Monday's Top 10 with NZ Mint: China's self-destructive tendencies; Ending the extending and pretending; RBA's over-zealous money printing; Dilbert

Here are my Top 10 links from around the Internet at 10 past 12pm, brought to you in association with New Zealand Mint for your reading pleasure.

I welcome your additions and comments below, or please send suggestions for Tuesday's Top 10 at 10 via email to bernard.hickey@interest.co.nz.

I'll pop any surplus suggestions I get into the comment stream.

1. 'It's all about consumption' - Yves Smith at Naked Capitalism has a great summary of the problems in the global currency system now and how China's role is crucial.

China needs to revalue to boost its own consumption, and has even suggested as recently as last week that it wants to boost consumption.

Yves says don't believe it until you see it.

China is effectively subsidising producers and exporters at the expense of consumers and importers. There are all sorts of interested parties, including many state run banks and exporters, who don't want to change a thing.

China's bosses make themselves personally rich by creaming the top off the surpluses made by these exporters. They somehow need to work out how to make money out of consumers and consumption. What they need to do is increase GST...

The rest of the world tolerated China’s mercantilism when everyone was in growth mode. But China has made a monstrous mistake, and it is a fundamental, strategic error. At least until now, it gave no sign of planning to change from a mercantilist model. All the signs from China have been that its leaders think that if it can avoid what happened to Japan , ie being forced to revalue its currency (per the 1985 Plaza accord), all will be well.

It actually has been moving to a LOWER consumption share of GDP post crisis, the reverse of what you’d see if it were trying to rebalance the economy. This movie has ended badly for everyone who has tried China’s game plan.

As Michael Pettis has pointed out, China has the largest foreign exchange reserves relative to GDP of any country in modern history. Next two are the US on the eve of the Great Depression and Japan at the end of its bubble era.  

2. 'Do it for your own sake' - Nouriel Roubini makes some excellent points in this WSJ piece about the need for China to allow its yuan to revalue higher vs the US dollar.

He says China faces blowing up a destabilising growth bubble unless it allows revaluation, he says. Roubini points out China has 100 car makers producing 8 million more cars than are needed.

Anyone else noticed that Great Wall has started selling cars in New Zealand?

China needs to boost domestic consumption and reduce its reliance on exports. In fact, China's official government policy already embraces that concept. The problem, Mr. Roubini says, is that China's efforts to promote consumer spending ring hollow while the yuan remains weak. Consumption as a share of gross domestic product, in fact, has fallen to 36% from 45% in the last decade, compared with U.S. levels of about 70%. The key, he argues, is the exchange rate.

A cheap yuan keeps many foreign goods unaffordable, protecting state-owned enterprises, which also benefit from cheap credit. That's because suppressing the yuan's value requires China to keep interest rates artificially low. Both of these effects allow "a massive transfer of income from the household sector to the corporate sector," Mr. Roubini says. As a result, a quarter of China's GDP is the income or the retained earnings of companies, mostly state-owned. Those funds, rather than being distributed to the wider population through dividends, instead end up in assets such as real estate and new production facilities. All that spending is creating destabilizing gluts, particularly in production capacity. Mr. Roubini singles out the car industry as an example. This year, car sales jumped from eight to 12 million vehicles, a 50% increase. But production capacity went from 10 million to 20 million vehicles.

"China now has 100 separate car makers," he says. "The U.S. has only three." There's also a glut of commercial and residential real estate, he asserts, and even a glut of infrastructure, an area of Chinese investment usually singled out for praise. "You know, I go to China six or seven times a year, and you have brand-new airports three-quarters empty," he says.

"Highways to nowhere all over the country."  

3. 'The laws are written by lobbyists' - Google CEO Eric Schmidt has told The Atlantic in this video interview below that America's laws are written by corporate and other lobbyists. He should know. Google now has a very active operation in Washington.

This is another reason why we should steer well clear of a Free Trade Agreement with America and laugh in American politicians and officials faces when they describe themselves as a democracy.

"The average American doesn't realize how much of the laws are written by lobbyists" to protect incumbent interests, Google CEO Eric Schmidt told Atlantic editor James Bennet at the Washington Ideas Forum.

"It's shocking how the system actually works."

"Washington is an incumbent protection machine," Schmidt said

4. The end of 'extend and pretend' - The Las Vegas Sun reports that US banks are starting to pull the plug on commercial real estate loans that they had previously hoped would bounce back.

I wonder how much of the 'extend and pretend' is going on with banks in New Zealand, particularly with rural land and some commercial property. Your view?

Lenders are picking up the pace of foreclosing on commercial properties in Las Vegas in a move that could further reset prices and prompt rents to fall even further, analysts said. “Banks are in the business of lending money and not in the business of managing property,” said John Delikanakis, an attorney with Snell & Wilmer, who represents both banks who foreclose on properties and commercial property owners facing foreclosure.

“Because of that, a number of banks have been hesitant to pull the trigger on foreclosures, but we have seen recently banks are beginning to go ahead with the foreclosure process.” John Restrepo, principal at Restrepo Consulting Group, said the banks will continue to work with those property owners who have the financial staying power while cutting their ties with those who don’t. The mindset has been called “pretend and extend” in working with those property owners, Restrepo said.

