CREDIT CYCLE - HY Leading the Way

What A Correction Could Look Like 06-18-13 Morgan Stanley via ZH

While disappointment from the FOMC's comments tomorrow may not be enough to create 'the big one', it is perhaps worth a look at the more meaningful corrections over the last 10 years in equity and credit markets for some sense of context for what is possible. So far, it is clear, especially given today's equity rally (and ongoing credit weakness) that the consensus of the equity herd are not expecting disappointment tomorrow - while credit markets are preparing for the 'flow' to slow.

Credit markets are well on their way to a 'normal' correction...

But stocks remain notably confident relative to previous corrections...

and the divergence is becoming clearer...

and continues today...

Charts: Morgan Stanley

CREDIT CYCLE - Reversal Ahead

Is The Credit Cycle Over? 06-18-13 Zero Hedge

No matter how much pushing on the market- or economic-string a central planner tries, eventually the risk-based pricing of credit (as opposed to nominal price based stocks) turns the corner from accepting rising leverage as potentially good thing for growth to worrying that cash flows are at risk from an over-generous management transfer to shareholders. The four-year bullish period of this credit cycle is nearing its historical average and leverage is near its cycle highs with near record numbers of firms raising leverage YoY suggesting the credit cycle is over.

Leverage is rising...

and pretty much every other credit metric is deteriorating...

and the credit cycle is getting long in the tooth...

It seems the only factor driving credit from not being wider based on these leverage and cycle indications is the 'flow' from the Fed. We suspect that is what has created the weakness in bonds recently (even though we note that cash bond markets have not weakened as much as CDS since managers are preferring to hedge than cover for now - since, quite bluntly, they know that if they all collaborate and don't sell then everything is fine but once one manager decides to cover instead of hedge, the small doors and large crowds will see major liquidity gaps appear in HY credit).

TAPER - Why is the Fed Talking TAPER?

What The Fed Is Looking At 06-17-13 Bloomberg via ZH

A sense among investors that the global economy is unraveling has injected tremendous volatility into the markets.

Bloomberg's Rich Yamarone: "if the global equity market decline is not a “Sell in May” event, but the beginning of a great unwinding, then the economy, skating on thin ice, may be even more susceptible to recession."

Given all of this 'weakness' (or missing of Fed benchmarks - that the Fed is well aware of,) why would so many members have been out discussing 'Taper' if it were not due to their concerns of broken markets and bubble conditions.

Via Bloomberg,

• WORLD BANK reduced its global economic forecast to 2.2 percent in 2013 – from a previous 2.4 percent estimate, and lower than the 2.3 percent performance in 2012.
• COMMODITIES: The bifurcation between the CRB index and the S&P 500 first appeared in December 2012. The S&P 500 now looks as if it will rejoin the commodity benchmark.

• US GDP REDUCTION: Economists polled by Bloomberg forecast U.S. GDP to increase a lowly 1.9 percent in 2013, after a 2.2 percent gain in 2012.Detroit is on the brink of bankruptcy, and several top tier indicators are flashing warning signs.
• JOB OPENINGS declined in April
• INVENTORY-TO-SALES RATIO: The total business inventory-to-sales ratio increased to 1.31 months – the highest level since October 2009 (1.32) when the U.S. economy was in the initial stages of recovery from the Great Recession.
• FED INFLATION MEASURES: the inflation side of the dual-mandate is still missing massively... and going in the wrong direction. Prices just keep dropping, which has to be alarming for a Fed worried about fighting deflation.

• IMPORT PRICES: Fell 0.6 percent last month, and were 1.9 percent lower than in May 2012. All of the associated core measures (ex food, energy, etc.) were also contracting on a year-over-year basis.
• WHOLESALE CHANNEL: Core intermediate producer prices FELL 0.3 percent in May and was 0.2 percent lower than a year ago.
• INDUSTRIAL PRODUCTION: The second quarter is off to a very slow start as total production was unchanged in May and contracted 0.4 percent in April. Industrial production peaked in mid-2010 (8.5 percent versus 1.61 percent today
• REGIONAL FED INDEXES: Regional Fed manufacturing indexes are all in contractionary territory.

