Fascinating!

It seems that hot money inflows into China are even bigger and more complicated and ingenious than I had supposed. First, I will quote the article that enlightened me. It comes from Michael Pettis on Seekingalpha.

With appreciation pressures so strong, it is pretty clear that various forms of hot money have become the engine of money creation. It used to be the trade surplus that powered reserve growth, but the unexplained amount – after the trade surplus, FDI, currency valuations, interest income and all the other easily explained things are removed – is now by far the biggest
component of reserve growth, and even this understates its impact because there is increasing evidence that a large and growing part of FDI and the trade accounts are also simply disguised hot money.

In other words, investors buying yuan are pouring foreign money into China. The central bank continues to print yuan like crazy to buy up all the foreign money. This is one of the biggest factors in global inflation today.

In this context, one of my eagle-eyed readers sent me a link to this fascinating article from today’s Dow Jones Newswire:

SOFIA (Dow Jones)--Copper has become an instrument by which hot money flows into China but this has created the false impression that Chinese consumption has taken off, Wu Yuneng, general manager of JCC Southern Group Company, said Wednesday. Noting that investors are looking to capitalize on interest rate differentials between the renminbi and dollar, Wu said copper is being used as a tool for foreign exchange gains.

China's economic growth is a sham. It consists of importing raw materials and exporting printed yuan.

Financing and foreign exchange arbitrage means that copper cathode imports are large even when the arbitrage between the London Metal Exchange and the Shanghai Futures Exchange is negative, Wu said, speaking through an interpreter at the Metal Bulletin copper conference in Sofia.

Chinese traders are willing to lose money by buying copper for more than it's worth in London because they more than make up for the loss with profits on the currency exchange.

Evidence for this copper financing play can be seen in data from the Chinese Commerce Department, he noted. This showed Chinese foreign exchange reserves in the first quarter amounted to $1.68 trillion, an increase of 40%. Even accounting for a net surplus of foreign trade and foreign direct investment, $85.1 billion cannot be explained, said Wu.

China is printing $480 billion per quarter. If this sounds like a lot, it is. What does this really mean? This can be viewed as a measure of the pressure on the yuan to rise. If there was no pressure on the yuan, they wouldn't have to print any more to stabilize the value, would they? What might this look like quantitatively? How much should the yuan rise against, say, the dollar? Just look at oil.

Essentially what is happening is that commodities are being used as a medium of exchange for different currencies. If this sounds bass ackwards, it is. The way to play this is long yuan, short Chinese equities, and long commodities. I've got two out of three. The third, commodities, requires some waiting. (It's also the most dangerous play because it depends the most on the lie for its survival.) A regulatory clampdown on speculators should provide a golden opportunity to jump on the bandwagon. The time to buy will be a month or two later, when prices have flattened for a month or so.

Speaking of which, one of my investment strategies is to re-read everything I write a month later, at which time whatever trade I was considering shows some of the benefits of hindsight.