“The time for ‘extending and pretending’ by the banks for a variety of commercial real estate loans has ended,” Restrepo said. “There finally is a realization by the banks, regulators and borrowers that the market will not recover sufficiently to save many commercial projects from foreclosure. While, in the short term, rising foreclosures are very disruptive to our already fragile commercial markets, it’s the only real cure for the markets to start healing.”  

5. Currency war - What is it good for? The Economist's Buttonwood tries to explain why gold is at record levels of over US$1,320, implying inflation fear, at the same time as US bond yields are near record lows, implying deflationary fear. Buttonwood thinks quantitative easing may have reached a competitive stage. He's onto it.

If everyone is printing money, that would explain the repeated strength of gold, which hit $1,313 on Wednesday. But if inflation is the fear, why are bond yields so low (10-year rates in America, Britain and Germany are all below 3%). Why are inflation expectations (as backed out from the gap between conventional and index-linked yields) just 2% over the next 20 years in the US? One answer could be that Treasury bond yields are being held down artificially by either: the prospect of further QE (ie buying by the Fed) or by the purchases of Asian central banks, which are buying bonds for currency managment purposes and are indifferent to returns?

The problem with the first suggestion is that it requires QE to be simultaneously driving gold up and long-dated bond yields down. I can imagine that short-dated bond yields would be dragged lower by a Fed money-creating policy but it surely ought to make long-dated investors more nervous. And the problem with the second option is that Asian central banks tend to focus on the short-dated end of the curve; the long-dated portion ought to be most market-sensitive.  

6. How much QE should we expect? - Bank of America reckons the Fed will print US$500 billion to US$750 billion every six months until the economy accelerates, Zerohedge points out.

This is the Bernanke put and explains why the stock market had its best September in almost a decade.

"Investment decisions across many asset classes today are tantamount to an educated guess on what the Fed decides to do regarding QE. In the near-term this trumps fundamentals, valuations and almost everything else. Thus the risk in the market is man-made, not freely determined by the market. In general, this is not a good thing because it may invite greater risks in the future."

7. Aussie rate hike? - Terry McCrann writes in The Australian that a hike by the Reserve Bank of Australia is likely tomorrow. Thank goodness for the Aussies. Just imagine what position our exporters would be in now if the Australians weren't tightening and allowing their currency to rise.

Australia's commodity prices are now over their 2008 highs.

Much of this rise was due to increases in iron ore, coking coal and thermal coal export prices. That's otherwise known as a customised boom made in China just for us. More pointedly, the index is now actually higher than the peak it reached in 2008. Back then, the RBA's cash rate was at 7.25 per cent. Now it's just 4.5 per cent.

Anyone want to seriously bet against a rate rise? Make that rate rises, as the RBA sets about "catching up" and hopes it hasn't left things too late. Although, let me hasten to add, it doesn't intend to and hopefully won't have to go quite near 7.25 per cent: the world is a different place now.

8. RBA an effective counterfeiter? - Securency, the plastic note money printer owned by the Reserve Bank of Australia that prints New Zealand's money, produced millions of partly made Nigerian and Vietnamese notes without authorisation from their central banks.

This Securency scandal just gets worse, the Sydney Morning Herald reports.

The Australian Federal Police were told by three former staff members the Reserve Bank company produced banknote substrate - the unique base material used to make banknotes - belonging to at least three countries, including Nigeria and Vietnam, without formal orders from their central banks. Federal police have been investigating Securency - half-owned by the RBA - over its alleged bribery of foreign officials via large payments to middlemen hired to win contracts in Vietnam, Nigeria, Malaysia and Indonesia.

The Herald has learnt there is extreme sensitivity in some government departments about the implications of a wider inquiry into the Securency scandal, with fears further exposure could damage Australia's international relations with several countries that use the company's polymer banknotes. Government sources have said that among the potentially explosive evidence uncovered by the AFP are documents suggesting a senior trade official engaged in highly unethical behaviour to help win Securency contracts overseas.

In an AFP witness statement, one of the former employees states his colleagues had been told by Securency managers that an unauthorised print run ''would constitute counterfeiting''.

9. 'Euro collapse likely' - Nobel prize winner Joseph Stiglitz reckons that European governments will cut their deficits too quickly and speculators will push Spain hard, helping to accelerate the eventual demise of the Euro.

“Spain may be entering the kind of death spiral that afflicted Argentina just a decade ago. It was only when Argentina broke its currency peg with the dollar that it started to grow and its deficit came down. “At present, Spain has not been attacked by speculators, but it may be only a matter of time.”

Turning to the euro, Mr Stiglitz said that the different needs of countries with high trade surpluses, particularly Germany, and those running deficit such as Ireland, Portugal and Greece, meant that the single currency was under intense pressure and may not survive. He suggests that one way to save the euro would be for Germany to leave the eurozone, so allowing the currency to devalue and help struggling countries with exports.

10. Totally irrelevant video demonstration of speed knifethrowing by American David Adamovich, courtest of theWSJ. He's an interesting man. He's called the Great Throwdini that does some special things with Knives and the Wheel of Death.

He owns a billiard hall. He's also an ordained minister who runs a wedding business here, where he lives.

He sometimes marries a couple and then entertains the guests with a demonstration of knife throwing.