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The Most Dangerous Man in China

Written By Brian Hicks

Posted June 21, 2007

It will come as no surprise that the military planners deep within the Pentagon continue to wrestle with the growing threats posed by the Chinese People’s Liberation Army. But the biggest risk to America might not be an old red General bent on invading Taiwan, but an economic technocrat. His name is Lou Jiwei, and in many ways he’s the most dangerous man in China–especially if you are in the market for a mortgage.

A lifelong member of the Communist Party, it is now Mr. Jiwei’s job to decide how to invest the nation’s bloated supply of U.S. dollars stemming from the growing trade imbalance.

At his disposal, of course, is no small sum. Some would even call it river. Or better yet an ocean, sort of like the Pacific.

According to March data, the fast growing country now holds a total reserve hoard of $1.2 trillion dollars, and its growth shows no signs whatsoever of slowing down. In fact, the tilted trade manages to add another $20 billion to the pile each and every month.

That no doubt makes Mr. Jiwei quite happy. Investing, you see, is evidently one of his many interests. Now head of the China State Investment Company, it is more than just a passing interest–it his job to diversify the national portfolio.

As can be expected, Mr. Jiwei’s new mandate is really quite simple. Like any other financial planner, it’s to fatten the national portfolio by earning better returns on Chinese investments. That’s where the danger to Main Street comes in.

Part of Mr. Jiwei’s chore is to decide how much of that mountain of cash will be put into low-yielding bonds, such as U.S. Treasury notes and mortgage-backed securities, and how much will be invested in higher-yielding equities.

Those massive Chinese investments in bonds have helped to keep interest rates here at home as low as they have been even in the face of the Fed policy to hike them. A full seventy percent of China’s reserve is now held in bonds.

And while no one is really sure yet exactly how Jiwei will choose to invest that Everest of dollars, many believe that his goal is to move a larger portion of those recycled surplus dollars into the greater returns offered by equities and other investments like commodities.

His recent $3 billion investment in The Blackstone Group, a private equity firm, partly showed his hand. It was the first of what many on the Street believe will be numerous new moves emanating from the Ministry of Finance.

It’s the weight of those impending moves that has helped to spark fears of rising interest rates here at home, since a declining Chinese appetite for U.S. bonds would sending the yields on those instruments considerably higher.

That’s a view shared by Bill Gross, the renowned PIMCO bond guru, who surprised the markets recently by suddenly turning turned bearish on bonds after a long track record on the bullish side.

PIMCO, by the way, is itself something of an 800-pound gorilla in the bond world, with over 700 billion in net assets. That means that when Gross has something to say about bonds, the market listen.

Gross’s most recent comments only helped to exacerbate the recent selloff in U.S. Treasuries that sent the yield on ten-year notes to highs of 5.32%, in turn sending the 30-year fixed mortgage rate as high as 6.875%. Those are the highest rates since the summer of 2002.

A combination of inflationary pressures and the lessening of the worldwide appetite for recycling dollars into bonds, said Gross, would "move the range for ten-year U.S. Treasuries to 4.0-6.5% versus last year’s forecast range of 4.0-5.5%."

He also said that "global yields are and have been subsidized by as much as 50 to 75 basis points in terms of lower yields, based upon the willingness of the central banks to buy safe U.S. Treasury bonds." Chief among those central banks is China’s, the greatest yield subsidizer of them all.

That combination, Gross says, is "not necessarily bond friendly," which has even PIMCO in the mood to diversify towards riskier investments.

The result is that interest rates on home mortgages and other consumer purchases will rise right along with the ongoing shift to higher yields in the bond market.

That means that after years of "historically low rates" in the low 6% range, future mortgage holders will be likely looking at more "normal" rates above 7%.

These higher rates, naturally, will put even more pressure on home prices at time when the real-estate market can least afford it. A 1% increase in the interest rate decreases a buyer’s purchasing power by roughly 8%.

More than that, it means that refinancing just won’t be an option for more and more distressed mortgage holders, causing more foreclosures as a result.

That’s what makes Mr. Jiwei so dangerous to homeowners. He’s sort of like that flapping butterfly in China that can cause a tornado on the Great Plains. His actions may just be what pushes housing into its final act–higher interest rates.

By the Way: The PMI U.S. Market Risk Index, released yesterday by PMI Mortgage Insurance, found that 15 of the nation’s biggest metro areas have a greater than 50 percent chance of seeing price drops.

PMI’s Risk Index estimates the probability that home prices will fall within the next two years, but does not forecast the depth of the decline.

Its calculations are based on first-quarter data on home-price appreciation from the Office of Federal Housing Enterprise Oversight, along with mortgage prices, labor market trends and housing demand in each market.

Eleven of those markets are in California and Florida.


Wishing you happiness, health, and wealth,


Steve Christ, Editor