Brazil has had a higher percentage of exports of commodities to China and it has recently boosted its trade. Since we are far from high growth, the demand for commodities over the past few months has been driven by China. As China pulls back, so will the demand for Brazilian commodities.

Much of the theory of decoupling rests with the idea that China, like the United States in the past, will be the engine of growth that will help take the world especially the emerging markets out of recession. One aspect of this argument is that as the Chinese economy grows it will increase the demand for commodities especially oil from Russia, minerals from Australia and food from Brazil. So as many parts of the world remain mired in a severe recession, the commodities markets, especially oil, have surged. The surge in prices for industrial commodities like copper and lead seem to be proof that the Chinese industrial miracle is up and running again at its usual break neck pace.

The first paper was produced for the Hong Kong Monetary Authority and written by Giovanni Ferri, of Italy’s University of Bari, and Li-Gang Liu of BBVA. Its finding was that Chinese state owned banks profits were the “product of subsidized financing by state banks, which lets them borrow much more cheaply”. The result was that capital would be allocated inefficiently and that there would be future losses.

That said, we are still in a severe worldwide recession. Since the legal infrastructures of emerging markets (and some developed markets) are not as efficient in delivering information to the markets (e.g. European banks will have stress tests but not reveal the information), the full extent of the problems in emerging markets has not yet been revealed.

Actually, I was accurate. My hypothesis does seem to have some validity. The culprit in chief turns out to have been none other than the IMF. The IMF admitted today that it grossly exaggerated estimates of the external debt levels of crisis-hit eastern European states. The estimates were sometimes double the actual amounts. The numbers are a ration of external debt refinancing needs to foreign exchange reserves. The ratio for the Czech Republic was cut from 236 per cent to 89 per cent and Estonia’s was reduced to 132 per cent from 210 per cent. It is understood the figure for Ukraine is also being cut to 116 per cent from 208 per cent and even Lithuania’s dreadful ration of 425 per cent will be recalculated. Although still high compared to other parts of the world, the new numbers make the situation in Eastern Europe more tenable. For example, by comparison, the highest ratio in Asia is Korea with 93%.

In law and economics there is a function as to the probability of a law being obeyed. The function is the probability of getting caught versus the severity of the punishment. For example, in many states in the US the penalty for murder is death which should be a good deterrent. It isn’t because less than 50% of the murderers are ever caught.

Although Goldman Sachs (GS) economists keep cranking out bullish forecasts, they may not be correct. Remember these are the same people who brought you $200 oil and a financial meltdown. The only reason they remain solvent at all is because the US taxpayer has backed AIG derivatives, which should have been worthless and put Goldman under.

The first reason is information. Emerging markets are far more volatile than markets in developing countries. I believe that the reason is information. Emerging markets are dominated by family owned and state owned companies. This combined with weak legal infrastructures and conflicts of interests suggests that the legal disincentives for revealing accurate, timely and complete information are not there. So these markets often trade on what Robert Shiller refers to as “stories” that is plausible tales and forecasts—for example, that house prices will never go down. In addition, Shiller points out another aspect of irrational behavior that is particularly prevalent in these markets, corruption. It is not that people in emerging markets are more or less corrupt than people in developing markets. Certainly the US market has had its share of villains. It is just that the weak legal infrastructures and relationship based systems makes it easier for them to be corrupt. So booms and busts in emerging markets tend to follow each other in rapid succession and may or may not reflect economic reality which may or may not be possible to forecast based on the accuracy of the information available.

It appears that the bad loans on the books of China’s banks are about to get far worse. According to the Financial Times, the banks lent out an astonishing $273 billion dollars. This amount when added to the amounts already lent in the first quarter means that the banks have lent out Rmb4,580bn almost the equal to the Rmb5,000bn that they planned to lend out for the entire year. This wall of money also went to the wrong place.

Professor Roubini and his colleagues did not take into consideration the Osoyoos Indians.

Mr. Jiang agreed with the Chinese government forecasts that China’s economy would grow at 8% this year. Last November, in a quarterly report on the Chinese economy, the World Bank reduced its forecast from the 9.2 per cent growth that it predicted in July down to 7.5%. Its latest prediction is 6.5%.

Why wouldn’t you want to own shares in the Industrial and Commercial Bank of China (HKG 1398 SHA 601398), the world’s biggest bank? The world’s largest telecom operator is China Mobile (CHL), in one of the world’s fastest growing market. Who would not want the safety of a telephone company in a dynamic market? The combination of oil and China seems irresistible, especially for an investor in PetroChina (PTR), a company that is only slightly smaller in size than ExxonMobil (XOM). There is no life insurer anywhere larger than China Life. The Chinese economy has been growing at over 10 % for years, as have the profits of these companies. It appears to be a no-brainer.

Sweden had a similar problem. It deregulated its banks in the mid 1980’s. The new bankers ignored the risks and made bad loans to industry and property developers. By 1992, their bad loans had wiped out their capital. In response, the Swedish government recapitalized the banks. The shareholders were wiped out, but the bond holders were protected. The dud loans were transferred to a bad bank called Securum, an asset management company. Securum was given the task of cleaning up the mess. The process was to last for 15 years, but was accomplished in 5. It helped lower the cost of the clean up to 2% of GDP.

The SEC’s failure was definitely due to incompetence and possibly inherent economic flaws. Any referee of any game is supposed to be independent and free from political and economic influence. The value of any central bank and its ability to successfully manage any monetary system must be based on its degree of independence from politics. The same is true of any market regulator.

Although the economic situation in Eastern Europe looks pretty bleak, what appears to be a major risk may have another effect. One of the best things that happened to the banking sector of EU Eastern Europe is that it is largely controlled by western European banks. Many commentators have worried about large foreign currency loans specifically loans denominated in Swiss Francs to borrowers in Hungary. Certainly this is something to worry about but it is nothing new. The banks that made these loans are European banks from Austria, France, Italy, Belgium, Germany and Sweden. [iShares MSCI France Index (EWQ), iShares MSCI Italy Index (EWI), iShares MSCI Belgium Investable Mkt Idx (EWK), iShares MSCI Germany Index (EWG), iShares MSCI Sweden Index (EWD)]. One must remember that the Euro has not been around that long and that most EU Eastern European currencies have been fluctuating, sometimes drastically (in the case of the Hungarian forint) over the past ten years. These banks are certainly used to dealing with currency fluctuations. Some of these problems were certainly clear in 2007. It is not that there wasn’t sufficient warning.

In one of my earlier newsletters, I pointed out that Citigroup Inc. (C) and Citadel Investment Group LLC hired the huge international law firm Clifford Chance LLP to attempt to seize the assets of bankrupt FerroChina. It is estimated that FerroChina owes over a billion dollars and the creditors hope to recoup $130 million of bonds due in 2011 and $160 million of loans. If they are lucky they will collect as little as 3%.

The odd thing about China’s massive four trillion yuan ($586 billion) economic stimulus package is that it is not using purely taxpayer money. Instead the vast majority of the funds are to come from taxpayer bank deposits. The Chinese central government announced last November that the central government will directly fund only about a quarter of the four trillion yuan ($586 billion) economic-stimulus package. The rest of the funds are expected to come from bonds issued by the local governments, bank loans and the private sector.