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Good for Now, Bad for Later

July 11, 2012 – 5:02 pm

We are going to get a lot of data released from China this week. The most interesting report will be on Friday when they release their second quarter GDP number.

China has reduced interest rates twice in a month and this morning they have approved over 100 new infrastructure projects. Obviously, they are concerned about growth and the slowdown of their exports to Europe.

China’s efforts point out two issues that clearly indicate that at some point they are going to fall into a deep recession, though that day may be far off. First, is that in their command and control economy the government dictates what is needed rather than what the market place wants. For instance one of the major infrastructure projects was a huge new steel plant. In a time of a worldwide glut of steel the new plant is not needed. The other issue is that they have turned away, for the time being, from free market reforms to try and improve efficiency and domestic demand.

Those two steps are in the wrong direction. As we know, with their huge cash hoard they can overcome these issues. However, just as Japan relied on exports and built up a large surplus and then collapsed in the late 80’s, at some point without a robust domestic economy reliance on exports will cause a big problem. Japan has not recovered from their imploded economy, spending the surplus, and now has the highest GDP to debt ratio in the world.

For the present this effort by China will work but there will come a day of reckoning unless they dramatically increase internal demand and break up state owned enterprises that are not market oriented and lack efficiency.

Good Trading
Steve Peasley

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