Michael: You’ve written a report called China: Danger, Red Dragon! DANGER. China’s growth and India’s growth and prosperity has driven the commodity boom which is what’s rescued Canada, especially Western Canada to this point. Can you give us a minute nut shell on what worries you about China?
Jack: What scares us so much about China is going to rip up through the entire global economy. The nut shell is linkages; China is still extremely dependent on external demand, and in fact what they’re doing internally to prop up their GDP continues to destroy internal demand on a relative basis. 70% of their GDP is now driven by internal investment and speculation in the property markets. Of the various major industries there is too much over supply. We’re seeing major speculation in copper by companies that have nothing to do with copper. Major speculation in the housing market by companies that have nothing to do with real estate or real estate development.
So they’re reaching that stage internally where they’ve created a major investment problem. The GDP numbers in the US, Canada, the UK and the Euro zones are sinking, going down hill. So the demand from outside that China was so highly dependent on is going away. Now internal investment is so close to the saturation point, internal demand will not be able to sustain Chinese growth to any significant degree. So they have to make a transition and there’s a lot of powerful interests that don’t want to make a transition to a more domestic oriented economy because they love it the way it is. The current system has created many billionaires and though there’s many Chinese policy makers that know they need to make this transition, knowing and doing it as we just talked about with the US debt situation, are two different things. We think that because the industrial countries around the world don’t have any bullets left to stimulate we’re seeing China extremely exposed and we think there’s going to be a major growth accident there. (continued below)
China: Danger, Red Dragon! DANGER!
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Michael: Black Swan Trading slogan is ‘Be prepared’. If these problems to continue and maybe worsen in the States and Europe and the dramatic impact these Western problems will have on China. Will we be seeing interruptions in the commodity cycle? What are you advising individual investors to be doing?
Jack: It’s a very tough problem and I think that’s why you’re seeing gold catch this major bid. Interestingly too with all the chaos going on in the US you’re also seeing US bonds just soared yesterday as it seems for lack of other alternatives the US market is still the place to be. I say that because what’s happening in Asia,. The fact that there is no external demand that’s supporting them at the moment, they are very worried about that so they don’t want to see the US dollar fall to zero because then it puts pressure for then competitively and pushes up their relative currency values. So I think you’re going to see Asia being majorly supportive of the US dollar. I’m not saying the US dollar doesn’t possibly go to new lows but I’m saying I don’t see a disaster scenario there because Asia is in such a pickle. They will continue to buy treasuries I think, and continue to support the dollar from that stand point so to me the US treasury market still looks like the place to be. Even when they’re actually down to a double ‘A’, it’s really the only game in town. You don’t want to go to Europe given the situation and you just can’t hide anywhere else so…
Michael: Jack, its an interesting weekend in the States given that they’ve created a political dead line of August 2nd which is Tuesday of course to try and raise their debt ceiling.
Jack: Yes, you’ve hit it pretty well, it’s quite a mess. My perspective on this goes along the same line as yours. I think this is the time, there’s no better time, to make some serious changes in the direction of government spending and to me if that requires them to fall so be it. They really need to just start eliminating sections of the federal government in order to ever cover the main mandates that they’ve made into the future.
Michael: By the nature of politics when you’re trying to solicit support from varying special interests or groups of people the greater good rarely comes into it. Greece is on the precipice of bankruptcy, the same in Portugal, Ireland and soon Spain and Italy. Now the US is Centre stage, and both Republicans and the Democrats are offering plans that are going to raise the debt ceiling as well as the overall debt. They seem to be just refusing to address the problem. Do you think there’s any hope for any meaningful kind of change?
Jack: I’ll be extremely disappointed I’m sure because you have nailed it. Both Republicans and Democrats have so many different interest groups that they are tied to. It’s really sad to watch but they know spending is power and to them that’s sort of the bottom line.
Michael: The European debt crisis is temporarily on the back banner but it is going to rise to the fore front much very soon. I saw that with Spain this week when on wednesday Standard & Poor’s revised its outlook on the Kingdom of Spain to negative from stable
Jack: I think the European crisis is far from over. The core issue in these periphery countries is how do they create wealth to a degree that they can pay back any of the debt when the problem is they can’t create wealth in this system when they have to compete against Germany. So they’re throwing more and more good money after bad and the dirty little secret is that they’re just trying to protect the banks. The banks have huge exposure not only to the periphery countries in Europe but also to the emerging market countries in central Europe that were formerly Russian satellites, so the contagion problem to me and it’s going to rear its ugly head again. We see Cypress in trouble now and we see the interests rates blowing out in Italy and Spain. If everything was hunky dory we wouldn’t interest rates rising to record highs in Spain and Italy.
Michael: This is one of the real keys that people have to understand is that you’ve always got to put your money somewhere. There’s only three really major currencies in the World, the US dollar, the Euro and the Yen. So it’s the case of whose the best looking of ugly sisters. Japan’s got dramatic problems especially demographically, you’ve got Europe which we’ve just described and you’ve got the US. So I guess what the out look is on the very short term is they’re all ugly but the US is less ugly.
Jack: I’m not saying that the dollar looks that great to tell you the truth I mean it got only a little bid yesterday even when the biding went up in US treasuries. The Swiss Franc is doing well and that’s the safe haven whose not part of the European Union. Even despite of the troubles in Japan, the Yen is also acting as a safe haven again for the major Japanese institutions coming home and hiding in there. So you do have some other avenues outside the US dollar, the Swiss Franc as I said and Japanese Yen seems to be playing those roles. I was using the Australian dollar and New Zealand dollar as a hiding place but if China breaks those two currencies would get hit very, very hard whereas Swiss and Japanese Yen would not.
Michael: Do you think that gold is being traded as an alternative currency?
Jack: Yes I think there’s no doubt about that. Gold is soaring against all the major currencies.
Michael: Are all of the currencies are going to blow up at some point?
Jack: Yes I think that’s absolutely right. I think you can garner that from Gold’s movement.
Michael: What do you see for the Canadian dollar?
Jack: I was really surprised by the Canadian GDP report on friday which showed GDP falling .03 % in May against forecasts of a rise of .01%. You have to look at Canada really as kind of a safe haven for North American money from a currency standpoint so I think we’ll find out very soon whether they’re going to look right past that GDP report and the Canadian dollar will move higher, more again as a safe haven just to get out of the US . If that’s the case and we make a new high in here, the Canadian dollar will probably test those old highs we made a couple of years back. But the Canadian dollar is technically very, very overbought.
Michael: Well, in summary you’re just saying the debt ceiling issue is irrelevant. Even if they find some sort of short term solution, the problem is they borrowed more money than they’re ever paying back and they have unfunded liabilities that are not going to be met. That’s the problem and they’re certainly not showing any signs of being willing to address that.
Jack: You’re exactly right and that’s why it’s so interesting. The situation now is the US winning by default, doing much better than they should from an asset stand point. But once China gets through this period that we’ve talked about, a danger period probably over the next year or two, and they make that transition and are a less reliant on outside demand, the whole game changes. Then the US is going to then look like a very ugly sister relative to the potential in Asia if china gets through this without some political upheaval. So, that clock is ticking too, a whole potential change in the global macro environment. If the US does not get its house in order and continues to depend on the fact that it has the world reserve currency, if the game changes that’s where the real damage will come big time for the US dollar.
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China: Danger, Red Dragon! DANGER!
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China is Staring down a major contraction. They’re trying their best to prevent it. But their best won’t be enough. A hard landing is coming. The coming implosion of Chinese economic growth will exacerbate investor fears and shake markets.