Archive for December, 2007

I don’t read the Economist much. I think of it as a Time Magazine for the mid-brow transnational elite: a crystallization of conventional wisdom, and therefore a powerful contrary indicator.

But sometimes, they are right. Their latest article on China, “Flashing Red,” is an excellent layman’s summary of why investing in China is so insane.

THE scene on the trading floor of the Shanghai Stock Exchange appears to be strikingly out of character for a market that is on fire. Situated in an iconic square building at the heart of Shanghai’s costly new financial district, it has a vast trading floor filled with orderly rows of obsolete, box-like terminals. Clustered in one corner are a dozen clerks, heads resting on desks, dozing peacefully.

On a purely objective level, the lack of activity on the exchange is the result of trading becoming fully electronic. But why, then, does the trading floor exist at all? A rather more worrying interpretation of the Potemkin village set-up is that it does speak of something more than merely a shift to electronic trading. The Shanghai market itself is a kind of façade—not really a market, at least in the Western sense where prices are set by broad forces of supply and demand, but rather a place where China’s government can provide the appearance of a modern economy, complete with a signature statement of modern finance and business: an equity exchange.

The result is an odd trading venue where companies are tied to shares but the shares do not carry genuine ownership rights, such as the authority to determine management (often directly controlled by the central government) or dividends. And, perhaps most importantly, it is not a trading venue where people believe shares are as likely to go down as to go up. Currently, they believe they can only go up.

This confidence has its roots in a spate of initial public offerings of government-controlled companies, each of which was deliberately priced to leap on opening day. Wealth made from flipping offerings proved to be contagious, particularly given the lack of alternatives. With few exceptions, China bans its citizens from investing abroad. At home, the choice is between savings accounts paying less than inflation or real estate with uncertain property rights.

The flood of money into shares has pushed stock prices so high that even China’s remarkable growth cannot justify them: 65 times trailing earnings on the Shanghai exchange in October 2007, and 75 times earnings on the exchange in Shenzhen, which caters to smaller companies. The valuations are even more jarring because earnings are often inflated by corporate investment in the stockmarket, a circular logic that can just as easily come unwound. Similar distortions are also rife throughout the balance sheets of public Chinese companies as a result of recently adopted accounting rules that require assets to be revalued at prevailing prices, though the markets to set prices, for example in real-estate holdings and exotic securities, often do not exist.

In a normal stockmarket, speculators can deflate bubbles by shorting shares. That is illegal in China. In a normal stockmarket, investors can reap large rewards by having their investments bought in a heavily fought acquisition. In China, an acquisition must survive central planning (and often doesn’t). Most of all, in normal markets, share prices are based on how a substantial amount of the shares in a company trade. In China, shares in many of the benchmark companies are held by the company or the government and do not trade. Prices are determined by just a few shares being batted back and forth.

If only a few shares are determining the overall valuation, it means only a few people need change their opinions for the market to unwind. Normally, a counter-balancing force for a sudden panic comes from contrarian-minded investors who believe an objective understanding of information provides a reason to buy shares as their prices become more reasonable. Put simply, crashing prices are an opportunity, not just a problem. But finding objectivity in the Chinese market is no easy task because information disclosure is wretched. Companies, and the investment banks that coddle them, distribute information to favoured investors but not to the market at large. For its part, the Chinese government broadly abets this process, granting selective permission to favoured foreigners wanting to invest.

These insiders are comforting friends for China to have, but they are insidious forces for a genuine market. Instead, China needs disinterested outsiders—and insiders—free to do research, free to buy and free to sell. Yet the market in China has become an example of moral hazard gone wild. Historically, this is not uncommon. Markets work in nasty ways and countries frequently try to control them. Critics are faulted for misunderstanding the local “culture” or for missing the crucial fact that this time, really, is different. And then, inevitably, there is a crash.

Couldn’t have said it better myself.

The point about the government owning most companies on the Exchanges is crucial. I can’t remember how many times I read that PetroChina was a “$1 trillion company,” “double the size of ExxonMobil.” 2 percent of PetroChina shares were capitalized at $20 billion on the day of the IPO; that doesn’t mean that the other 98 percent, which is locked up in one form or another by the government, is or was ever worth 49 * 20bn = $980 billion.

But I guess that would have gotten in the way of a lot of “great” headlines.

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Onward hip-hop soldiers

I was watching the trip-hop “The Way I Are” music video, and I wandered to the song’s Wikipedia entry because I have wondered what 3 English footballers could possibly have to do with an American rap/ hip-hop song. (There were 3 UK footballers in the video.) I didn’t get an answer to that question, but I did find out how incredibly popular this song has been around the world.

