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China has been growing at around 10% per year, for so long, and I mean decades now, that people forget what its like in the global commodity markets when China wasn’t the growing beast that it is currently.

Historically, the commodity super-cycle’s tends to last about 16 years give or take 4 years.  This cycled bottomed in 1996-1997.  Which puts this cycle into the short end of the typical window at 14 years old now.  Consider that data point as you read the the following quotes from an article by A.E.P.

He hits on a couple of major points about China that is worth considering.  The first one is the ratios that the internal Chinese property bubble has been allowed to grow to.

Prices are 22 times disposable income in Beijing, and 18 times in Shenzen, compared to eight in Tokyo. The US bubble peaked at 6.4 and has since dropped 4.7. The price-to-rent ratio in China’s eastern cities has risen by over 200pc since 2004

The IMF said land sales make up 30pc of local government revenue in Beijing.

The Chinese have taken bubble blowing to all time new highs.  They are showing Western civilization what a REAL bubble looks like.  China is reported to consume as much as 40% of the worlds concrete.  That kind of usage will need to slow down, and when it does, commodities will be in for a head wind.

In a review of Asia and China, using a model of a slow down in growth to “only 5%”.  Remember, this is not a recession.  This is only growing at a fast rate for a western nation, and the results were pretty eye opening.

As it happens, Fitch Ratings has just done a study with Oxford Economics on what would happen if China does indeed slow to under 5pc next year, tantamount to a recession for China. The risk is clearly there. Fitch said private credit has grown to 148pc of GDP, compared to a median of 41pc for emerging markets. It said the true scale of loans to local governments and state entities has been disguised.

The result of such a hard landing would be a 20pc fall in global commodity prices, a 100 basis point widening of spreads on emerging market debt, a 25pc fall in Asian bourses, a fall in the growth in emerging Asia by 2.6 percentage points, with a risk that toxic politics could make matters much worse.

It is sobering that even a slight cooling of China’s credit growth led to economic contraction in Malaysia and Thailand in the third quarter, and sharp slowdowns across Asia. Japan’s economy will almost certainly contract this quarter.

A drop in Asian markets of 25% because China “only” grew at 5% is an ugly outcome.  At some point, the law of large numbers says China has to quit growing.  What would happen to Asian markets then? CDS on China debt makes sense to me.  Its like the CDS quotes on US Treasuries in July 2008. US T’s were quoted at 15 bps.  Oh how I wish I had placed the trade.  At the time I was in Beverly Hills meeting with the owner founder of a broker dealer that specialized in esoteric trades for hedge funds.  The owner of the B/D told me over lunch that it was the most stupid trade he had heard of.  Buying a CDS on US Ts.  Oil collapsed from $147 per barrel that day.  I would have done even better in 08 if I had put the trade on.  Oh well.  Back to current story…

China is an extremely low risk of actually defaulting, but they are not a low risk trade on an economic slow down that becomes recessionary if they cant engineer a soft landing.  I like RBS trade for 2011 here.  China is the real bubble here, and when the Chinese leaders cant handle the inflation the US is exporting to them, things will change.  Abruptly most likely.