China's Triple Whammy: Will it Matter?

China delivered a three-combo punch in order to rein in their economy. All three moves, when looked at separately, will have an ever so slight effect on the economy. But pushing all three through on the same day may deliver an impact....

Or not.

The overnight rate in China is sitting at 1.6%. That didn't change. And why would it? Why would a country who's looking more and more intent on curbing excessive growth target their overnight bank rate when they can hit borrowers where it really counts, with an increase in the 1-year rate up to 6.57%. My point exactly. This is almost a no-brainer. Their overnight rate is so low that it makes sense to borrow on the 1-year and just lend the money right back to whomever. Yeah. This is really going to slow growth.

And let's take that thinking a little further. Your economy is churning at 11.1% GDP annually and your overnight rate is sitting at 1.6%. Yup. Now you see why the SSE Index is up 212% in the past 12 months, and likely to continue.

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But then the Bank also moved to at least curb lending with a bigger than normal increase in their reserve requirements (without the subsequent move in the borrowing rate on that particular element) to 11.50% from 11.00%. China has $1 trillion in savings currently. Push the reserve requirements up 0.50% and you've just made $5 billion dormant. I'm not sure if that sounds like a great thing or not. But let's put it into further perspective just to see how it weighs in. Back in August the reserve requirements were sitting at 6.00%. So, effectively, we've gone up a full 5.50% since then, pulling $55 billion out of the economy. The net result? China's GDP is growing at a sizzling 11.1%, which is even more accelerated rate of growth than before.

Then there's the one thing that may wobble the economy. China allowed its currency to float at a faster pace, paving the way for even more currency appreciation and one step closer to a free float. They allowed the currency to fluctuate to 0.50% per trading day vs. the 0.30% before. That means the currency could appreciate a full 1.00% per week faster or 2.50% per week total, assuming that it pushed its limits every single day which, when you look at this chart, it pretty much has:

So, how do we translate this? Well, Americans will be buying fewer and fewer Chinese goods as the prices of these goods increase. Other countries will become more competitive, including America. At the same time, China won't need to use as much of their own currency to buy the same products of ours, such as our debt markets. But the thinking will be that they will be getting less and less excess reserves because the U.S. will be giving them less and less business.

That one thing, right there, could be enough to wobble the economy. China is a far cry from a domestically led economy. Factor in their biggest customer folding their arms, then the smart money may finally "get it" and perhaps take some profits off of the table.

But, then there's the factor that on May 8th the country of China saw the single biggest one day record for brand new accounts being opened at brokerage firms. 385,121. In one day. Are you kidding me? Think about that for a second. What about all the other days in that week that weren't one day records? If they were over 150k per day then there were 1 million new accounts opened that week alone! That could easily translate into 5 million new accounts in that month.

When you think about it, who cares what the government does? There is so much momentum pushing the market forward, it's going to take a butt-load more than this to make that market take a breather.

But, if we take all three together, then maybe. Maybe. MAYBE, the bourses will get it, and take a much needed breather.

So, what if we do see a market misstep? This is where the entanglement of the world's economies play in. First, where is all of this money coming from? Japan and the carry. The carry doesn't like instability. If world equity markets start to shake, the carry will roll. Hard. We saw a taste of this in late February when the Chinese bourses tripped up, and the carry got whacked. This will very likely be the domino effect that pushes all, as in every single one, equity market in the world to take the necessary tumble back into normalcy.

At the same time, the ramifications are going to metastasize around the global financial system. The money that's been accumulating in the carry will head right back to Japan, providing a liquidity crunch.

The good news will be that inflation will be cured.

The world was sitting around waiting for one thing this weekend - will the Chinese bourses dump or not? If they do, then hold on for a pretty fun summer. If not, then we can push forward with the carry trade all day long, and it's the 90's all over again.