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"No iron spike can pierce a human heart as icily as a period in the right place."
                                    Isaak Babel

Commentary & Analysis
Bank of America executives may know more than we think!

Yesterday, while sitting comfortably in my living room, sipping a generous dram or two of 16-year Lagavulin (an Islay single malt scotch to the downtrodden who abstain from such pleasures), which I recently discovered and now think about constantly, I had the TV blaring subtly in the background; unfortunately it was tuned to CNBC. And of course, always looking for software to fill the void, another banking analyst was trotted out of the stable to share his view on Bank of America. The bottom line was that he believed that Bank of America’s dumping of half its stake in China Construction bank, raising a cool $8.3 billion and pocketing an estimated profit of $3.3 billion on the sale, was a sign of desperation. I wish I could discover some desperate profit with that many zeroes behind it!

It was pure desperation on Bank of America’s part, what else could it be? Well, it could be lots of things. As I went back to enjoying my new discovery, I thought to myself: Did this analyst ever consider that just maybe BOA executives know a bit more about Chinese “banking” than he does? Nah … likely never crossed his mind; all he knew was this maneuver was oddly timed.

A rational observer of financial markets, assuming such a creature exists, would likely say that China is “bubble-icous” based upon the Treadmill scenario we created several months ago.

Let’s tick off the forecasts we made shown in the chart below:

  • Currency appreciation? Check!
  • Social unrest? Check!
  • Inflation? Check!
  • Credit restraint? Checkmate?

As we have said before, paraphrasing a money manager whose name escapes us, China’s monetary controls have two speeds: flame thrower and fire extinguisher.

From The Wall Street Journal today:

As policy makers from the U.S. and Europe gathered in Jackson Hole, Wyo., to discuss ways to revive a fragile global recovery, China’s central bank was issuing a secret memo to further rein in lending in the world’s second-largest economy.

The tightening move by the People’s Bank of China, which was reported Monday by the official Xinhua news agency, highlights two key points about China’s economic management: how starkly it is diverging from that of other big economies–which continue to seek ways to pump money into the financial system–and how it remains shrouded in secrecy that some call unbefitting such an important global player.

So maybe China Premier Wen “Windbag” Jiabao was only blowing more smoke when he declared victory over inflation back on June 23rd: “China has made capping price rises the priority of macro-economic regulation and introduced a host of targeted policies. These have worked.” Mr. Wen wrote in the Financial Times. “We are confident price rises will be firmly under control this year. The overall price level now is within a controllable range and is expected to drop steadily. “

Take a gander back at that Treadmill Scenario on the page above. Notice the box that says “Non-Performing Loans”; that is where the banks take hits as a result of capital misallocation; this process theoretically and empirically can be swift.

Over to George Soros, the brilliant global macro strategist vintage 1987 version (not the liberal nut bag who has gone completely off the boards, al la 2011 version):

Collateral values have become greatly dependent on the stimulative effect of new lending and as new lending fails to accelerate, collateral values begin to decline. The erosion of collateral values has a depressing effect on economic activity, which in turn reinforces the erosion of collateral values. Since the collateral has been fully utilized at that point, a decline may precipitate the liquidation of loans, which in turn may make the decline more precipitous.

…In a bust, the reflexive interaction between loans and collateral becomes compressed within a very short time frame and the consequences can be catastrophic.

Now, with a nice hot cup of black coffee in front of me (but still thinking of my new discovery; that may be a red-flag come to think of it; oh well), I ask myself again: is it possible that BOA executives know a little bit more about Chinese banking than most cocksure Street analysts give them credit for knowing?

I am going to go out on a limb and answer yes!