Mike Shedlock

The Chinese hard landing is on its way. Please consider China's epic hangover begins by Ambrose Evans-Pritchard.

China's credit bubble has finally popped. The property market is swinging wildly from boom to bust, the cautionary exhibit of a BRIC's dream that is at last coming down to earth with a thud.

"Investors are massively underestimating the risk of a hard-landing in China, and indeed other BRICS (Brazil, Russia, India, China)... a 'Bloody Ridiculous Investment Concept' in my view," said Albert Edwards at Societe Generale.

"The BRICs are falling like bricks and the crises are home-blown, caused by their own boom-bust credit cycles. Industrial production is already falling in India, and Brazil will soon follow."

"There is so much spare capacity that they will start dumping goods, risking a deflation shock for the rest of the world. It no surpise that China has just imposed tariffs on imports of GM cars. I think it is highly likely that China will devalue the yuan next year, risking a trade war," he said.

China's $3.2 trillion foreign reserves have been falling for three months despite the trade surplus. Hot money is flowing out of the country. "One-way capital inflow or one-way bets on a yuan rise have become history. Our foreign reserves are basically falling every day," said Li Yang, a former central bank rate-setter.

The reserve loss acts as a form of monetary tightening, exactly the opposite of the effect during the boom. The reserves cannot be tapped to prop up China's internal banking system. To do so would mean repatriating the money – now in US Treasuries and European bonds – pushing up the yuan at the worst moment.

"The reality is that China's economy today requires significantly more financing to achieve the same level of growth as in the past," said China analyst Charlene Chu.

Ms Chu warned that there had been a "massive build-up in leverage" and fears a "fundamental, structural erosion" in the banking system that differs from past downturns. "For the first time, a large number of Chinese banks are beginning to face cash pressures. The forthcoming wave of asset quality issues has the potential to become uglier than in previous episodes".

Investors had thought China was immune to a property crash because mortgage finance is just 19pc of GDP. Wealthy Chinese often buy two, three or more flats with cash to park money because they cannot invest overseas and bank deposit rates have been minus 3pc in real terms this year.

But with price to income levels reaching nosebleed levels of 18 in East coast cities, it is clear that apartments – often left empty – have themselves become a momentum trade.

Mark Williams from Capital Economics said the great hope was that China would use is credit spree after 2008 to buy time, switching from chronic over-investment to consumer-led growth. "It hasn't work out as planned. The next few weeks are likely to reveal how little progress has been made. China may ride out the storm over the next few months, but the dangers of over-capacity and bad debt will only intensify".

In truth, China faces an epic deleveraging hangover, like the rest of us.

Hot Money Outflows Increase

Bingo to Ambrose. And hedge funds have finally figured out this massive revaluation of the Yuan upward they expected is not going to happen, and the tail does not wag the dog. Thus the hot-money outflow.

China is prepared for that outflow with massive reserves, but the US is not prepared for the Yuan to stop or even slow appreciating. Devastating trade wars are likely.

They may have already started. Please see China to Impose Anti-Dumping Duties on GM; "Fair Trade" Idea is Self-Serving Scam; Proposal to Stop "Free Sunlight" Gains Support From Mitt Romney for details.

All Asia-Pacific Equity indices are in the red overnight following more bad news from China and Japan.

Asia Pacific Equities

Japanese Manufacturing Sentiment Sinks

Bloomberg reports Japan Manufacturing Slides on Europe Crisis

Japan’s largest manufacturers became more pessimistic than economists expected and China reported the first decline in foreign direct investment since 2009 as Europe’s crisis drags down the global economy.

The Tankan large manufacturer index of sentiment fell to minus 4 in December, the Bank of Japan (8301) said today in Tokyo, worse than the median estimate for a reading of minus 2 by 24 economists surveyed by Bloomberg News. Investment in China slid 9.8 percent from a year earlier to $8.76 billion, the Ministry of Commerce said.

In Japan, manufacturers from Toyota Motor Corp. (7203) to TDK Corp. (6762) are also under threat from a yen that rose to a postwar record against the dollar on Oct. 31 as investors seek a haven from turmoil in Europe.

TDK, the world’s biggest maker of magnetic heads for disk drives, is among Japanese companies cutting jobs, while Panasonic Corp. (6752) has picked Malaysia as the site for a solar-cell plant, to hedge against currency risks. At Toyota, poised to lose its crown as the world’s largest automaker, currency gains have forced price increases, threatening to further erode global market share after production disruptions from the temblor and floods in Thailand.

“We raised prices of some our models on the high yen, and this is very difficult for us to admit, but we expect a drop in sales from this,” Satoshi Ozawa, chief financial officer at Toyota, said this month. “Still, the yen is too strong, and we had to sacrifice some unit sales.”

China Manufacturing Contraction Continues Second Month

MarketWatch reports China manufacturing cools further

Chinese manufacturing activity extended its decline in December, as production at factories and the volume of new orders generated eased from the previous month, according to the preliminary reading of an HSBC survey, released Thursday.

HSBC’s so-called “flash” Purchasing Managers’ Index for the month printed at 49, staying below the threshold of 50 that separates expansion and contraction.

The flash PMI number is based on the responses of 85% to 90% of the total respondents in a survey.

In response to the weakening fundamentals of China, the Shanghai Stock index is down again this evening, having fallen back to March 2009 lows.

$SSEC Weekly Chart

click on chart for sharper image

That snapshot is as of yesterday's close. The Shanghai Index is down another 2% this evening to 2,182, approximately where the dashed blue line is in the above chart.

Mike "Mish" Shedlock

Mike Shedlock

Mike Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management.