• POWER USAGE: Electricity output has fallen in each of the last five weeks (on a year-over-year basis)
• CAPITAL GOODS: Shipments of nondefense capital goods excluding aircraft plunged 1.5 percent in April.

So once again we ask - given all of this 'weakness' or missing of Fed benchmarks- that the Fed is well aware of, why would so many members have been out discussing 'Taper' if it were not due to their concerns of broken markets and bubble conditions. We fear an equity market positioned far too enthusiastically given the risks of a disappointing Fed.

MANIPULATED MARKETS - A Rigged System

Currency Markets Are Rigged

Bloomberg reports today:

Traders at some of the world’s biggest banks manipulated benchmark foreign-exchange rates used to set the value of trillions of dollars of investments, according to five dealers with knowledge of the practice.

Employees have been front-running client orders and rigging WM/Reuters rates by pushing through trades before and during the 60-second windows when the benchmarks are set, said the current and former traders, who requested anonymity because the practice is controversial. Dealers colluded with counterparts to boost chances of moving the rates, said two of the people, who worked in the industry for a total of more than 20 years.

The behavior occurred daily in the spot foreign-exchange market and has been going on for at least a decade, affecting the value of funds and derivatives, the two traders said.

***

The $4.7-trillion-a-day currency market, the biggest in the financial system, is one of the least regulated. The inherent conflict banks face between executing client orders and profiting from their own trades is exacerbated because most currency trading takes place away from exchanges.

***

While the rates aren’t followed by most investors, even small movements can affect the value of what Morningstar Inc. (MORN) estimates is $3.6 trillion in funds including pension and savings accounts that track global indexes.

***

As market-makers, banks execute orders to buy and sell for clients as well as trade on their own accounts.

***

By concentrating orders in the moments before and during the 60-second window, traders can push the rate up or down, a process known as “banging the close,” four dealers said.

Three said that when they received a large order they would adjust their own positions knowing that their client’s trade could move the market. If they didn’t do so, they said, they risked losing money for their banks.

One trader with more than a decade of experience said that if he received an order at 3:30 p.m. to sell 1 billion euros ($1.3 billion) in exchange for Swiss francs at the 4 p.m. fix, he would have two objectives: to sell his own euros at the highest price and also to move the rate lower so that at 4 p.m. he could buy the currency from his client at a lower price.

He would profit from the difference between the reference rate and the higher price at which he sold his own euros, he said. A move in the benchmark of 2 basis points, or 0.02 percent, would be worth 200,000 francs ($216,000), he said.

***

To maximize profit, dealers would buy or sell client orders in installments during the 60-second window to exert the most pressure possible on the published rate, three traders said. Because the benchmark is based on the median of transactions during the period, placing a number of smaller trades could have a greater impact than one big deal, one dealer said.

Traders would share details of orders with brokers and counterparts at banks through instant messages to align their strategies, two of them said. They also would seek to glean information about impending trades to improve their chances of getting the desired move in the benchmark, they said.

Interest Rates Are Manipulated

Unless you live under a rock, you know about the Libor scandal.

For those just now emerging from a coma, here’s a recap:

• The big banks have conspired for years to rig interest rates … upon which $800 trillion in assets are pegged

• This was the largest insider trading scandal ever … and the largest financial scam in world history

• Local governments got ripped off bigtime by the Libor manipulation

• Libor is still being manipulated

Derivatives Are Manipulated

The big banks have long manipulated derivatives … a $1,200 Trillion Dollar market.

Indeed, many trillions of dollars of derivatives are being manipulated in the exact same same way that interest rates are fixed: through gamed self-reporting.

Commodities Are Manipulated

The big and and government agencies have been conspiring to manipulate commodities prices for decades.

Gold and Silver Are Manipulated

The Guardian and Telegraph report that gold and silver prices are “fixed” in the same way as interest rates and derivatives – in daily conference calls by the powers-that-be.

