Wednesday's Top 10 with NZ Mint: China headed for stagflation?; Marc Faber's warning for Australia; China's shadow banking double whammy; Printing Greenbacks again; Dilbert

Here's my Top 10 links from around the Internet at 10.30 am in association with NZ Mint.

I welcome your additions in the comments below or via email tobernard.hickey@interest.co.nz.

I'll pop the extras into the comment stream. See all previous Top 10s here.

Check out the Chinese shadow banking stuff at #6. A little unsettling.

1. 'Seven lean years' - GMO Fund Manager Jeremy Grantham's quarterly letter is always worth reading. This quarter is no different.

He points to the growing problems in the developed world.

Income inequality.

Ageing populations.

Depleting resources.

Poor infrastructure.

All produce lower asset values over the long run and extreme volatility over the short run.

His chart below shows where he thinks the S&P 500 will go. Here's Grantham:

Sadly, I feel increasingly vindicated by my “seven lean years” forecast of 2½ years ago. The U.S., and to some extent the world, will not easily recover from the current level of debt overhang, the loss of perceived asset values, and the gross fi nancial incompetence on a scale hitherto undreamed of. Separate from the “seven lean years” syndrome, the U.S. and the developed world have permanently slowed in their GDP growth.

This is mostly the result of slowing population growth, an aging profi le, and an overcommitment to the old, which leaves inadequate resources for growth. Also contributing to the slowdown, particularly in the U.S. and the U.K., is inadequate long-term savings Meriting a separate, special point are the drastic declines in both U.S. income equality – the U.S. has become quite quickly one of the least equal societies – and in the stickiness of economic position from one generation to another. We have gone from having been notably upwardly mobile during the Eisenhower era to having fallen behind other developed countries today, even the U.K.!

The net result of these factors is a growing feeling of social injustice, a weakening of social cohesiveness, and, possibly, a decrease in work ethic. A healthy growth rate becomes more diffi cult. I also believe that having an economy in which the average worker makes little or no economic progress slowly erodes economic balance, leaving us (as mentioned last quarter) with strong sales of BMWs and other premium goods, and weak and erratic sales of what might be called ordinary goods, resulting in weaker and more unstable growth. Sales are erratic because, with little or no income progress, buying surges by the “middle class” depend increasingly on shifts in confi dence and a willingness to go into debt.

2. Brace for it - George Soros says the Global Financial System is on the brink of collapse.

He must be very short in something.

The current global financial system is in a “self-reinforcing process of disintegration,” Mr. Soros warned, and “the consequences could be quite disastrous. You have to do what you can to stop it developing in that direction.”

3. China headed for stagflation ? - Panos Mourdoukoutas writes at Forbes that China appears to be headed for stagflation where inflation is high but growth is low.

Economic growth is slowing down, while inflation remains high.  Last Saturday, The China Federation of  Logistics and Purchasing (CFLP) announced that nonmanufacturing sector slowed down sharply, with the non-service Purchasing Manager’s Index (PMI) dropped from 57.7 in October to 49.7 in November.

The slow-down in the non-manufacturing sector follows a similar slow-down in the manufacturing sector, as announced last Thursday; the manufacturing PMI dropped to 49 in November from 50.4 in October– a contraction that comes at time inflation is still running above 5.5 percent.

China’s stagflation complicates economic policy, posing dilemmas to policy makers.  An effort to stimulate economic growth by raising bank reserves and by boosting infrastructure spending will worsen inflation (as it is currently underway), while an effort to curtail inflation will lead to slower growth.

4. 'It's all a plot' - Missouri University Economics Professor Michael Hudson has written a broad sweep through history (via Naked Capitalism) about the relationship between kings, democracies and bankers.

It's worth a read.

The financial sector has gained sufficient influence to use such emergencies as an opportunity to convince governments that that the economy will collapse they it do not “save the banks.” In practice this means consolidating their control over policy, which they use in ways that further polarize economies. The basic model is what occurred in ancient Rome, moving from democracy to oligarchy. In fact, giving priority to bankers and leaving economic planning to be dictated by the EU, ECB and IMF threatens to strip the nation-state of the power to coin or print money and levy taxes.

The resulting conflict is pitting financial interests against national self-determination. The idea of an independent central bank being “the hallmark of democracy” is a euphemism for relinquishing the most important policy decision – the ability to create money and credit – to the financial sector. Rather than leaving the policy choice to popular referendums, the rescue of banks organized by the EU and ECB now represents the largest category of rising national debt. The private bank debts taken onto government balance sheets in Ireland and Greece have been turned into taxpayer obligations. The same is true for America’s $13 trillion added since September 2008 (including $5.3 trillion in Fannie Mae and Freddie Mac bad mortgages taken onto the government’s balance sheet, and $2 trillion of Federal Reserve “cash-for-trash” swaps).

This is being dictated by financial proxies euphemized as technocrats. Designated by creditor lobbyists, their role is to calculate just how much unemployment and depression is needed to squeeze out a surplus to pay creditors for debts now on the books. What makes this calculation self-defeating is the fact that economic shrinkage – debt deflation – makes the debt burden even more unpayable.

His conclusion:

Re-regulation of banking and providing a public option for credit and banking services would renew the social democratic program that seemed well underway a century ago.

Iceland and Argentina are most recent examples, but one may look back to the moratorium on Inter-Ally arms debts and German reparations in 1931.A basic mathematical as well as political principle is at work: Debts that can’t be paid, won’t be.

5. Hard landing possible - CNBC reports Marc Faber has warned of a hard landing in China.

 "I think growth will be much lower and it is possible that we could have a hard landing with no growth at all."

