Trader’s Narrative

Just a few months ago everyone was wringing their hands over the Chinese stock market (myself included).

With Greenspan chiming in to join the chorus of “bubble” talk, everyone was expecting it to implode at any minute. So what happened?

Nothing.

In fact, the Chinese market is going strong (see graph below). This is remarkable considering that it has done so when almost all the global markets have corrected along with the US recently.

That’ll teach me for not using Greenspan as what he is: the world’s rarest contrarian indicator. From his poo-pooing of ARMs (adjustible rate mortgages), which are now coming home to roost, to his prediction about natural gas, to his casualness about this generations greatest financial bubble, and going back to his econometric predictions even before he was in the Fed, Greenspan has a knack for taking the wrong side of a trade. He rarely makes statements on the market, but when he does, it pays to go the other way.

Bubble or no bubble, technically speaking China looks like one hell of a resilient market.

Calling China’s Bluff
The economic war of words between China and the US hit a new shrill high note with China explicitely warning that it will use its $1.3 trillion dollar reserve to cause a crash in the US dollar if it is pushed around in trade talks. From the Telegraph in the UK:

Xia Bin, finance chief at the Development Research Centre (which has cabinet rank), kicked off what now appears to be government policy with a comment last week that Beijing’s foreign reserves should be used as a “bargaining chip” in talks with the US.

“Of course, China doesn’t want any undesirable phenomenon in the global financial order,” he added.

He Fan, an official at the Chinese Academy of Social Sciences, went even further today, letting it be known that Beijing had the power to set off a dollar collapse if it choose to do so.

“China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency. Russia, Switzerland, and several other countries have reduced the their dollar holdings.

Of course if we play this forward like a chess move, it is clear that China is in reality threatening to shoot itself in the face with both barrells. The dominoes would fall like this:

1. China sells dollar reserve
2. US dollar crashes through 80 support area
3. US interest rates shoot through the roof (bond/yield inverse relationship)
4. the wounded US housing market gets a stake through the heart
5. stock market crashes as yields shoot up
6. liquidity dries up causing a cascade
7. US economy nose dives into a deep recession
8. US recession reverberates throughout global economy
9. US imports of Chinese goods are drastically reduced
10. Europe and Asia fall into a recession (perhaps milder)
11. Chinese economy sputters
12. Chinese factories shut down causing unemployment to rise
13. rioting and unrest increases exponentially in China
14. the fan is soiled with #2 in China

Why would the Chinese put in motion the scenario which would in the end see them lose those cushy Communist Party jobs? They are not that stupid. Here’s hoping that the US politicians aren’t either.

Anyway, here’s the chart showing the Chinese and US markets: