Mish's Global Economic Trend Analysis

In Rare Agreement with Krugman; Onerous "Bailout" Rates of 6.7% Denied; Don't do Stupid Things; "Tell the EU and IMF to Shove It!"
Spain, Portugal Deny Need for Bailouts; Swaps Soar on ‘Sacrosanct’ Senior Europe Debt; Bank of China Adviser Tell US to Sell Gold
Merkel's Dilemma; Eurozone Borrowing Costs Hit Record; Expect Sovereign Defaults
China's Economic Treadmill to Hell; Shadow Over Asia; What happen WHEN China Slows?

In Rare Agreement with Krugman; Onerous "Bailout" Rates of 6.7% Denied; Don't do Stupid Things; "Tell the EU and IMF to Shove It!"

Posted: 26 Nov 2010 06:52 PM PST

News on Ireland is pouring in so fast from all corners it is a struggle keeping up with it.

In a Memo to Ireland, Mike Whitney says, "Tell the EU and IMF to Shove It!" and on that score I agree 100% having said the same thing quite some time ago.

Some articles suggest the bailout rate will be 6.7%, other stories deny that. Finally, I find myself in rare agreement with Paul Krugman. Let's start there.

Agreement With Krugman

In one of his longest pieces that I remember, Paul Krugman makes the case Ireland is getting screwed. Please consider Eating the Irish

Before the bank bust, Ireland had little public debt. But with taxpayers suddenly on the hook for gigantic bank losses, even as revenues plunged, the nation's creditworthiness was put in doubt. So Ireland tried to reassure the markets with a harsh program of spending cuts.

Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts.

Or to be more accurate, they're bearing a burden much larger than the debt — because those spending cuts have caused a severe recession so that in addition to taking on the banks' debts, the Irish are suffering from plunging incomes and high unemployment.

But there is no alternative, say the serious people: all of this is necessary to restore confidence.

Strange to say, however, confidence is not improving. On the contrary: investors have noticed that all those austerity measures are depressing the Irish economy — and are fleeing Irish debt because of that economic weakness.

Now what? Last weekend Ireland and its neighbors put together what has been widely described as a "bailout." But what really happened was that the Irish government promised to impose even more pain, in return for a credit line — a credit line that would presumably give Ireland more time to, um, restore confidence. Markets, understandably, were not impressed: interest rates on Irish bonds have risen even further.

Ireland is now in its third year of austerity, and confidence just keeps draining away. And you have to wonder what it will take for serious people to realize that punishing the populace for the bankers' sins is worse than a crime; it's a mistake.

"Tell the EU and IMF to Shove It!"

Krugman asks "Does it really have to be this way?"

Of course it doesn't. In a Memo to Ireland, Mike Whitney says, "Tell the EU and IMF to Shove It!"

Irish Prime Minister Brian Cowen is Mahmoud Abbas. He's caved in to the demands of foreign capital and transferred control over the nation's budget to the EU and the IMF.

This is a black day for Ireland. The Irish people will now face a decade or more of grinding poverty and depression thanks to their venal leaders. As soon as the ink dries on the IMF loans, the second occupation of Ireland will begin, only this time there won't be armored cars and Paramilitaries in fatigues, but nerdy-looking bureaucrats trained in the art of spreading misery. In fact, the loans haven't even been signed yet, and already IMF officials are urging the government to cut jobless benefits and the minimum wage. They're literally champing at the bit. They just can't wait to get their hands on the budget and start slashing away.

And don't believe the hype about European unity or saving Ireland. My ass. This is about bailing out the banks. The bondholders get a free ride while workers get kicked to the curb. Here's a clip from the Financial Times that spells it out in black and white:

"According to data compiled by the Bank of International Settlements, the three largest creditors to the Irish economy at the end of June...were Germany to the tune of €109bn, the UK at €100bn and France at €40bn. These sums amount to 2 per cent of France's gross domestic product, 4.5 per cent of Germany's GDP, and 7 per cent of British GDP."