Oil Prices Are Manipulated

Oil prices are manipulated as well.

Everything Can Be Manipulated through High-Frequency Trading

Traders with high-tech computers can manipulate stocks, bonds, options, currencies and commodities. And see this.

Manipulating Numerous Markets In Myriad Ways

The big banks and other giants manipulate numerous markets in myriad ways, for example:

• Engaging in mafia-style big-rigging fraud against local governments. See this, this and this

• Shaving money off of virtually every pension transaction they handled over the course of decades, stealing collectively billions of dollars from pensions worldwide. Details here, here, here, here, here, here, here, here, here, here, here and here

• Charging “storage fees” to store gold bullion … without even buying or storing any gold . And raiding allocated gold accounts

• Committing massive and pervasive fraud both when they initiated mortgage loans and when they foreclosed on them (and see this)

• Pledging the same mortgage multiple times to different buyers. See this, this, this, this and this. This would be like selling your car, and collecting money from 10 different buyers for the same car

• Cheating homeowners by gaming laws meant to protect people from unfair foreclosure

• Pushing investments which they knew were terrible, and then betting against the same investments to make money for themselves. See this, this, this, this and this

• Engaging in unlawful “frontrunning” to manipulate markets. See this, this, this, this, this and this

• Engaging in unlawful “Wash Trades” to manipulate asset prices. See this, this and this

• Otherwise manipulating markets. And see this

• Participating in various Ponzi schemes. See this, this and this

• Charging veterans unlawful mortgage fees

• Cooking their books (and see this)

• Bribing and bullying ratings agencies to inflate ratings on their risky investments

TAPER - The Fed is Unlikely to Taper

Don’t Fear the Taper 06-16-13 Read the full newsletter here. Featured articles include: My Deere, Market Shadows added agricultural machinery manufacturer Deere (DE) to our Virtual Value Portfolio. And When Tear-Gas Flies, It’s Time to Buy (buying EMF). Chart by Lee Adler of the Wall Street Examiner.

Quantitative easing (QE) programs, courtesy of the Federal Reserve, have pushed cash into Primary Dealer accounts at the fastest rate in history. This has been massively bullish for equities over the past four years, as the Primary Dealers used some of that cash to bid up equity prices. This will likely continue until the Fed significantly curtails or discontinues its QE operations. 

US stock indices have been marking time during the past four weeks gauging “talk” about whether Chairman Ben Bernanke will slow down his printing presses. Notwithstanding the rumors, we doubt that QE tapering is on the horizon.

In our view, unless the Fed stops funneling money to the Primary Dealers, which we deem doubtful, pullbacks in stock prices are likely temporary pauses along an upward path. Therefore, in both of our Virtual Portfolios (Value and Put Selling), we are remaining long and unhedged.

The Fed is Unlikely to Taper

America’s national debt now runs approximately $16.5 trillion. President Obama use his power to hold rates down because the cost of higher debt service would devastate his political agenda. 

Bernanke does Washington’s bidding so he is probably just ‘talking down’ market enthusiasm by leaking news of a coming ‘taper.’ In this fashion, he uses fear of reduced QE to contain equity prices without actually changing the Fed’s policy.

During the fiscal cliff debate in December 2012, people assumed tax rates would be much higher in following years. That precipitated an enormous amount of accelerated income and dividend payments that would have been made in 2013. Because of the higher income booked in Q4 2012, estimated tax payments due January 15, 2013, soared. This reduced the size of the expected Q1 deficit. 

Bernanke’s primary mission is to monetize the debt created by federal budgets that far exceed revenues. We see no way for the Fed to reverse course on QE regardless of the whispers to the contrary. 

The Fed has painted itself into a corner and there is no way to unwind the QE trade without debt service costs eating everyone alive. Unwinding would cause interest rates on U.S. sovereign debt to soar, because no one would buy debt at interest rates the government could manage. For every one percent rise in interest rates, there would be an estimated $80Bn in increased annual debt service costs at the federal level. The payment of interest would overwhelm all other spending.

