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"To compel a man to subsidize with his taxes the propagation of ideas which he disbelieves and abhors is sinful and tyrannical.”

                               Thomas Jefferson

FX Trading – China, China, China … A Nightmare in the Making?
Our attention turns towards the latest economic data from China. Yes, because it fits our fundamental story but also because the ramifications reach far and wide.

The low-down: manufacturing in China shrunk by the largest margin ever … EVER.

A Purchasing Mangers’ Index showed manufacturing contracted to 38.8 in November from 44.6 in October. A separate PMI showed a similarly dramatic plunge. Exports are plunging as developed economies enter recession and scale back noticeably on demand for China’s stuff.

Last week in a Bloomberg TV interview, Stephen Roach, Chairman of Morgan Stanley Asia, commented on the economies of Asia and how they’re faring in this environment. His comments:

There is “no country in Asia that is either not declining, or in recession, or slowing sharply. No one is spared.” They’re the “most linked region of the world for the rest of the global economy.”


He went on to say China is “slowing very, very sharply.”

Mr. Roach’s comments add some credence to this story, since he’s right in the middle of the action. But we didn’t really need his word to substantiate this idea. You see, China has come to represent a very important middle-man between developed and emerging market economies – in Asia and across the globe. Their low-cost, cheap-labor production model entails gobbling up input products and raw materials from emerging economies in order to satiate the demand from developed economies.

Signs that China is in trouble stem from, among other items, collapsing demand for the stuff they produce. The current estimate for the next round of GDP results out of China sit at around 7.5%. Besides being a long ways short of 12% growth China delivered not long ago, the instances of political and social unrest are rising. And should growth contract as much or more than is now expected, we could see a very unruly situation develop in China.

The ramifications of such a slow-down will spread not only through China but across the global economy.

Governments across the globe are taking all kinds of efforts to bailout key institutions, and contagious markets. They understand the severity of the cleansing cycle that’s begun; and are very afraid of what they see.

Eventually though, they’re going to have to take their economies, and the financial system, off life-support. If not, after too long they may be left with a system incapable of organic growth.

In the meantime, Mr. Consumer is starting to get very worried. His wealth has been hammered by lower housing prices and collapsing stocks, and now his job is either already gone or in jeopardy. This fear is leading to a major uptick in savings. And that means spending takes a back seat. And that means global consumption takes a hit.

And that means China feels the hurt and pain is passed on down the line …

Lacking many features of strong, well-rounded economies, emerging markets have put all their chips into their exports sector. They’ve come to rely almost entirely on neighboring (China) and developed economies buying up cheap goods and raw materials. And they failed to adequately invest in the domestic side of their economies, leaving them woefully exposed to external demand for growth and foreign investors for funding.

We now know that generous global demand is plunging rather quickly. Therefore, it’s easy to understand why emerging economies’ stocks and their currencies are being hit the hardest. This is the worst possible environment for emerging economies because they were built for sustained global demand, as far as the eye can see. When global capital flow dries up, or reverses course, these emerging economies struggle to make ends meet.

What’s more, as quickly as these economies gained the backing of foreign investors in the last couple years, these same foreign investors are running for cover just as fast.

Vulnerable to Emerging Market Defaults

When it comes to emerging markets, Eastern and Central Europe account for $1.6 trillion in loans from G10 countries’ banks. Asia and Latin America are next on the list — recipients of $1.5 trillion and $1 trillion, respectively, according to Morgan Stanley’s Global Economic Forum.

And if you break down the loan originators, Western Europe and the United Kingdom are where roughly 45% of these emerging market loans came from. Whereas only 9% originated from U.S. or Japanese banks. In fact, European and UK banks are more exposed to emerging economies in Eastern Europe, Asia and Latin America.

Take Ecuador for example, they recently revealed they’re at risk of defaulting on $4 billion worth of debt. And this is just the tip of the iceberg. Plenty more defaults will likely follow from countries who failed to invest sufficiently in anything but the hope that the global economy would never stop speeding along.

Currencies of emerging markets are no doubt set to suffer as the cycle of leveraging and global capital flow morphs into deleveraging and reverses course. And the currencies of developed nations heavily exposed to these coming defaults are also hugely vulnerable.

Just as China was vital to the boom, it is critical to the bust. Hopes are that the greatest economic and financial “minds” in governments can ease the severity of a global bust. But it seems the deck is stacked against them right now.

Global capital flow seems to tell the story. And that story seems far from over.