Ireland is being asked to cut to social services, slash wages, renegotiate contracts, and dismantle the welfare state so that undercapitalized banks in France and Germany can get their pound of flesh. But, why? They're the ones who bought the bonds. No one put a gun to their head. They knew they could lose money if Irish banks went south. That's the risk they took. "You pays your money, and you takes your chances." Right? That's how capitalism works.

Not any more, it doesn't. Not while Cowen's in charge, at least. The Irish PM has decided to bail them out; make all the bondholders "whole again." But who made Cowen God? Who gave Cowen the right to hand over his country to the IMF?

No one. Cowen is a rogue agent kowtowing to international capital. After he finishes his work in Ireland, he'll probably join globalist Tony Blair on the French Riviera for a little hobnobbing with the tuxedo crowd.

The Irish people didn't struggle through centuries of famine and foreign occupation so they could be debt-peons in the EU's corporate Uberstate. Like Sinn Fein president Gerry Adams said, "We don't need anyone coming in to run the place for us. We can run it ourselves." Right. Tell the EU plutocrats to take their Utopian Bankstate and shove it.

Irish Citizens Sold Down the River in "Firepower of Stupidity"

On November 21, in Irish Citizens Sold Down the River in "Firepower of Stupidity" I wrote...

Today the Irish Government sold its citizens into debt slavery by agreeing to guarantee stupid loans made by German, British, and US banks. Those loans fueled one of the biggest property bubbles in the world. Ireland has since crashed.

Why the average Irish citizen should have to bail out foreign bondholders is beyond me, but I do note that the same happened in the US with taxpayers footing an enormous bill for Fannie Mae, Freddie Mac, and AIG.

No matter what stupid thing banks do, prime ministers and presidents are all too willing to make the average taxpayer foot the bill for the mess. That by the way, is one reason why we get into these messes in the first place.

Firepower of Stupidity

Finance Minister Brian Lenihan bragged about the "firepower that stands behind the banking system." Yes there is firepower alright, a firepower of stupidity.

Wikipedia notes the population of Ireland is approximately 4.35 million. Going into debt to the tune of $137 billion would saddle the average Irish citizen with $31,494.

How long will it take to pay that back? For whose benefit? Perhaps a better question is will it be paid back?

By agreeing to take on that debt, and sticking it to the Irish taxpayers who will be forced to accept various austerity measures to pay back that debt, Irish Prime Minister Brian Cowen and Finance Minister Brian Lenihan just sold Ireland down the river.

For additional insight on how the crash affects Ireland, please see Ghost Estates and Broken Lives: the Human Cost of the Irish Crash

6.7% Rate?

RTE News reports EU/IMF interest rate likely to be 6.7%

The interest rate to be charged on the European Unions/International Monetary Fund package is likely to be 6.7% for nine year money.

This compares to an average borrowing rate of 4.7% on funds raised by the NTMA over the past two years. In May, Greece arranged an EU/IMF loan for three years at 5.2%.

The Government's four year plan assumes that by 2014, interest payments will have increased from €2.5 billion to €8.4 billion a year - around one fifth of all tax revenue.

Fine Gael Finance Spokesman Michael Noonan said the suggestion of a 6.7% rate was very disturbing.

He said the Government must not abandon the national interest and settle on unaffordable terms in its negotiations.

6.7% rate rejected

The Irish Times reports 6.7% rate rejected

The interest rate for a nine-year EU/IMF loan would be lower than the 6.7 per cent being quoted in some reports today, a source involved in the talks has indicated.

The source said the interest rate was still under negotiation but would not be that high.

The loan of €85 billion would come from a number of different funds, some controlled by European Union institutions, others by the IMF. It is understood that the interest rate for the IMF portion of the loan will be in the region of 4.5 per cent, while the interest charged by EU bodies will be considerably higher.