In Love with TINA explains why stocks are attractive. There are no viable competing investments if you seek to protect your life saving’s long-term buying power. Absent a major change in policy, a full allocation to equities seems reasonable, as does avoiding fixed income. Bonds today are in a bubble, and a pop of the fixed income bubble is apt to be louder and more astonishing than anything we will see in the equity markets.

TAPER - Fed Trapped in a Box

Why the Fed Cannot "Exit" Successfully... Without a Market Crash 06-15-13 www.gainspainscapital.com Graham SummersBernanke claims the Fed can successfully exit its current strategy. He’s lying. Or he’s adhering too strongly to economics and ignoring human nature.

One of the easiest trades for financial institutions over the last four years has been to simply front-run the Fed during its QE programs.

After all, the Fed was literally broadcasting its intentions to the markets. So traders did what they do best and took advantage of this.

In this context, the second rumors begin that the Fed would taper its bond buying you should see bonds collapse as traders realize the game is up.

And if the Fed actually did taper or begin to implement a strategy that even resembled taking its foot off the gas… or God forbid exit, then we’d see a very rapid adjustment to reveal the “real” risk in the system and the “real” level at which rates should be.

Take a look at what happened to the 10-Year Treasury when rumors of “tapering” appeared:

The Fed cannot exit. It will claim that it can, but market reactions to any real exit will be disastrous. We’ve passed the point of no return. Bernanke’s best home is to retire before the music stops.

CHINA - Credit Fueled Growth

The Chinese Credit Bubble In Four Charts 06-17-13 BI

China's credit bubble is unlike anything in modern history, according to Fitch. Ambrose Evans-Pritchard of The Daily Telegraph reported that Fitch thinks the scale of Chinese credit is so massive that it can no longer grow out of its excesses. And the statistics are scary:

• "Overall credit has jumped from $9 trillion to $23 trillion since the Lehman crisis. 'They have replicated the entire US commercial banking system in five years,' she said."
• "The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990."

In light of this, we put together four charts on China's credit bubble that you need to see.

FIRST up, the main bear argument on China: It is taking more and more credit growth to deliver less economic growth.

SECOND, the estimated outstanding Wealth Management Products. In China, wealth management products are popular, interest-bearing retail products that are backed by a hodge-podge of risky assets. They function as a replacement for normal investment/savings accounts, but are not guaranteed.

A crackdown on Wealth Management Products (WMPs) has seen WMP issuance slow in 2013. But Charlene Chu at Fitch writes that this continues to pose a risk to the banking sector because it accounts for a "sizable amount of funding."

"In Fitch's view, the primary risk centers on:

1. Cash payout pressure posed by WMPs' short-term nature,
2. Poor liquidity of underlying assets,
3. High mobility of WMP investors, and
4. Banks' mismatched assets and liabilities."

THIRD the rise in gross issuance which is close to 115 products a day.

FOURTH, the recent spike in SHIBOR, or the Shanghai interbank offered rate, which is an interest rate used among banks showed signs of liquidity stress in China.

SHIBOR is considered a useful proxy for liquidity in the Chinese credit markets, more specifically, the recent spike in Shibor showed a liquidity squeeze. In a new note, Morgan Stanley's Richard Xu writes that "SHIBOR and repo two-week rates did not ease significantly after the three-day holiday, and one-month rates even spiked by ~80bps, implying that the recent liquidity tightness is likely more associated with recent intense regulatory actions than holiday effect."

These four charts show the rise in China's credit bubble and the recent liquidity squeeze.

CHINA - Shadow Banking System Showing Signs of Implosion

Fitch says China credit bubble unprecedented in modern world history 06-16-13 Ambrose Evans-Pritchard, The Telegraph

China's shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned.

