Global Tsunami

           All major markets plunged on Monday, because of renewed fears of the credit crunch.  The Nikkei actually rose until the tsunami went across the world and crashed on the Nikkei on Tuesday morning.  Merrill Lynch just wrote off another 5 billion in mortgage related assets, which sparked fears that more are to come.  Expectations within all stock markets are shaky.  Investors see a global slowdown approaching juxtaposed with the fastest increase in prices in twenty years, which equals stagflation.  Currency markets reflect the uncertainty in the market place because they have been range bound for the last four months.  The only currency that is not range bound in the AUD which is still appreciating against all major currencies.  However Australia’s growth is correlated with the rise of Chinese GDP.  Australia is a commodity rich country that has provided the raw materials for China’s economic boom.  Iron ore mined in Australia costs 1/3 less than ore produced in Brazil, mainly due to transportation costs.  This has provided Australian mining companies with record profits, and an unemployment rate that is below natural unemployment. 

Once China slows down, which is not a certainty but highly correlated with the health of the U.S. consumer then Australia will slow down.  However due to the fact that most Chinese goods are inelastic trinkets the relation may not be as strong as expected.  The country that will lose the most in regards to a global slow down is Japan, because articles manufactured in Japan are elastic.  China produces GI Joes and Barbie’s which believe it or not are very inelastic.  They are inelastic because the purchase represents a small percentage of consumer spending, thus consumers don’t change their spending patterns dramatically.  Exporters such as Canon, Toyota, and Sony stand to lose the most because these big ticket items are not consumed when a recession hits.  The prediction of China’s demise does not apply unless a correlation is found between US consumer spending and Chinese exports. 

The Politburo wrote in the five year plan that they wish to augment domestic consumer spending.  This could be accomplished by allowing the Yuan to appreciate because the Chinese could afford international goods not found in China.  However this solution is highly unlikely because the PRC focuses on export lead growth.  The other option is to single handedly prop up the USD.  In order to do this the PRC must buy more US bonds, which would strengthen the dollar, but puts the Chinese in a bad situation.  The risk premium associated with U.S. bonds has risen, the U.S. will not default but the value of the dollar may be outside of China’s power.  If the dollar depreciates then the PRC stands to lose billions, from there 1.8 trillion dollar position in dollars.  Expect this to happen because it is a tricky way of augmenting exports.  It is not the prudent path but the PRC is known for the Great Leap forward and the Cultural Revolution.  By augmenting their dollar positions they are helping exporters at the expense of Chinese tax payers.  In short the global tsunami will first fall on Japan then on the Chinese tax payer.