The source accepted that the average interest rate was likely to be higher than the 5.2 per cent charged to Greece when it was bailed out earlier this year. But it was pointed out that the Greek loan was for a period of only three years.

Higher rates of interest are attached to longer loans and the nine-year loan being negotiated on behalf of the State will involve a higher interest rate, as the risk of default is considered to be higher.

Officials in the EU-IMF mission to Dublin are examining how senior bondholders could be compelled to pay some of the cost of rescuing Ireland's banks.

Debt Slaves Forever

Fintan O'Toole writing for the Irish Times says The people must act or we will remain irrelevant

HAVING AN election after agreeing a four-year deal that will shape all key decisions is like debating which brand of condom to buy after you've become pregnant. It is a parody of democratic choice. Popular sovereignty has almost no meaning in Ireland right now. Its restoration is the precondition for a meaningful election.

The primary goal of the IMF-EU package to which any new government will be committed is not to stop Ireland spiralling downwards into economic depression. It is to ensure that Irish citizens cough up yet more money for the banks.

Instead of the banks borrowing money from the European Central Bank at one per cent interest to fund their operations, the State (you and me) will borrow it for them at perhaps five per cent.

Sovereignty belongs, not to the State, or the government, but to the people. We have outsourced it for too long to an incompetent, amoral and self-serving elite. Now we face the starkest of choices: use it or lose it.

Don't Do Stupid Things

I will tell Ireland the same thing I told Iceland on March 6, 2010: Iceland Rejects IceSave; Does No Mean No?

Icelanders overwhelmingly rejected a bill that would saddle each citizen with $16,400 of debt in protest at U.K. and Dutch demands that they cover losses triggered by the failure of a private bank, first results show.

Ninety-three percent voted against the so-called Icesave bill, according to preliminary results on national broadcaster RUV. Final results may be published tomorrow morning.

Iceland does not need help from the IMF when it will saddle every citizen with $16,400 of debt. Fools in the UK and Netherlands rushed in to Icelandic banks and the fools in the UK and Netherlands are the ones who should suffer the consequences.

It was perfectly obvious Iceland was in an unsustainable situation so the prudent thing to do would be to get the hell out of the way.

By defaulting on debt, Iceland will send a much needed message "Don't do stupid things".

In response to the above post I even received a nice Email From Birgitta Jonsdottir, Member of Iceland's Parliament thanking me for my help.

ANY Rate is Onerous

All these questions "Is the rate 4.7%, 5.2%, or 6.7% and if so for who long and on what portion?" are complete silliness.

ANY Rate is Onerous.

Except for those who participated in the property bubble (and they will be adequately punished), the people of Ireland are not at fault, at least in general.

Should Irish Prime Minister Brian Cowen manage to hang on long enough to get the votes for an onerous bailout, I would encourage Irish voter to elect someone who campaigns on a promise to renege on the deal and default.

Irish citizens cannot afford to rescue German, UK, and French banks stupid enough to bet on bubbles in Ireland. It should be the creditors' problem not the problem of Irish citizens.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Spain, Portugal Deny Need for Bailouts; Swaps Soar on ‘Sacrosanct’ Senior Europe Debt; Bank of China Adviser Tell US to Sell Gold

Posted: 26 Nov 2010 09:55 AM PST

Not that anyone can possibly believe these stories, but Spain's Prime minister says "says no chance Spain will need bailout".

In other humorous news on this Black Friday, Portugal denies the need for a bailout, and the always late S&P drops Anglo Irish Bank six notches to a junk-bond B grade.

Topping off the humorous news stories of the day, an adviser for the PBOC tells the US to sell gold to balance its budget.

Spain "Absolutely" Rules Out Bailout

Spain's Prime Minister says says no chance Spain will need bailout

Prime Minister Jose Luis Rodriguez Zapatero said Friday there was no chance Spain would seek a bailout. Asked in an interview on Spain's RAC 1 radio if he ruled out financial help from the European Union, Zapatero said "absolutely."