CHINA - PBOC Wants to Hold the Line on Explosive Credit Expansion through A Liquidity Squeeze

China Banks Request Cash-Crunch Relief 06-17-13 WSJ

BEIJING—China's big banks are pressuring the central bank to free up funds to ease an unusual cash squeeze in the world's No. 2 economy, according to people familiar with the matter, illustrating a stark choice facing Beijing as it grapples with weaknesses in its financial system: add money to its system to help its lenders, or stay the course to rein in a rapid expansion of credit.

The Chinese interbank funding market has seen rates soar since early this month amid slowing foreign-capital inflows and banks' needs to fulfill investor obligations, among other factors. The squeeze is pushing up banks' funding costs and could impede a key source of funds for growth even as the economy slows.

In a further sign of tighter conditions, Agricultural Development Bank of China, a state-controlled policy bank, on Monday reduced by a third the size of its planned 26 billion yuan ($4.2 billion) bond offering. The Ministry of Finance, in a rare failure on Friday, was unable to sell all of the debt it offered at an auction.

The tight liquidity situation is leading to some calls from Chinese banks for the People's Bank of China to inject more cash into the market by lowering the share of deposits banks are required to set aside against financial trouble. The measure is known as the reserve-requirement ratio, or RRR. "Internally, we're hoping for an RRR cut by the end of Wednesday," said a senior executive at one of China's top four state-owned banks. The central bank didn't respond to a request for comment.

Some analysts, including Xu Gao at Everbright Securities Co. in Beijing, expect the PBOC to take measures to ease the liquidity crunch in the coming weeks. The central bank last cut its reserve-requirement ratio in May 2012.

The concern about a credit crunch comes at a time when Chinese officials are also trying to combat the opposite: a credit binge that dates from the stimulus spending of 2009. The two are linked, analysts say.

By trying to rein in the long-term credit surge, the PBOC may have produced a short-term credit crunch.

But any big intervention by the PBOC—which, unlike the central banks in the West, isn't independent of the nation's political leaders—would risk sending a signal that China's top leaders would rather sacrifice their goal of keeping on credit growth in favor of pumping up domestic economic growth. That would run counter to the remarks made by Chinese leaders in recent months. Premier Li Keqiang, for instance, has indicated that Beijing is reluctant to change its monetary- and fiscal-policy stance to counter a slowdown while pledging to press ahead with changes that could make the country's growth more sustainable.

"Right now, an RRR cut would be very controversial because that would signal a change in macroeconomic policy," said Li Wei, an economist with Standard Chartered in Shanghai.

Traders and economists cite a sudden reduction in foreign capital inflows— the result of China's recent crackdown on speculative money flows and of a slowing economy—as one of the main reasons for the ongoing cash squeeze.

That is because

• Companies aren't converting as much foreign currency into China's currency, the yuan, resulting in less yuan funds flowing into the economy.
• Adding to the shortage of funds is additional demand for cash so that banks can meet the obligations of repaying investors who hold some high-yielding investment products sold by banks, known as wealth-management products.

On Monday, China's benchmark seven-day bond repurchase rate reached 6.85% on a weighted-average basis, near its highest level since China started compiling the rate in 2006. The highest level, at 6.9%, was reached Friday. So far, China's central bank has appeared to be more willing to keep what it calls a "prudent" monetary-policy stance than to carry out operations aimed at easing banks' funding constraints. As part of the prudent monetary stance, the PBOC has been trying to stem a surge in credit that could produce a wave of bad debts and financial failures.

Total social financing, China's widest measure of credit that includes both bank loans and credit created outside formal banking channels, fell by about one-third to 1.19 trillion yuan in May from April, the second month of substantial decline. But the central bank still has a way to go to curb overall lending: In the first five months of 2013, total social financing was up 52% from 2012.

A commentary published on Monday by China's Financial Times, a newspaper backed by the PBOC, dismissed the prospect of a liquidity crisis in China's money market but said some individual banks suffered funding problems because they had relied heavily on borrowing short-term funds in the interbank market and exceeded regulatory limits on lending. The article also said banks should sort out the funding problems on their own and shouldn't count on the PBOC to step in to provide liquidity.

