"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 timeJust 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.
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.
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.
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