The markets were not convinced, however. The yield on Spain's 10-year bonds rose to nearly 5.2 percent Friday. Germany's 10-year bonds, a benchmark of lending safety, stood at 2.7 percent, bringing the spread against the Spanish bonds to 249 basis points, among its highest since the euro was introduced in 2002.

Portugal Denies Bailout Talk

The odds Portugal is not in some kind of discussion with the EU regarding bailouts seems rather slim, yet Portugal Denies Bailout Talk

The epicenter of Europe's sovereign-debt crisis shifted from Ireland to the Iberian peninsula on Friday, with European Union, Portuguese and Spanish officials scrambling to head off speculation that Lisbon or Madrid could soon be forced to seek help to meet their borrowing needs.

A spokesman for the Portuguese government said a report in the Financial Times Deutschland newspaper -- that Lisbon was under pressure from the European Central Bank and a majority of euro-zone countries to seek a bailout in order to ease pressure on Spain -- was "totally false," news reports said.

News reports, meanwhile, said that Germany this week rejected a suggestion by the European Commission to double the size of Europe's 440 billion euro ($588 billion) bailout fund for euro-zone governments. The euro-zone contribution is part of the total €750 billion rescue program put in place with the International Monetary Fund in the spring.

"Our strong conviction is that this is going to be enormously challenging unless new money is put on the table," said James Nixon, European economist at Societe Generale, in a research note.

My strong conviction is that the more money the EU puts on the table to rescue the PIGS, the more money will ultimately go up in smoke.

Anglo Irish Bank Drops Six Notches to Junk-Bond B Grade

The never on-time and totally useless rating agency S&P cuts ratings on Irish banks; Anglo deemed junk

New York-based S&P said in a statement Friday it was lowering Anglo Irish Bank six notches to a junk-bond B grade. It also cut the ratings on Bank of Ireland and Allied Irish Banks one notch each to BBB+ and BBB, respectively.

Junior bondholders at Anglo already have been forced to accept losses of 80 percent to 95 percent on their loans.

Swaps Soar on 'Sacrosanct' Senior Europe Debt

Bloomberg reports Swaps Soar on 'Sacrosanct' Senior Europe Debt

The cost of protecting against defaults on senior notes of European banks is soaring on speculation bondholders will be forced to take losses as governments try to share the burden of taxpayer-funded bailouts.

The Markit iTraxx Financial Index of credit-default swaps on senior debt rose 6.5 basis points, or 0.065 percentage point, to 157.5. basis points. Contracts on Portugal's Banco Espirito Santo SA are at a record, and Spain's Banco Santander SA are at the highest level in five months.

"Under a 'bail-in' regime, senior bondholders will most likely find themselves as potential burden-sharers, which is in stark contrast with the rules of engagement of the market hitherto," Roberto Henriques, an analyst at JPMorgan Chase & Co. in London, said in a research report. "Even at the worst point of the current crisis, it was generally a given that senior debt was sacrosanct."

Subordinated bonds have largely borne the brunt of losses because they stop paying before senior securities in case of a default or debt restructuring. Should banks be unable to pay senior bondholders, they may find it more difficult and expensive to raise money. Anglo Irish Bank Corp. investors were forced to take 20 cents on the euro for subordinated debt this week.

Bank of China Adviser Tell US to Sell Gold

Please consider PBOC Researcher Calls on U.S. to Sell Gold, People's Daily Says

The U.S. should cut its government spending and sell some gold reserves to balance its budget and fund its recovery, the People's Daily overseas edition reported, citing Xia Bin, an adviser to the People's Bank of China.

The U.S. has to resolve its "twin deficits" in the government budget and the current account, Xia was quoted as saying. Three ways that may help the U.S. achieve that target include reducing military expenses, selling part of its gold reserves and relaxing some export limits on technology, he said.

