China Is the Real Potential Black Swan

As usual in bear markets, people are looking at the wrong thing. I don’t think the Greek situation will bring on trouble. The market doesn’t wait for trouble, it looks ahead – it discounts. So far, the stock market is snoozing through the Greek situation. I’m tired of hearing about Greece. Will it? Won’t it? Maybe? From the market’s standpoint, Greece is a non-event. My thinking is that Greece will exit the euro and the Eurozone. The stock market obviously knows of this possibility, and it is surely discounted already.

I suspect the real trouble will come from China. Chinese stocks are in a bear market (is it a Black Swan?). They’re down over 20%. The government is obviously worried about the falling Chinese market, and is preparing for a huge injection of liquidity. I’m much afraid that the primary trend of the Chinese stock market is bearish. I’m also afraid that the bear market in China is on route to fully express itself. When the planet’s second largest economy and stock market is in trouble, I have to take it seriously.

China has been on a furious building boom, which has pushed its GDP up. China has built trillions of dollars worth of buildings. But the buildings are empty; nobody came to the party. How did China pay for all this? China owns $1.22 trillion of US bonds. It paid for it by selling a portion of its US bonds.

China’s selling of US bonds has pressured the bond market down for the past five months. As bonds decline, interest rates rise. This is the last thing the Fed wants. Rising interest rates are deflationary. What will the Fed’s reaction to deflation and rising rates be? They will fight deflation with inflation, by creating billions more fiat dollars.

The above content was an excerpt of Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.

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