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“When a herd ‘thinks,’ the result is not reason but an emotional interpersonal superorganic dynamic that must be the sourse of waves. A person’s patterned psyhological dynamics asthey relate to the social environment produce an unconsious impulse to herd, which in compination with like minds produces global patterns of interactive dynamics in a shared social setting.”

                 Robert Prechter, The Wave Principle of Human Social Behavior

Commentary & Analysis
Three Reasons I am Still Short the New Zealand Dollar

I recently shared some reasons why I thought the New Zealand dollar represented a good longer term short position. Since then, Kiwi (as the New Zealand dollar is affectionately known) has rallied a bit. My longer term bet here is pretty simple. It’s based on three rationales which are of course are interlinked:

1) China’s growth decelerates a bit more rapidly than now expected (this has nothing to do with a China crisis, as real reform as promised at the Third Plenum likely slows GDP near-term while strengthening China’s strategic position long term). I am only talking demand from China falling more than now expected.

A stumble in China likely flows from extension to support investment as export demand waned after the credit crunch; banks have more liabilities than assets and Shadow Banking troubles loom…

From …Chinese banks have a long way to go before they are healthy and can be considered prudently managed. If nonperforming loans and other assets were valued correctly, these banks would be technically insolvent. In a November 2006 report, Fitch Ratings estimated the total amount of nonperforming loans in the system, and calculated, assuming a 30% recovery rate on nonperforming loans (though on average the recovery rate for Chinese banks has been closer to 20%), total unrealized losses in the banking system to be roughly $250 billion, which exceeds total capital and reserves by more than one-third.

This figure does not include estimates made for the rapid loan expansion of the past two years, with loans growing 10.2% in just the first half of 2006. Most analysts believe this breakneck growth will result in a surge in new nonperforming loans. Fitch’s figures also do not include another $300 billion in loan carve-outs by asset management companies, who paid for the loans with low-coupon bonds which, if marked to market, would involve a further write-down of 10-15%. After taking into account these adjustments, liabilities materially exceed the true value of assets for every major bank in China.

From Reuter’s columnist John Foley, “The thrust on trusts”:

2) New Zealand has become most highly dependent on China—who is now by far its largest source of demand for its food exports—any slowdown in China will likely further exacerbate and already nasty current account deficit for New Zealand; especially as exports to Australia (now its second largest trading partner) wane on weaker Australian demand.

New Zealand Exports to China (purple line) and Australia (gold line):

3) New Zealand’s banking system is highly exposed (60% of lending goes to real estate) to a housing market that seems bubble-ish-ish (see stats next page). If these proves true, there is a good chance any interest rate hikes from the central bank will be delayed.

From Global Property Guide: An external shock could trigger a major correction in housing prices in New Zealand, an international rating agency’s new report has warned, causing a crisis for New Zealand’s banking system.

House prices in New Zealand are sensitive to developments in the economies of China and Australia, its two biggest trading partners, a report prepared by Standard & Poor’s has warned.

“Persistent house price inflation in New Zealand could trigger the risk of a sharp property price correction sometime in the future, particularly if there is an external shock to the economy…We are of the view that a hard landing in China could potentially have a material impact on the New Zealand banking system,” noting that house price corrections could trigger significant bank credit losses.

A hard landing in China could result in a huge deterioration in the terms of trade, weakening the country’s export earnings and business and consumer confidence, and impacting labour market and household debt-servicing ability, says the report. Residential property loans account for about 60% of total lending by the banking sector in New Zealand.

NZD/USD Daily: Targeting to around 0.8000 on the next wave down…

Caution: My short position may prove very wrong if the global macro environment, which I have dubbed the “new abnormal,” stages a normal cyclical rebound. Stay tuned.