"The U.S. has more than 8,000 tons of gold reserves; why can't it sell some of it since the country wants to raise funds for economic recovery but doesn't want to add more burden to the fiscal deficit," Xia told the newspaper.

Here's the punch line, "the PBOC researcher didn't mention whether China would be willing to purchase any gold from the U.S." Ya think not?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Merkel's Dilemma; Eurozone Borrowing Costs Hit Record; Expect Sovereign Defaults

Posted: 26 Nov 2010 07:58 AM PST

The Spiegel Online shows the severe problem facing facing Germany in terms of investments at risk, the enormous amount of money owed German banks by the PIGS (Portugal, Ireland, Greece, and Spain).

Please consider Merkel's Dilemma, Chancellor Faces Tough Sell on Irish Bailout

For the second time in just a few months, Angela Merkel will have to explain to voters why Germany must bail out a fellow euro-zone member state. Skepticism is growing -- amongst voters, in the media and within her party. Many want to see Dublin raise its low corporate tax.

Germany will be the largest guarantor of the bonds that the European Union rescue fund, which was set up in the spring, will likely issue to borrow money to help stabilize Ireland. Unofficially, there is talk of guarantees worth an estimated €90 billion ($122 billion), with Germany's share possibly amounting to around €25 billion.

In order to secure popular acceptance for a bailout, Merkel and her colleagues want to put pressure on Dublin to implement a tough reform program that would also address the issue of government revenues. Ireland's low rate of corporate tax, which is just 12.5 percent, has attracted many companies to the country. For the time being, the German government has not revealed what it wants from Dublin in terms of concrete demands.

But many people in Merkel's conservative-liberal coalition want Ireland to raise its tax rate. "It is unacceptable that countries such as Ireland poached companies in Europe through low tax rates only to rely on aid from other countries during a crisis," said Michael Fuchs, a CDU expert on small- and medium-sized enterprises. Ireland must take action on both spending and revenues and aim for a "European level" for its corporate tax rate, Fuchs told SPIEGEL ONLINE.

Misplaced Blame on Ireland's Corporate Tax Structure

Note the repeated blame placed on Ireland's corporate tax structure.

The blame really should be placed on German banks stupid enough to fund Ireland's property bubble.

Investments at Risk

Ireland's Budget Deficit 10 Times Maximum Allowed Under Maastricht Treaty

There is much more in that Spiegel Online column, please give it a look.

In what way is Ireland responsible for that debt structure? Did Ireland put a bazooka to Germany's head demanding those loans?

If not, and the answer is "not", then why should either German citizens or Ireland's citizens have to pay for a bailout of Ireland?

German, UK, and US holders of Irish debt (banks) should have to (and will have to) take a big haircut on that debt. It's as simple as that.

Eurozone Borrowing Costs Hit Record

One look at the above is all you need to understand to figure out this would happen: Eurozone borrowing costs hit record

Irish, Portuguese and Spanish bond yields surged to their highest points since the launch of the euro, as traders said even some of the bigger eurozone countries could soon be affected. Matt King, global head of credit strategy at Citi, said the danger was the selling could develop a momentum of its own.

Myles Clarke at RBS said: "Some people want to put on a just-in-case euro break-up trade and they're looking for any way to do this. You can't do trades in any size in the stressed peripherals like Ireland or Spain, so people are looking for what else might work."

A senior trader at a US investment bank added: "I'm freaking out. The investors who were bottom-fishing last week are all selling this week."

Irish 10-year bond yields rose above 9 per cent, Portuguese yields jumped further above 7 per cent – a level Lisbon says is not sustainable – while Spanish yields rose further above 5 per cent. The euro dipped towards two-month lows, falling for the fourth day in a row.

The clearing house increased the charges or margins from 30 per cent to 45 per cent above normal requirements to trade Irish bonds. This makes Ireland's banks, which use sovereign bonds to raise money for funding, even more dependent on the European Central Bank.