Most of my cultural “notes” ooze pessimism. But this song exemplifies how American culture, for all its faults and sludge, has wiped the floor in the global cultural marketplace. I think American cultural dominance is sad, because I think American culture is pretty much garbage.

But, assuming the Wikipedia entry is correct, this American hip-hop song was stunningly the #1 single for at least 1 week in countries as different as: Australia, Bulgaria, Cyprus, Denmark, Estonia, Ireland, Israel, Norway, Poland, Slovakia, Turkey, the UK, and of course the United States.

It was also the #2 or #3 single in Belgium, the Netherlands, France, Switzerland, and Hungary.

That is profound soft power.

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I need to figure out how to widen the main column of the page (this one). I wish I didn’t have to squish these graphs so much.

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[in translation]This is how it was …

A female student was bicycling down the right side of the street on her way back to the dormitory, and a Buick vehicle came along in the same direction. The two vastly different vehicles collided with each other, and the bicycle left a scratch of 20 to 30 millimeters on the car.

At that time, the female car owner got out of the vehicle angrily and demanded an apology from the student. Furthermore, an apology was not good enough because there had to be payment for damages. So the student called her teacher for assistance. By this time, many students had gathered around the scene and one of them asked the car owner: “Where do you come from? Why are you on our school campus?”

The woman said something that was provocative: “If I produce my identification document, you should be scared to death.”

So the students began to confront the car owner while refusing to listen to the police. The police pulled the car owner aside and began a discussion. But the elder brother of the car owner has shown up with some friends. They talked tough and they began shoving the students around! The students were infuriated and there was physical contact. But since the car owner is female, the students restrained themselves.

Then a male student tried to make scratch marks on the car. The brother of the car owner assaulted him and they also demanded that the police take him in. According to rumors, the male students was severely injured (note: it was very chaotic at the time).

Then we called 120 (note: emergency medical service) and an ambulance came to take the injured male student away. The elder brother of the car owner saw trouble coming and quietly sneaked away. This became the focus of the story later on.

The woman was trapped. Her mother came. Although the mother was an elderly lady, she was just as unreasonable and barbaric. The campus security guards also came. But we chased them away. Then the security director came, and the students asked; “How did a car without a permit enter campus? What do you guys do for a living?”

A teacher showed up and promised that the chancellor will be here.

Before the chancellor could arrive, the students demanded that the car owner turn over the person who conducted the physical assault on the male student. That would be the elder brother of the car owner. But the car owner refused to say a word.

Then the security guards showed up again. We started cursing and yelling, and called them a bunch of pigs. Someone said that the security guards were letting outsiders without student ID’s come and go in the university. We now have proof that a vehicle without a permit could come and go on university campus. The security guards were speechless and they could only glare at us. At that moment, someone began to assault the car. First, they broke the windshield glass. Then they yanked out the registration plate.

A teacher came to mediate, but he was told to scram. The security guards tried to stop the vandalism, but the students would not budge and held them off. A teacher then said that the chancellor would come in ten minutes. We stood and counted ten minutes. He did not show up, and so we started to assault the car again. The police tried to stop us, but the students pushed them out. There was some physical contact. One police officer was hit and left holding his head in his hands. The police did not come back again.

The teachers who tried to intercede were dragged off. We asked the people on the other side to disperse, and then we overturned the car. The female car owner tried to stop us, but we dragged her off by force. The car was overturned and the chancellor still had not shown up.

Someone there said that he was from the Student Affairs Office, but the students told him to scram (and that applied to the teachers, security guards and police officers).

Then we broke all the windows on the car and nearly ripped the car doors out. It was quite a scene. But the car was solidly built as the front window never came off.

A student leader jumped on the car and tried to speak, but we couldn’t hear what he was saying. On one hand, his voice had gone hoarse from all the yelling. On the other hand, too many other people were yelling.

Then we Nankai University students got together and sang our school song! When the school song is sung, all Nankai people are united. Back then, the Japanese military bombed our campus but they could not destroy our unity!!! So this city bum couldn’t count for anything!!!!

Finally, Chancellor Zhang Jing appeared and promised:

1. The students will not be pursued for responsibility
2. Traffic within the campus will be improved
3. The instigator will be pursued in accordance with the law.


I have always said that the current Chinese system will unravel from either currency revaluation (better, but unlikely), or from inflation-driven unrest (very likely). The Chinese status quo is totally unsustainable, and I believe it will only be brought down by force.

