Dragon in serious trouble ?

Morgan Stanley’s Stephen Roach—chairman of Morgan Stanley Asia—stated that Chinese officials were “appalled” by the debt ceiling delay.and why not after all there spending is highest.According to Bloomberg, Roach stated, “coming so shortly on the heels of the subprime crisis, the debate over the debt ceiling and the budget deficit is the last straw [for China].”

Why are the Chinese so disturbed by the possible default of the U.S. government?

Well, for one, China is the largest foreign holder of U.S. treasuries. The U.S.’s debt makes up a significant percentage of China’s reserves. Effectively, China’s investment portfolio is severely overweight U.S. debt.A U.S. default could lead to a strong devaluation of those assets, in effect, robbing China of billions of dollars.
Reuters reported that Chinese rating agency Dagong Global plans to downgrade its ratings of U.S. debt as early as next week, even if an agreement is reached before the deadline. The company’s chairman has stated that enough damage has already been done so as to warrant a downgrade.

Would a default affect the Chinese economy?

As the U.S. remains the financial capital of the world, it may have quite a severe affect on the Chinese economy, especially if the U.S. economy itself suffers from the default.Federal Reserve Chairman Ben Bernanke has warned that a failure to raise the debt ceiling would have “catastrophic” consequences for the broader U.S. economy. As the U.S. consumer remains a major customer for China, deteriorating economic conditions in the U.S. could harm China’s export-based economy.

Further, the ability of the People’s Bank of China (PBC) to control the value of the yuan depends on the banks reserves.

Although China has resisted the yuan’s appreciation, inflation has been trending higher. The PBC may eventually be forced to revalue the yuan to fight off inflation in the country. In order to do that, the PBC may have to sell its assets and buy yuan.Of course if its assets (U.S. debt) are devalued, the PBC may be hamstrung in its ability to strengthen the yuan.

Still, China’s statements are simply another reminder that the ongoing debt ceiling negotiation affects the entire world. Should the U.S. government default, the entire globe may feel the consequences.

Chart That Explains the Entire Financial Crisis

The chart above appeared on this recent CD post showing the close historical relationship between: a) the U.S. homeownership rate, and b) the share of mortgages for home purchases with a 3% down payment or less (97% loan-to-value ratio or higher), especially starting in about 1995 when they both increased sharply.At a recent post at the SayAnythingBlog, Donny Baseball writes that if you had to look at just one chart to understand the entire financial crisis, it would be the chart . Here's some additional commentary:

3%! Simply amazing. 3% isn’t even close to serious. If you are only able or willing to put down 3% you simply aren’t serious about homeownership. It’s laughable. 3% would have gotten you laughed out of any bank in America prior to 1994. Yet by 2007 40% of all mortgages had less than 3% downpayments. It’s additionally frightening to wonder what that number would be for less than 4% down or 5% down, still totally laughable and un-serious levels of equity.Mortgage lending to creditworthy home buyers has been a stable, profitable, and boring business in the United States of America for about a hundred years; so for those who blame “Wall Street greed” for the crisis, I ask you “why now?” Why did greed not appear, not infect the system, not attempt to seize filthy lucre for that hundred years? Why did greed only show up at that particular moment in time? I further ask why did greed not make its way to Canada, where they did not have a housing and/or banking crisis? Is greed only a US and highly time specific phenomenon?The answer is that government embarked, at the urging of “social justice” activists, on a policy campaign to degrade the prudential standards that prevailed in the housing lending market. The government effectively demanded and enforced irresponsible lending, and they got it. Unfortunately the government can’t repeal the iron laws of economics, so what they got was a flimsy, risk-infected financial system that was bound to crash, which it did.

monetary policy

he past week in monetary policy was dominated by Asian central banks, with the central banks of Japan, Indonesia, Thailand, and South Korea all announcing interest rate decisions. The only banks to adjust interest rates were Thailand +25bps to 3.25%, and Kenya, which dropped its discount window rate -175bps to 6.25%. Meanwhile those that held interest rates unchanged were: Japan 0.10%, Indonesia 6.75%, Latvia 3.50%, South Korea 3.25%, and Chile 5.25%. Elsewhere in monetary policy and central banking, Brazil's central bank announced further policy measures to curb speculation on its currency, the Real.

While inflation remained a threat for most of the central banks who reviewed monetary policy settings during the week, for many the focus was squarely on the downside risks to both domestic and global growth. Indeed a couple of the banks pointed specifically to the tail risks in the form of the European sovereign debt crisis. For those that held rates unchanged, for the most part the messaging was positive, with some viewing inflationary pressures as somewhat contained, while many presented a positive outlook on their domestic economy.

As per usual, following is a selection of key quotes from central bank monetary policy statements and media releases from the past week:

Bank of Japan (held interest rate at 0.10%): "Japan's economic activity is picking up with an easing of the supply-side constraints caused by the earthquake disaster. After declining sharply following the earthquake, production has recently shown clear signs of picking up with the easing of supply-side constraints."
Bank Indonesia (held interest rate at 6.75%): "Bank Indonesia views that the current BI Rate level is still in line with the effort to maintain stronger economic activities supported by stability, amid domestic excess liquidity and continued large capital inflows... Meanwhile, inflation is estimated to be under control and could be lower than earlier forecasted if there is no Government policies regarding energy prices while the supply and distribution of basic foods are well maintained."
Bank of Thailand (increased interest rate 25bps to 3.25%): "In light of the continued risks to inflation amid robust domestic demand, the MPC deemed it necessary to continue increasing the policy rate to maintain economic stability and anchor inflation expectations... Inflationary pressure remained high due to elevated energy prices and continued upward adjustments in the prices of prepared foods."
Bank of Korea (held interest rate at 3.25%): "The Committee expects the high level of inflation to continue in the coming months, driven largely by demand-side pressures resulting from the underlying uptrend in economic activity and by inflation expectations."
Banco Central de Chile (held interest rate at 5.25%): "Domestically, output, demand and labor market figures are progressing with strength, showing signs of moderation in line with the baseline scenario in the last Monetary Policy Report. Annual CPI inflation indicators have hovered around 3%, while measures of core inflation remain bounded. Private inflation expectations show a decline, although some of them remain above the target."


As for next week the Reserve Bank of Australia (19th of July), and the Bank of England (20th of July) will release the minutes from their most recent monetary policy meetings, meanwhile the following central banks are scheduled to review interest rates:

Canada (Bank of Canada) - expected to hold at 1.00% on the 19th of July
Brazil (Banco Central do Brasil) - expected to increase rate 25bps to 12.50% on the 20th of July
South Africa (South African Reserve Bank) - expected to hold at 5.50% on the 21st of July
Turkey (Central Bank of the Republic of Turkey) - expected to hold at 6.25% on the 21st of July

ITALY Loss or survive ?

• The Borsa Italiana - Italy's main exchange - consists of only 331 companies.
• Italy has little industrial presence in chemicals, pharmaceuticals, computers, and even food processing.
• Public spending accounted for 51.7% of GDP in 2009.
• Italy ranks #80 on the World Bank's list, meaning it's more difficult to do business in Italy than in Namibia.
• It is more expensive to purchase electricity as an industrial producer in Italy than it is in any other EU state
• Tax evasion costs the Italian government an estimated €100 billion per year in revenues
• Italy's annual growth rate has been under 4% since 1988.
• Their stocks have lost 27% on average since the beginning of the year.
• Moody's is currently reevaluating Italy's Aa2 rating.