Emerging Market Mania: China Tells Bernanke to Take a Hike

Over the last few months, I’ve noted that the most important monetary relationship in the world is that between China and the US, the world’s largest creditor and debtor countries respectively.

Both countries’ central banks engaged in a money-printing orgy to counter the Financial Crisis in 2008. Now they’re butting heads on the consequences of their actions: the US Federal Reserve wants to create inflation, while China wants to aggressively halt it.

This is IT, the #1 dynamic for the financial markets going forward. How this plays out will impact everything from the US Dollar’s reserve currency status to where the stock markets will head.

With that in mind, we need to consider the power dynamics between these two countries from a monetary perspective.

China has made it clear that it is NOT pleased with the US’s current monetary policy (China has blamed the Fed for its inflation woes with some officials going so far as to label the Dollar’s status as a reserve currency, “absurd”).

The US has in turn responded by labeling China a currency manipulator and blaming it for the US’s economic woes. Indeed, it seems almost every other week that some US Government official comes out with a “it’s ALL China’s fault” statement.

However, when push comes to shove, it is China that holds the trump cards in the form of interest rates.

Many commentators have posited that the US Federal Reserve will not hike interest for several years. It is my contention that the Fed CANNOT raise rates EVER again. The reason for this is that some 80% of the $600 TRILLION in over the counter derivatives market is based on interest rates.

If even 4% of this is “at risk” and 10% of it goes wrong you’ve wiped out ALL The equity at the five largest banks in the US.

If you’re looking for the REAL reason Ben Bernanke is scared stiff about state of the US financial system and continues to pump money into Wall Street by the hundreds of billions despite the fact the stock market has hit new highs from the March 2009 lows (when the Fed first announced its QE program), you’ve got it.

China, on the other hand, not only WANTS to cool its monetary system, but CAN do something about it. To whit, the People’s Republic has already hiked interest rates once without warning on October 10 2010. Rumors are swirling that it’s about to do this again over the coming weekend.

Why does this matter?

Well, for one thing this move, if it happens, will cool China’s “loose money” flow even more, which will affect its economy: the economy the financial industry is banking on pulling the world back into recovery.

Secondly, if China hikes rates again, it would have an adverse effect on the world financial markets pushing stocks and commodities down: an interest rate hike indicates China is trying to cool its economy and so will have less demand for commodities. And stocks, which are now just a single asset class that moves in correlation to others thanks to the overly-computerized state of the markets, will fall too.

And then of course, there’s the $190+ trillion of interest rate-based derivatives sitting on US commercial banks’ balance sheets. If China chooses to rock the interest rate boat too heavily… KA-BOOM.

In plain terms, China holds the trump cards when it comes to monetary policy. Ben Bernanke better pray they don’t start playing them, because no matter how “certain” he is off his abilities, he’s got the weaker hand. And he’s definitely clueless about the risks of getting it wrong.

Good Investing!

Graham Summers

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