Destabilizing Rescue

It's clear that Ireland needs many reforms, but raising its corporate tax rate now sure does not appear to be one of them. That low tax rate is the only possible way Ireland can maintain any growth edge that would allow it to dig out of its hole.

Moreover, it's important to understand that the alleged "bailout" is nothing more than a moderately-high-interest loan with unsound-strings attached.

Those strings are more like anchors. They put added stress on the system. Even if, the ECB comes to yet another rescue for Portugal and Spain (and some complete fools are calling for preemptive ECB action to do just that), the whole structure of these bailouts is destabilizing.

What cannot be paid back, will not be paid back. Thus, lending Ireland, Greece, Spain, and Portugal more money under onerous terms is the height of extend-and-pretend stupidity.

Expect sovereign defaults.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

China's Economic Treadmill to Hell; Shadow Over Asia; What happen WHEN China Slows?

Posted: 26 Nov 2010 12:51 AM PST

Last week in his China Financial Markets blog, Michael Pettis raised the interesting question What happens IF Chinese growth slows?. His answer may surprise you, and mine is quite different, even though I agree with most of his discussion.

How can that be? Let's take a look at his post. Pettis writes ...

Last week I suggested that slowly the consensus is shifting towards a recognition that Chinese growth may slow sharply in the next few years. When I discuss this prospect with analysts and investors, however, they almost always worry about two things. First, since China represents the largest component of global growth, it seems reasonable to expect that a sharp slowdown in China will also mean a sharp slowdown in global growth. Slowing Chinese growth, in other words, should be terrible for the world. Secondly, if growth does slow sharply, this should cause an equally sharp rise in social instability and, with it, rising political instability.

I disagree with both claims — not that they are necessarily wrong but rather that they are not obviously true, and depend heavily on the way China rebalances. To see why it is worth considering what happened to Japan.

Pettis goes on to explain how Japan in 1990 was 17% of the global economy, and every one figured Japan would soon take over the world. Yet in spite of the fact that Japan's growth rate collapsed to 1%, the rest of the world expanded rapidly and there certainly was little social instability in Japan.

What Pettis failed to mention is 1990's global economy received a tremendous productivity boost from the interment boom, more than making up for any slowdown because of Japan.

Moreover, that internet boom was quickly followed by global housing and credit bubbles, the likes of which the world has never seen.

Now we have global headwinds of extremely slow global growth outside of China, with credit contracting in the US for 10 straight quarters, and an increasingly hostile to further deficit spending in the UK and in US Congress.

I believe it is very safe to assume we are not going to have another internet revolution or another massive housing boom. History shows, the last bubble is never re-blown.

Could there be another boom-causing bubble? Of course, but I sure would not bet on it, or even think it is highly likely.

Nonetheless, Pettis cleverly left himself an "out", and it's one I agree with: "...not that they are necessarily wrong but rather that they are not obviously true"

Pettis continues ....

I think the Japanese story has important implications for our analysis of China. If China indeed experiences a rapid slowdown in GDP growth, the impact on the rest of the world may be far less than we expect. The real key is the evolution of the Chinese trade surplus. If it contracts, it will provide an expansionary boost to the rest of the world, not a contractionary one.

Of course that doesn't mean that the world will grow quickly. My expectation is that global demand growth over the next several years is likely to be anemic with or without China. But it does man that a slowdown in Chinese growth might not be the disaster for the world that many believe.

Also a rapid slowdown in Chinese growth does not mean a social or political disaster domestically It depends on how serious China is about rebalancing its economy. If policymakers are willing to force up interest rates and wages, most of the adjustment pain will be borne by SOEs and the state sector, not by the household sector. In that case we might see a slowdown in Chinese consumption growth, but one not nearly as severe as the slowdown in Chinese GDP growth. Since the Chinese, like everyone else, probably measures their well-being in terms of purchasing power per capita, rather than GDP per capita, a sharp slowdown might not be nearly as painful as we assume.

