Global Markets Out Past Chinese Lending Curfew

In eras past, investors who hoped to get an early read on the economic trends that influence equity markets would monitor data like US factory orders or the Baltic Dry Freight Index. But today, all eyes are on China.

Even though the Chinese economy is only the world’s fourth largest, it is the first largest influence on stock market trends. Accordingly, the Chinese stock market tends to lead all the other stock markets of the world…for better or worse.

In the wake of the 2008 credit crisis, for example, the Chinese stock market bottomed out in late October – more than four months before the US stock market hit its post-crisis lows. Over the ensuing months, Chinese stocks rallied more than double, before topping out on November 16 of last year. Chinese stocks have been drifting lower ever since, even as the US stock market has been churning toward higher highs.

Chinese Stock Peak

But now, two months after the Chinese stock market topped out, US stocks are starting to falter. Should we US investors be concerned? “Yes,” say that stock market technicians.

As options expert, Jay Shartsis, observed in last week’s Daily Reckoning, “The important emerging markets of China, Russia and Brazil have topped out already and have been trending lower. They have leading tendencies to our market, having bottomed out before ours did last March.”

Admittedly, Shartsis derives his opinions from squiggles on a computer screen. So his gloomy outlook would be easy to dismiss. Unfortunately, the data points of real-world commerce refuse to argue with his squiggles…especially now that the Chinese central bank has applied the thumb screws to bank lending.

Rumours surfaced last week that the Chinese authorities would impose a “lending curfew.” Yesterday, rumours become fact.

“Banks have suspended new lending since 19 January across the country,” reports Yuen Tuck Siew, an analyst with Credit Suisse. “The suspension in lending was imposed by the authorities after an emergency meeting by the central bank’s monetary policy bureau.

“This sudden suspension in lending has caught importers by surprise,” Siew continues. “Letters of credit (LoC) suddenly became unavailable, despite previous agreements. We believe that this will inevitably lead to delays or cancellations in China’s imports. Import orders for commodities and machineries could be affected most.”

If this curfew continues, many sectors of the global economy could feel the effects. This realization seems to be troubling global equity markets. All of the world’s major equity markets have slipped into the red for 2010.

Your California editor has no idea if Chinese lenders should be withdrawing credit or extending it. But he has observed that Chinese lending volumes have inflated well beyond what underlying economic conditions would justify. And when credit inflates, bubbles form…then burst.

The renowned short-seller, Jim Chanos, has been highlighting the credit excesses in China for months…and worrying publicly that these excesses will end badly. Chanos calls the credit-fuelled real estate bubble in China “unprecedented.” And in a recent CNBC interview, he remarked, “One fun fact I’d like to mention: Right now, for commercial real estate, there’s 30 billion square feet under construction. Not all of that will probably get finished…but to put 30 billion square feet in context, that would be a 5 foot-by-5 foot office cubicle for every man, woman and child in China.”

Excesses of this magnitude rarely correct themselves painlessly…which causes us to wonder: If China sneezes, what disease will the global economy contract? Just a head cold? Or tuberculosis?