Saturday, January 31, 2009

The Debts of the Lenders: China Speaks On Davos and the West's Bad Bank Plan

Actions - not words - are the ultimate decider.

Beijing has ultimate authority over any US bailout package - indeed
any Western bailout package. The Chinese could care less about the
Western stock market. All they want is preservation of jobs back at
home and their Treasuries to be worth something.

The Chinese just sent a shot across our bow. The Davos conference is
a collection of Western bankers and politicians who still think they
are in control. Meanwhile, China issued this statement:

"Whether we will continue to buy U.S. Treasuries, how much we will
buy, depends on our own need for maintaining the value of our foreign
reserve investments and keeping them secure."

We also heard from the Chinese on Thursday when the 30 year long bond dropped 4 or 5
points and finally closed on Friday at 3.6%.

To be sure the Chinese did not suggest that they would liquidate treasuries but traders interpreted it that way. Chinese comments also set the tone for the big oversupply of bonds on Thursday's treasury auction on the 5 year note. This encouraged bond shorts to call Bernanke's bluff about monetizing the 30 year long bond and allowed them to ride it 4-5 points lower.

BUT we remain in deflation. This is evidenced by:

1) UUP - strong dollar; AND
2) USD/JPY - (relatively) strong yen; AND
3) General Macro-economic environment