Three Key Points From Pettis

Global demand growth over the next several years is likely to be anemic with or without China.
If China's trade surplus contracts, it will provide an expansionary boost to the rest of the world, not a contractionary one.
A slowdown in Chinese growth might not be the disaster for the world that many believe.

Uneven Consequences

Point number one is a given. I agree with point number two and three although I can see how many would disagree. The devil of course is in the details, and that's where I possibly differ from Pettis. It's hard to say for sure because he did not expound on country-to-country differences.

This is how I see it.

China is clearly overheating. When (not if) China slows, that will halt pressure on rising commodity prices. Falling oil prices would help reduce the US trade deficit, especially if grain prices remain firm.

Falling energy, copper, and metal prices would help US homebuilders and small businesses hurt in a price squeeze of rising input prices and falling prices of goods and services.

The net effect of this would be to strengthen the US dollar, yet help the US economy. Ironically, Bernanke might not see it that way because short-term it might cause the CPI to go negative.

Moreover, it might not be good for multinational corporations or the US stock market in general which generally benefits from a falling US dollar. However, long-term it would help rebalance the global economy, and hopefully shut off protectionist trade measures in Congress. That last point is crucial. Everything depends on how fast China slows, and how rambunctious the next Congress is, and whether or not President Obama would veto currency manipulation legislation from Congress.

Assuming that Congress does not act to kill global trade (admittedly that's a big assumption), net-net the overall global effect of China slowing would not be a disaster for the world "in general", and in fact, the world would likely benefit.

The key words in the last sentence however, are "in general". An additional caveat is: if Congress manages to kill global trade with ill-advised protectionist legislation, the whole world loses.

Australia and Canada Will Suffer

As noted above, the US would likely benefit from a normal slowdown in China (or a crash not caused by collapsing global trade). However, Australia and Canada with their housing bubbles already poised to implode would suffer mightily if commodity prices tumble.

Given that the US and Europe are far more important globally, A slowdown in China might be a net benefit for the world "in general", yet a total disaster for countries overly dependent on continuous strong growth in China.

Australia and Canada would be especially hard hit, right at the worst possible time.

Why China Will Implode

Now that we have addressed what happens WHEN China slows. Let's discuss WHY China will do so.

China's Economic Treadmill to Hell

Please consider Fortune Magazine's Chanos vs. China

The influential short-seller is betting that China's economy is about to implode in a spectacular real estate bust. A lot of people are hoping that Chanos - who called Enron right - is wrong this time.

For over a year now Chanos -- the man who got Enron (among other things) right before anyone else -- has been on a rampage about China. The guy who became famous -- and rich -- shorting companies now says he is shorting the entire country.

When I mention the "treadmill to hell" line to the group in Shanghai, the reaction is the usual one when Chanos's name comes up here: "What does he know about China?" the American VC asks. "Has he ever lived here? Does he have staff here? Does he speak Chinese?"

The answers are no, no, and no. But our host, who counts Chanos as a friend, knows that is not the point. "He did get Enron right," Pete says. "And Tyco. And the whole mortgage bust." He concludes: "Look, he may be wrong, but you need to tell me why he's wrong, not point out that he doesn't live here."

How did Chanos come to his China obsession? It started in 2009, when he and his team at Kynikos looked at commodity prices and the stocks of big mining companies. "Everything we did in our microwork [on commodities] kept leading us back to China's property market," Chanos says. China's construction boom was driving demand for nearly every basic material.

One day, at a research conference in 2009, Chanos listened to an analyst tick off numbers about the scale of China's building boom. "He said they were building 5 billion square meters of new residential and office space -- 2.6 billion square meters in new office space alone. I said to him, 'You must have the decimal point in the wrong place.' He said no, the numbers are right. So do the math: That's almost 30 billion square feet of new construction. There are 1.3 billion people in China. [In terms of new office space alone] that amounts to about a five-by-five-foot cubicle for every man, woman, and child in the country. That's when it dawned on me that China was embarking on something unprecedented.''

