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Guide to the Collapse of China and Europe

Written By Brian Hicks

Posted October 5, 2011

What kind of S.O.B do you folks think I am?

I’ve gotten some nasty emails lately accusing me of cheerleading for a complete economic collapse.

They claim (rather rudely, in a few cases) that just talking about the sword swinging over us all actually spreads even more gloom and danger…

“Don’t I know that those helpful fellas on Wall Street and their sock puppets in Washington are trying jawbone us into believing that Santa and the Tooth Fairy will somehow set us all onto a ladder to the moon… yadda, yadda, yadda.”

Damn, there I go again.

NOT Cheerleading

No, I am not “rooting” for a bear market, praying for another recession, or any other such foolishness.

Yes, I have written at length on the sloppy habits we have acquired over the years and the inevitable results of same. And I have reported in detail on the negative technical indications building up in the market charts of late.

And yes, I have set up my readers to profit in quadruple digits from this downturn…

But I simply refuse to apologize for any of this.

Out in the Cold, Rain, and Snow

I may be completely out of stocks right now. But that doesn’t separate me from society at large.

Like many of you, my parents are retirees, utterly dependent on their portfolio for income. If this whole mess really comes unwound — if we are indeed on our way down into the next leg of a depression — I will be forced to make room for them here at Liberty Park, chin-to-jowl with my beloved, hot-flashing wife (sorry if that’s too much info, but there it is) and rambunctious darling daughters…

And while I love them all dearly, I WILL be spending weekends up in the mountains dining on MREs and sleeping on the cold ground just to keep my remaining shred of sanity.

More Imaginary Money!

As I write to you today, the markets as a whole and financial stocks in particular put in another new low. When the bottom broke, the “blog-o-sphere” began to hum with word of a new bear market.

The only thing that stemmed the bleeding was Ben Bernanke’s statement in front of Congress’s Joint Economic Committee that the central bank “will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability.”

But can more imaginary money save us from crisis created entirely by imaginary money?

No, it can’t.
PIIGS Get Slaughtered

Since the Financials are leading this latest plunge, let’s tear back the curtain of bogus talk and look at what’s really bedeviling the banks and brokers.

I’m sure you’ve heard so much about the Euro crisis that you’re ready to bang your head against a wall. Unfortunately, I am going to cover it yet again. I will, however, try to be brief.

The PIIGS — Portugal, Italy, Ireland, Greece and Spain — borrowed gobs more than they could ever actually pay.


Greece is bankrupt and will inevitably default. Some of the rest will follow suit. It looks like Ireland is in the best shape.

The “Club Med” states? It’s really anyone’s guess which one tumbles next.

This is really more about German banks than it is about Greek teachers. Europe’s conservative North — England, France and Germany — are on the hook for the multi-trillion-euro tab. Politically, the citizens of same are inclined to tell the South to go hang. The bankers know this road leads directly to a currency crisis.

The 10 largest U.S. money market funds are desperately trying to get as far away from Europe as fast as they possibly can without actually triggering the very collapse they fear. However, Fitch Ratings warns that Europe’s debt still represents some 42% of these funds’ total assets.

Let’s call this “Wave One”: an economic tsunami that has circled around the world and is already washing up against our financial seawalls as we speak.

Wave Two

Now look to the West, because that’s where “Wave Two” is coming from.

China led the world out of the first leg of the great recession/depression and has been doing its level best to prop us all. Last year, China contributed more than 30 percent to global growth by and of itself.

But now that engine has overheated.

And once you take away all the hot money that was papering over China’s troubles… bad loans to local governments, a fading real estate boom, and slower economic growth are terrorizing most experienced “China Hands,” who are now trying to get the hell away from this market without triggering the very collapse they fear most.

Hey, didn’t I just write that about Europe? You betcha, pilgrim!

China’s Slow-Mo Collapse

The MSCI China Financials Index has lost more than 43% of its value over the past year, with half of that loss coming in the past 30 days.
This is actually worse than the benchmark bank gauges for Europe, the United States, Japan, and the emerging markets.

  • Jim Chanos, famed for calling Enron Corp.’s collapse, predicts Chinese banks will fall below the value of their net assets for the first time since December 2003.
  • Grantham, Mayo, Van Otterloo & Co.’s Edward Chancellor warns: “China’s economy is very distorted, and the banks, as ever, are at the epicenter of the distortions. If China runs into problems with the banking system, which I think it will, I cannot see a situation in which foreign investors are the main priority of Beijing.”
  • HSBC is supposed to be contemplating selling its 8% share of Bank of Shanghai.
  • Fund managers at Vontobel Asset Management Inc. and International Value Advisers LLC are all reputed to be avoiding Chinese banking stocks.

How big is our exposure to this storm brewing in the East?

Hard to say for sure, as many American financial institutions remain as opaque as ever.

However, I’ve learned that Bank of America (NYSE: BAC) has been struggling desperately to unload its $20 billion stake in China Construction Bank. Goldman Sachs just downgraded its outlook for BAC shares for this very reason.

Cash Reserves Are Down — Not Up

Those are the waves that threaten to swamp us.

Now let’s talk about our metaphorical “seawalls.”

As I reported in my most recent Viral Investing column, post the banking disasters of 2007-2009, American banks and trading houses are now supposed to be protected against breakdown with enormous reserves of cash.

Unfortunately, money sitting is money that isn’t making profits.

And as we have seen over the past couple of days, no profits quickly translates into share price collapse. If you want to compete at all, you need ALL your money making money.

So it should come as no shock after the most recent FDIC quarterly banking report revealed that American banks’ revenues have declined for two consecutive quarters. The banks have cut their loan loss reserves in half over the past year.

Private Rewards, Public Risk

In a speech last May before the 47th Annual Conference on Bank Structure and Competition, FDIC Chairman Sheila C. Bair warned:

[this situation] can only be regarded as a new and dangerous form of state capitalism, where the market assumes large, complex, and powerful financial companies are in line to receive generous government subsidies in times of financial distress.

Unless reversed, we can expect to see more concentration of market power in the hands of the largest institutions, more complexity in financial structures and relationships, more risk-taking at the expense of the public, and, in due time, another financial crisis.

So let’s sum up:

  • Europe is corrupt and headed for systemic bankruptcy and currency crisis;
  • China is also corrupt, opaque, and headed for collapse;
  • American banks and trading houses have cut reserves, and are now trying to chew off their own feet to get free of these twin bear traps.

You can ignore these global forces and take the hit to your portfolio when the market fully prices them in… or you can protect yourself.

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