Jim Jubak: Focus on Bank of China, not the Fed

Jubak's Journal12/16/2010 1:15 PM ET

Focus on Bank of China, not the Fed

The old market wisdom says investors shouldn't fight the Fed. But these days, what China does matters a whole lot more than what Bernanke's crew says.

By Jim Jubak

"Don't fight the People's Bank of China," is my new mantra for investing in today's global financial markets.

It replaces that old Wall Street saw "Don't fight the Fed."

Right now, what China's central bank does on currency exchange rates, money supply and interest rates is way more important to the global economy and global markets than interest rates and quantitative easing from the Federal Reserve or sovereign debt purchases and bailouts engineered by the European Central Bank.

The People's Bank of China, China's central bank, drives the world's financial markets.

But before I ship "Don't fight the Fed" off to the Valhalla for old slogans to drink mead with "Remember the Maine" and "Kilroy was here," I want to extract some lessons for how to turn this new mantra into investing profits.

No mantra works all the time

Just as "Don't fight the Fed" worked very profitably most of the time, I think "Don't fight the People's Bank" will produce good profits most of the time. But just like the old mantra, the new one is likely to blow up on investors some of the time.

All you've got to do to turn good profits into great profits is avoid some of the explosions.

And that's where "Don't fight the Fed" can give us some important clues for when to follow "Don't fight the People's Bank" and when to ignore it.

For example, "Don't fight the Fed" was a winning strategy in 1997, 1998 and 1999.

The technology-dominated Nasdaq Composite ($COMPX) climbed 22% in 1997 and then accelerated to a 40% gain in 1998. Stocks rose because the Federal Reserve, rather than acting to let air out of the bubble, was pumping it in.

Money supply, as measured by M2, rose by 8.5% from December 1997 to December 1998, according to data from the Federal Reserve.

And in 1999? The Fed still didn't throttle back -- much. Money supply grew by 6% that year, providing plenty of cash to drive stock prices even higher. The Nasdaq climbed 86% that year.

In 1998 and 1999, studiously bearish investors questioned stock market valuations and called the run-up in stocks unsustainable. They argued that what was then called the "Greenspan put," a virtual guarantee from the Fed that it would pump money into the markets if any crisis threatened the markets, was encouraging reckless investing in stocks with wildly unrealistic valuations.

They were right, of course. Eventually. But if you shorted on that wisdom in 1998 or 1999, you got killed. The bottom didn't fall out of stocks until 2000. The Nasdaq fell 39% in 2000, an additional 21% in 2001 and an additional 32% in 2002. Investors who had been arguing that stocks were overvalued for years were totally vindicated, although many of them had pulled out of the market to lick their wounds. (As John Maynard Keynes put it, "Markets can remain irrational a lot longer than you and I can remain solvent.")

These bears had fought the Fed, and the Fed won. Which illustrated aptly the mantra's cynical view of the financial world: You can be oh, so right, and the Fed oh, so wrong, and for much of the time all your superior knowledge, wisdom and smarts don't matter. The Fed, even if it's dead wrong, will win, because it's got the trillions to back up its point of view.

Remember this history as we look at the present.

How wrong is the Bank of China?

I think there's a good chance that the People's Bank of China is going to turn out to be disastrously wrong about how to run China's economy.

The country's central bank has apparently decided that it's OK to let bank lending run wild, to rely on price controls to fight inflation, to keep the yuan cheap versus the dollar and to discourage saving by keeping deposit rates well below the rate of inflation. The bank's monetary policy risks letting inflation get so far out of control that there won't be any way to gently step on the brake.

And that wouldn't be good. Even thinking about it as an investor makes me want to run for the hills.

But not yet, my mantra says. While the People's Bank may be wrong, its moves will still move the markets. And it would be foolish to bet against the People's Bank.

For a while at least.

What, China worry?

China's government is apparently much less worried about inflation than are overseas investors and market analysts.

On Dec. 14, in the first official statement after the weekend meeting of the Central Economic Work Conference, Zhang Ping, the head of the National Development and Reform Commission, told state television that Beijing plans to set a 4% target for consumer price inflation next year, up from 3% in 2010.