To understand Chanos's China skepticism -- he calls it "Dubai times 1,000" -- it's worth visiting the Rose and Ginko Valley housing development near Sheshan Mountain, a new suburb outside Shanghai. Block after block after block of villas have gone up. And they are empty.

In the country's largest, most affluent cities -- Beijing, Shanghai, Guangzhou, and Shenzhen, known as tier-one cities to the real estate cognoscenti -- it is not an unusual phenomenon. There is a lot of new, unoccupied housing in China. Just how much -- and just how much of a concern it should be -- is a central debate.

Fixed-asset investment accounts for more than 60% of China's overall GDP. No other major economy even comes close. And of that fixed investment, slightly less than a quarter is attributable to new real estate investment.

Consider Dubai, he says: At the peak of its building boom, there were 240 square meters of property under development for every $1 million in national GDP. In urban China today that ratio is four times as high. "We've seen this movie before," he says. Whether it was Dubai a couple of years ago, Thailand and Indonesia during the Asian crisis of the late '90s, or Tokyo circa 1989, "this always ends badly."

Chanos: China's Treadmill to Hell Video

Shadow Over Asia

Inquiring minds are reading The Only Question About The China Crash Is When

by David Galland, Managing Editor, The Casey Report
An interview with Vitaliy Katsenelson

TCR: What our readers are looking for is a better sense of China and Japan, both of which are very important in the context of the global economy. As we have to start somewhere, let's start with China.

Today the conventional wisdom is that somehow the Chinese economy is better managed than its competitors, very similar to how people viewed Japan in the 1970s and 1980s. Back then people were absolutely convinced that Japan was the superior country with superior policies and that its economy was unstoppable. We all know how that ended.

So, let's start there. Is China's system better than everyone else's? Is it really possible the Chinese economy can keep steamrolling along?

Hyperinflation in Japan

The interview is quite lengthy and extremely good. It covers both Japan and China. It is hard to excerpt because I agree with nearly everything Vitaliy Katsenelson says.

I find it interesting that Vitaliy makes a case that Hyperinflation will occur in Japan before the United states. That is something I proposed 5 years ago and have stated a few times since.

Vitaliy makes a solid case ...

VK: Japan's story is very simple. The economy slowed down in the 1990s. To keep the economy growing, the government lowered taxes and increased government spending, sending budget deficits up. In order to finance those deficits, the amount of government debt has tripled.

The only reason they were able to finance that debt was because over 90% of the government debt was purchased internally; therefore, thanks to Japanese interest rates declining from 7.5% to 1.4%, the government was able to dramatically increase the amount of debt without the total borrowing costs going up.

Today, Japan is one of the most indebted nations in the developed world, and its population demographics are horrible because every fourth Japanese is over 65 years old. There's no immigration into Japan, and the population is aging rapidly, and the savings rate went from the middle teens to quickly approaching zero.

TCR: So there is less demand for Japanese government bonds.

VK: Yes, exactly. With the demand for Japanese bonds declining, they are going to have to start shopping their debt outside of Japan, and the second they do, they'll realize that no rational buyer would buy Japanese debt yielding 1.4% when they can buy U.S. debt or German debt with yields double that.

So the Japanese are going to have to start paying high interest rates, and they can't afford that, because one-quarter of the tax revenues already goes to servicing their debt. If their interest rates were to double to just 2.8%, it basically wipes out the funding for the country's Departments of Defense and Education. So this is a situation where they go from deflation to hyperinflation, because they're going to have to start printing money to be able to keep paying off their debt, so this is the case where they are going just from one extreme to another.

The interview is well worth a read in entirety with lots of charts and ideas. The one thing Vitaliy doesn't know is the same thing I don't know: When.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Friday, November 26, 2010

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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