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Pakistan: Stores Opening In Karachi
December 29, 2007 1532 GMT
More people are appearing on the streets, and stores are beginning to open in Karachi, Pakistan, a Stratfor source in the city reported Dec. 29. The situation is getting back to normal, the source said.

Pakistan will be fine, as long as the government settles on a reasonable explanation for the assassination instead of Pakistan’s equivalent of the ‘single bullet theory.’

Karachi is the beating heart of Sindh, the Bhutto clan’s home province, which has seen the highest levels of unrest.

The Pakistani army and Rangers have held back the flood, for now.

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Car bomb hits busy Baghdad market

At least 14 people have been killed in a car bombing at a busy market in the Iraqi capital, Baghdad, police and hospital officials have said.

At least 64 people were wounded in the explosion, which happened at about 1300 (1000 GMT) in a square crowded with shoppers after Friday prayers.

A police spokesman said the dead were all civilians, including at least one woman and a child.

The wounded were being treated at four hospitals, a medical official said.

The attack took place in Tayaran Square, the scene of other deadly bomb attacks in the past two and a half years.

It lies in a predominantly Shia quarter of the city, which makes it the target of Sunni extremists.

Meanwhile, US military officials reported that coalition forces had killed five insurgents and detained 14 suspects, during operations targeting al-Qaeda in central and northern Iraq.

US officials say violence has been reduced by 60% in Iraq although bombings and other attacks are still frequent.

This one probably was engineered by the Sunnis, considering the two bombs that shredded Sunnis the other day.

The NIE has signaled that the United States is done. Iran and her proxies are going for broke. The American-backed Sunnis will bomb back.

(Thank you, Gen. Hayden. No doubt you are fulfilling “the CIA’s social contract with the American people” by removing the one weapon — a significant probability of conventional escalation — which could have deterred Iran.)

It’s important to remember whose hands are dirty, as Iran reels in southern Iraq. Unless Petraeus all but orders the Sunnis to ‘cut down the tall trees’ and preemptively cleanse Shiites, the NIE lost the war, and Petraeus’s work has been undone.

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Plunging MZM = bullish. MZM has been historically high, and is now dropping rapidly.

Plunging commercial lending ( = TOTCI) = bearish. Commercial credit is also at a secular extreme — although the 2001-04 plunge was also a secular extreme.

The dollar has tanked a lot in recent days, which implies that MZM is falling with it (more so than the graph suggests, because MZM data is about 2 weeks old). The dollar is at $1.47/euro again, and 112 yen per dollar instead of 114.5 or so. So the dollar is once again pretty weak. I previously thought it would strengthen dramatically, as the disparity between MZM and USD converged, to the benefit of general asset prices and the value of the dollar.

But that doesn’t seem to be happening … and probably won’t, until the US trade deficit is below 2.5% of GDP. The most recent figures clocked in at 5.1 percent, but dropping.

The sterling has tanked along with the dollar. All of the sudden nobody wants to invest in the UK anymore. Its budget deficit is about 3.5% of GDP, and its trade deficit is even bigger than the United States’.

I wonder if the forex market is pricing in a seismic shift in the yuan/dollar relationship by knocking DTWEXM out of line with MZM until the yuan revalues. The US trade deficit ex-oil is overwhelmingly centered on China, which means it won’t come down as long as the yuan remains unconvertible. And as long as China continues its bull(####) market, commodities will keep going up, so the US deficit will, if anything, increase. But as the dollar goes down, the yuan will come down with it, and continue exacerbating the problem.

In the PBOC’s “dollar sterilization” procedure, as I understand it, dollars are handed over to the central bank in exchange for yuan, at what is basically a state-set rate. Those yuan are not useful outside of China, so China has what amounts to a domestic inflation glut, in line with its accumulated foreign exchange surplus (its “savings glut”). Only massive, systematic rioting will force Beijing to change their ways, and nobody is convinced that that will happen until after the Olympic Games.

Gold, however, is still rising at a blistering rate. I’m surprised the “GOLD AT 28-YEAR HIGH” canard hasn’t been plastered all over the headlines by now. I guess that will come over the weekend and Monday after everybody has gotten the point about Bhutto.


EUR-USD 1.4706 0.0080 0.55
USD-JPY 112.9300 -0.8055 -0.71
GBP-USD 1.9919 -0.0042 -0.21


Oil 96.72 0.10 0.10
Gold 842.70 10.90 1.31
Natural Gas 7.23 0.03 0.42

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