And the government doesn't seem to be worried at all that inflation, at 5.1% in November, is running way above its targets for 2010 and 2011.

Reports out of Beijing suggest the government will set the 2011 quota for new bank lending at 7.5 trillion yuan, about $1.1 trillion. That's the same quota that the government set for 2010 and that banks will almost certainly exceed by the end of this month. 2010 was supposed to be the year that China reined in bank lending from the stunning doubling in new loans in 2009 from 2008 in response to the global financial crisis. Instead, once you add in off-balance-sheet lending, the total for 2010 will be essentially unchanged from 2009. And the new target will continue that pace.

The effects have been huge. The money supply has climbed by 50% in the last two years. Even for a country growing as fast as China, that's wildly inflationary.

Continued: Don't fight the inflation

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9Comments
12/23/2010 4:03 PM
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Of course China matters when you owe them lots of MONEY, Duh! When will we ever learn. All the FED knows is how to manipulate money, They operate outside of logic or reason, red could mean black or plus could be minus. So up could mean down or left could be right or infinity could also equal zero and something could be created from nothing its

all possible as long as it's matter in space and time.

12/18/2010 1:48 PM
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The main issue I have with QE2 is not that the economy is not in need of help. The main issue is that, given the distorted and corrupt financial and corporate system in this country, QE2 will be ineffective (the money will just go into the commodity and currency markets where it will drive up prices which causes inflation). It will be a waste of breath, time and money.

 

It would be a different situation if, like in China, they actually use their fiscal stimulus and central bank policies to build something that people could actually use and employee someone other than an army of lawyers and bankers.

 

12/17/2010 9:05 PM
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After our tax cut bill, China will surely have realized that the last 30 years they have been doing some CHEAP SLAVE LABOR for us to keep THEIR economy going. That’s why they are so eager to get away from EXPORT-oriented economy and create a DOMESTIC economy. From now on, they are going to WORK FOR THEM.

 

So no matter the rhetoric, their interest rates are going to stay low FOR EVER, and LOANS are going to be FREELY available.

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as an australian living in Melbourne china south korea india developement must be fully explored through careful diversification of investments i use many tools in my investment decisions and find jim jumbaks articles interesting with out being commitial upon apinion
12/17/2010 12:30 PM
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Give me Jubak's sensibility over Cramer's sheer lunacy any day of the week.  This article was fantastic in that he formed a very convincing argument for investors to remain calm for a while at least, before the awful storm that is building in China.    
12/17/2010 11:41 AM
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Kcn Nelson, "I vote Jimmy Cramer off my financial island and call in an air drop for Jim Jubak."

 

LMAO, thanks!

12/17/2010 11:05 AM
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I agree with Fun-bags. Jim your not sensational, your sensible. You illuminate the facts from the fiction and you operate from rationality instead of emotionality. That's why I tune in everyday. 

It's too bad that TV demands fantastic fictions, emotion and drama from everything from reality tv to financial advisors. Unfortunately, the people want "The Situation" (Jim Cramer) to tell them where to put their money. 

I vote Jimmy Cramer off my financial island and call in an air drop for Jim Jubak.
12/17/2010 8:54 AM
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Take it easy on my buddy Jim - he's got to write something every day, and interesting stuff can be hard to come by. I have followed him for years and have found him the most interesting and informative of all the MSN money writers. Keep it up Jim!
12/17/2010 3:33 AM
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Jim..Jim.. Jim  (Jubak)

 

Once again my head slammed on my desk from the absolute boredom of your articles.  C'mon buddy--I believe your heart is in the right place--trying to guide us with our investments.  But, Jim--You can spice it up once in awhile.  You know--get out of the missionary position and mix it up a little. 

Last week you wrote a piece--- that for once--didn't immediately start sleep mode--it was on Spain and silver.  You seemed to have fun.  I could imagine your little fingers gliding across the keys as if you were playing a grand piano.  Your viewers were applauding you, Jim.  That article was, well uh, interesting!

 

Jimmy, for the new year do us a favor;  Think outside of the cubicle.

 

P.S.

Thanks for the invite to meet you at The Money show.  But, I still have articles of yours to put me to sleep and I don't want to snore in public.

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