.

A governmental ofcial, Ba Shusong, deputy director of the

Institute of Finance at the Development and Research Centerunder the State Council (Cabinet) says that although there is a

slim chance of a hard landing, overall economic growth is still

expected to reach around 9% this year.

He must be Ben Bernankes long lost twin brother.

You see, he also makes the mistake of looking at GDP, a number

which is adjusted for ination. However, actual ination ismuch higher, and therefore real GDP is much lower than the

ofcial number. The GDP growth actually consists mostly of priceincreases.

Mr. Ba Shusong says that the Chinese government should be

more cautious against possible excess control measures in

certain sectors.

Ba said the real credit-tightening pressure to be faced by

enterprises will come mainly from the banking system rather

than from ofcial interest rates. He said capital costs for privateenterprises in the Yangtze and Pearl River deltas, the two regions

with the most vibrant economy, are now essentially similar to

those during the 2007-2008 period.


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CHINA CAR SALES PLUNGE

In late July 2011, we got a report that new car sales in China are


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y , g p

plunging. Dealers are getting stuck with excessive inventories as

the car builders continue to produce at a high pace but the dealers

encounter a dearth of buyers. Currently, unsold inventories are

expected to reach 4 million cars, although our own estimate

is up to 50% greater.

Margins on car sales are slim. With private rms basically

unable to get b

thecomingchinacrisis 10-06-2011 (1)

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