Faber, who correctly predicted the 1987 stock market crash and more recentlyforecast the stock market correction in August, says China's economy depends largely on capital spending, which tends to be volatile and has a strong multiplier effect on the economy.

While a recession in Europe could mean a gross domestic production contraction of 1-2 percent, he expects a shrinking Chinese economy to have a more widespread impact globally.

The commodities market, in particular, will bear the brunt of a China economic deceleration, said Faber. "If the Chinese economy grows at 10 percent, or 5 percent or no growth, it has a huge impact on iron ore, copper, nickel, anything. “

"It will have on the global economy a devastating impact via the resource producers of the world, whether it's Brazil or Australia or the Middle East or Africa," Faber added.

6. China's shadow banking risks - Cindy Tse writes at China Briefing about the risks in China's shadow banking system, which makes up about 20% of China's financial sector.

She makes an excellent point about how many commodity traders are using trade finance as a back door into property speculation. It creates a double whammy if commodity prices fall and the Chinese property market slumps.

The growth of informal lending channels can be traced back to the government’s response to the recent Global Financial Crisis, in which the country’s main banks were ordered to handout massive loans to state-owned enterprises (SOEs). The resulting inflation led to a subsequent and swift clampdown on lending with harsh quotas that have made credit available only to those SOEs least likely to default, and for the most part shutting out private sector enterprises.

China’s small and medium –sized enterprises (SMEs) account for 60 percent of China’s GDP and 80 percent of urban employment, according to Zheng Xin, deputy director of the SMEs division of China’s Ministry of Industry and Information Technology. Therefore, such preferential loan policies have rendered a massive chunk of the economy strapped for cash with little choice but to turn to informal channels in the shadow financing market.

Of particular concern since June of this year has been the involvement of commodity traders in this unregulated market. The state-led credit squeeze beginning in early 2010 forced SMEs and SOEs alike to turn to trade financing as a loophole. Trade loans fell outside the central bank’s restrictions, thus banks were able to offer them for commodities purchases such as copper, steel and soy beans.

The situation would start off harmlessly enough – with a letter of credit from a bank issued on behalf of an established borrower to a steel manufacturer for a given stock of steel. The borrower, perhaps a commodities trader, would then have a short period of time to repay the bank, but the time periods can vary depending on the bank and commodity. In the case of copper, the borrower may have three months to a year, with fees and commissions to the bank that may add up to only about 3.5 to 10 percent of the value of the cargo.

The risky business begins when these borrowers sell their cargo – be it at a loss or profit – and quickly funnel the cash into other investments or to other borrowers at exorbitant interest rates, sometimes upwards of 70 percent. One of the biggest recipients of this cash is China’s ever inflating property market; the very market state regulators have been trying to reign in. And what worries many analysts is the possibility that a fall in commodity prices might coincide with a sharp drop in property prices and demand, triggering a wave of defaults.

7. Printing Greenbacks - Washington College History Professor Richard Striner looks back through history via The American Scholar to find a time when America printed money to buy stuff, as opposed to just bailing out banks.

If the Federal Reserve can create new money, couldn’t Congress do the very same thing? The answer is yes, and here’s the precedent: the Legal Tender Act of 1862, in which the Republican-controlled Congress authorized creation of “United States Notes,” known as greenbacks, that were printed up and spent into use.

The U.S. Constitution has no provision for this practice, but it does authorize the minting of coins.

Why shouldn’t the American people have additional funds to be used for such impeccable purposes as national security, infrastructure maintenance, public safety, environmental protection, and research to counteract global climate change—funds created by the government without more taxes or debt? Does the principle seem too good to be true—a mere mirage, something for nothing? Think it over, for the system that we have right now is an exercise of mind over matter. The system I propose would give the people and their leaders an equal share in money creation with the bankers who are seeking private profit. It’s a profitable game, the creation of money, and we need more players at the table.

8. Diddums - An Wall St Hedge fund manager is worried about a change in the tone of the rhetoric likely to be adopted by Barack Obama in a speech this morning about them (the 1%) vs 'us' (the 99%).

So the NYTimes' Dealbook reports he wrote a letter to Obama that seems to have captured the mood (of the 1%), which is they don't like people saying nasty things about them.

Last week, in a widely circulated “open letter” to President Obama that whizzed around e-mail inboxes of Wall Street and corporate America, Mr. Cooperman argued that “the divisive, polarizing tone of your rhetoric is cleaving a widening gulf, at this point as much visceral as philosophical, between the downtrodden and those best positioned to help them.”

He went on to say, “To frame the debate as one of rich-and-entitled versus poor-and-dispossessed is to both miss the point and further inflame an already incendiary environment.”

9. Low interest rates not helping - The US Federal Reserve has been buying government bonds and toxic mortgage bonds to push down the long term interest rates that people use to borrow to buy houses in America. The theory is it will boost the economy.

The trouble is it's not working, as Tyler Durden points out at Zerohedge with this chart below:

What appears very clearly on this chart is that despite ever declining mortgage rates, there is simply no interest in home turnover, and sales are at record low levels due to lack of demand, and lack of desire to sell into a bidless market, in essence causing the entire housing market to halt.

And this makes intuitive sense: the bulk of home owners who can take advantage of cheap credit are those who already have a mortgage and at best will refi into a cheaper one. For everyone else, either the bank's admissions criteria are too stringent, or the potential borrower is simply convinced that a year from today, the 30 Year mortgage rate will be another 1% lower (most likely with 100% justification). As such there is absolutely no drive to naturally restart the housing market

Totally on the mark video of Daniel Hannan speech on the problems with debt globally