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“Successful traders are not gamblers, they are probability players.”

-Mark Weinstein


It has been a bad idea to be a bear on China over the last few years (though not necessarily their stock market) based on the expectation the credit crunch would lead to a financial crisis there.

I say that because I was very much aboard the China cum-financial-crisis bandwagon.

But no matter how you slice it, Chinese authorities have done a brilliant job of keeping all the balls in the air. As we know, there is often some type of transmission lag after a major global macro event. And the credit crunch bubble that popped may have been the mother of all bubbles. Are we now about to see, or are already seeing, its lagging impact finally bubbling to the surface in China?

For every action there is a reaction. China’s actions to avert the credit crunch impact now seem to be intersecting. Here are two actions, for example:

The massive injection of credit by the government and boom in shadow financing (not much different in every industrial country; just that China was already bumping up against excess capacity as this new credit was spread through its economy)
Initiation of real reform that should ultimately lead to higher quality growth and more competitiveness (in value-added products) for the economy in the years ahead
I thought today’s piece by George Magnus, appearing in the Financial Times, “China’s financial distress turns all too visible,” was particularly well done. Here is an excerpt [my emphasis]:
…Last week’s market scare, however, was focused on copper, which has fallen nearly 15 per cent this year, and by more than a third from its 2011 peak. Falling prices have embraced a swath of both ferrous and non-ferrous metals, sending ripples from Perth to Peru.

The underlying reason for the base metals shake-out is the mirror image of the prior boom, in which China’s voracious appetite raised its consumption to about 40 per cent of global production. Its per capita consumption is far higher than any other emerging country, regardless of income per head.

In short, what China gave producers and miners on the way up, it is taking away as the commodity composition and intensity of GDP growth tail off.

Large swings in market prices are happening also for murkier – and largely speculative – reasons that hinge on the use of copper and ore as collateral for loans, and as a means of raising finance abroad and bringing it onshore to spend or lend. As the authorities clamp down on credit creation and shadow financing, falling prices, including that of collateral, will expose participants to losses, and markets to the risk of distress selling.

The transmission effects of lower prices into emerging markets and the global economy are most likely to prove disruptive, even if the positive real income effects for consumers eventually win out.

China’s economic transformation is happening regardless. Its leaders have choices only about how to manage it, and when to accommodate what is likely to be a painful adjustment. Sage advice would be to grin and bear it now, so as to avoid harsher outcomes later. But the political willingness and capacity to do so is unpredictable.
That last sentence is the payoff: “… political willingness and capacity to do so is unpredictable.” So far China has surprised those who said they would do little in the way of reform while GDP growth was slowing. Might they surprise even more?

Either way, the reform in motion and potential for falling dollar liquidity (note the improvement in the US current account reported today) suggest to me pressure will continue on both copper and the emerging markets. This is in line with our wave view:

Copper Futures, weekly:

iShares MSCI Emerging Markets (EEM), daily: