Quarks of China’s Banks

Chine_YuanFuel for the Fire

Adjustable_Gastric_BandChinese Economic Policy

Last week, two major discoveries were announced. First, physicists found compelling evidence that dark matter—which comprises some 95% of the universe, yet has never been directly seen or observed—may in fact be positrons, the detritus of colliding energy. Just as worms leave digested matter behind as proof they exist, electrons and antimatter leave behind positrons. Physicists are overjoyed at this significant discovery. As they see things, it clearly justifies the billion-dollar spectrometer aboard the International Space Station.

The other discovery from last week came in Asia, where it was found that China’s foreign exchange reserves have reached an all-time high of $3.4 trillion. Western scientific economists, who have also been on a search—for where all the world’s stimulus money went—were horrified.

Or perhaps gratified.

There are two ways to weaken and kill something. One is to starve it of nutrients, cut off its calorie support and watch it wither away. The other is to force-feed it until it becomes toxic from excess calories that become fat. This overfeeding results in morbidity. It appears the West will attempt to kill the Chinese economy the latter way. China was just handed a credit downgrade by Fitch. If you read between the lines it was because they have too much liquidity, too much cash. The result: every other Chinaman is in the loan business. The official term for this is “shadow banking”, but on the street it means every CCP branch, every local business group, every locality and tens of millions of plain loan sharks are out there financing everyone’s “Chinese dream” at exorbitant interest rates.

Usually these “loans” can only be paid off by raising fresh capital. Hence, a Ponzi-scheming army of Marco Polos has officially arrived in the East.

Since China has the Renminbi fixed against the dollar, Federal Reserve Chairman Ben Bernanke is responding by pouring hot money into China, and it looks like Haruhiko Kuroda (the Governor of the Bank of Japan) will soon be following America’s lead. Because the Chinese government controls the flow of money into the country, it ends up holding tons of cash that it has no idea what to do with, and which it cannot spend in China—unless it wants to trigger inflation on a scale the world has never seen.

Add to that massive and pervasive corruption, outright corporate fraud, poorly focused infrastructure spending and severely restricted investment opportunities and you have the building blocks for a massive economic headache.  When those Japanese yen presses get going and the U.S. and Japan become a one-two punch, the amount of cash flowing into China may actually choke it to near death. China’s central bank will either have to drastically revalue the Renminbi upwards or liberate the economy and hope it finds its own way. The status quo simply cannot hold.

Like all gluttony, it looked and felt good for a while. But China has—by its central planning and one party rule—effectively gastric-banded itself while gorging on profits from exports and implementing predatory economic policies. One result has been an enormous real estate bubble, as speculation in apartments has caused the value and affordability of housing to become a mirror image of Japan in the 1980s. And China’s foreign reserves are in no better shape: they are invested in the silliest of assets, U.S and European bonds. These are the very assets central bankers Bernanke and Kuroda are out to destroy as they force everyone to re-inflate the real estate market and mega-corporations. Although policies that may lead to re-inflation might seem absolutely idiotic, Bernanke and Kuroda really have no choice. Politically, they may be as fearful of civil unrest as the Chinese. Not implementing these policies would lead to another recession or depression in America and/or Japan, which would be uncharted waters—especially with Europe already on the ropes. No modern economy can live with deflation for long.

It appears that both the U.S. and Japan finally fully understand China’s game plan. The only thing the Chinese want to trade or buy from the West—or Africa and Latin America for that matter—is what is going to feed their export machine. Most recently, as labor costs in China have increased, the government has turned to the high-tech sector to produce desired profits. The result has been a steady stream of high-tech equipment being shipped all over the world, further fueling China’s monstrous yet morbid economy.

To make matter’s worse, the whole process is becoming easier. Not too long ago, the Chinese would have to manufacture and export goods all over the world to collect revenue. Now with quantitative easing (QE), cash just flows into China usually via Hong Kong. This is the mother of all carry trades: borrow at no cost in the U.S. and Japan and collect fixed currency interest in China. No need to manufacture a product, just move money to make money. This phenomenon is force-feeding China’s legion of speculators like a French farmer does a goose.

All of this will result in a much more decisive and consequential collision than the type physicists now believe may produce the dark matter that makes up most of the universe. While this is significant, the real super collision that is coming is the Chinese state-controlled, repressive model versus the U.S. and Japanese capitalist model. If one was wondering what detritus was coming out of that collision, it would be safe to assume it will look a lot like the West. For all its flaws, the West’s free-wheeling will beat out the state-controlled, shadowy economic policies of China. While China may have most of the fiscal dark matter, the West has most of the transparency—and that is what counts.

About the Author
Jonathan Russo has been observing Israel and its policies since he first visited in 1966. He is a businessman in New York City.