China Raises Interest Rates Again; Markets Charge On

So what exactly is driving markets onwards these days? Certainly, China`s third hike of interest rates since the beginning of the current cycle should ring alarm bells for all but the most hallucination-prone members of the bull camp. Isn`t it Chinese purchases driving commodity prices higher? Isn`t it cheap Chinese products that keep the cycle going for those like Japan and the U.S., whose companies and consumers would get a severe shock if the Chinese workers were able to demand the just rises in pay that they deserve? And isn`t the Chinese banking system the third pillar of the global bubble, ensuring that even the craziest "investment" ideas will get funded? These and many other Chinese factors should make any believer in the bull phase extremely cautious and nervous about where the market is headed, including those brave souls who are brave enough to ignore the turmoil in the geostrategically pivotal Arab World, or the explosive E.U. But no, nothing matters for some except for cheap dollars and the same old game of borrowing to speculate, and that the Fed rules all.

The PBOC has raised its benchmark from 5.81% to 6.06% in response to inflation reaching the highest levels of the past 3 years. Chinese inflation has hit 4.6% in December as most readers of the blog would know, but it is a lot lower than the situation in much of the emerging market world. Put simply, there is too much money gushing in to these places and too little enthusiasm from central banks to combat the inflows through capital controls or interest rises. The outcome is rampant inflation, but inflation is probably the least of the ills that the discrepancy between advanced economies and the developing world will bring about. Above all, we have the boiling speculative bubbles that stretch all over the world from Turkey to South Africa to Israel and of course China. Bubbles characteristically end with rate rises (recall the gold and commodity bubble in late 70s that was killed by Paul Volker, or the stock market bubble in 2000 that was popped unwillingly by Alan Greenspan). If inflation causes interest rates to come higher, and causes these bubbles to pop, we may well have the worst economic disaster of the post-WWII era in a collapse that may well dwarf anything we experienced during the banking crisis. Because that one has been made to spread to all segments of the world economy by the experiments of central banks.

Commodities and EM stocks are the only ones for now to experience the reaction of the markets to the Chinese decision. We do not expect even gold to come unscathed if the Chinese keep tightening to perhaps as high as 10%. While that is a distinct possibility, we do not think that the PBOC will risk pushing the brakes too hard, as China will be one of the hardest hit when their engineered bubbles explode.