After the market close on Monday, the PBOC announced that it would sell two billion yuan worth of 91-day bills the next day. The bill sale means that the central bank would drain two billion yuan of liquidity from the money market, a negligible amount that would hardly sway the market but a signal that China's policy makers aren't yet ready to loosen the grip on money supply. Last week, the PBOC injected a net 92 billion yuan into the market, a small amount relative to Chinese banks' funding needs. Only 32 billion yuan in central-bank bills and other notes are due to mature this week, meaning the PBOC would have to inject extra liquidity if it wants to improve the funding situation significantly. "Through the events over the past week, we think the PBOC has made it clear that overly rapid credit expansion would not be accommodated, and that the PBOC still focuses more on the quantity of credit and money supply rather than on short-term interest rates," said Wang Tao, an economist at UBS AG.

"In other words," Ms. Wang said, "if banks let credit growth go too fast, the PBOC doesn't mind the spike in interbank rates in order to rein them in." The recent cash crunch may lead to banks trimming their credit exposure and manage liquidity more prudently, she added, even though "there is a small risk that this could lead to a credit crunch in the short run."

EM CRISIS - Will make the 1997 Asian Crisis Seem Like an Early Warning

Emerging markets displace Europe as fulcrum of world risk 06-05-13 Telegrpah, Ambrose Evans-Pritchard

There is a wicked double edge to the emerging-market boom that has so enthralled us for the past decade. The economies of these rising powers are by now big enough to shake the entire world if they come off the rails.

GLOBAL DELEVERAGING ACCELERATION - Developing Nations Feeling the Pain

Developing Crisis In The Developing World 06-15-13 John Rubino via The Dollar Collapse blog, via ZH

Things have been a little erratic lately here in US, but not really headline-worthy. The economy continues to grow, sort of, houses continue to sell and stock and bond prices fluctuate but can’t seem to follow through in either direction. We are not, in short, engulfed in any kind of crisis.

But out in the world, especially in once-hot emerging markets like Brazil and China, the story is very different. As Prudent Bear’s Doug Noland explains in his most recent Credit Bubble Bulletin:

Meanwhile, the “developing” market Bubble continues to unwind. As leverage comes out of the commodities, currency “carry trades” and developing stocks and bonds. And as capital flight becomes a more serious issue, the marketplace must ponder the consequences not only of what a faltering Bubble means for scores of markets and economies, there is as well the issue of developing central banks having to sell from their trove of Treasuries and bunds and such to finance a surge in outflows (“hot” and otherwise). There’s even this new dynamic where Treasury yields rise on days of global currency and equity market tumult. It’s been awhile...

I suspect that the global jump in yields (and CDS and risk premiums) has more to do with de-leveraging than it does with tapering worries. This dynamic has caught many by surprise. The speculators anticipated cleverly exiting their leveraged MBS and other trades based on their expectations for Fed policy. Now, there’s a tremendous amount of unanticipated market uncertainty.

Japanese policymakers have really mucked things up. The Nikkei sank 6.5% Thursday and was down 1.5% for the week. Perhaps it’s a little early to pronounce the BOJ’s “shock and awe” monetary experiment a failure. The yen rallied 3.5% this week against the dollar. Against the Philippine peso it was up 4.5%, versus the South Korean won 4.1%, the Indian ruppee 4.3%, the Malaysian ringgit 4.0%, the Indonesian rupiah 3.2%, the Argentine peso 3.9% and the Brazilian real 4.2%. Indonesia raised rates to support its weak currency. The yen “carry trade” (sell yen and use proceeds to buy higher-yielding instruments globally) is doling out painful losses – forcing the unwind of leveraged trades across many markets. I wouldn’t be surprised if the yen short is the largest short position in modern history. The yen bears are now running for cover – causing all kinds of havoc in the currencies and securities markets.

“Emerging” Asian markets are in the middle of an unfolding financial storm. Friday’s 2.1% gain cut the Philippine equities loss for the week to 9.2%. Even with Friday’s 4.4% recovery, the Thailand stock exchange ended the week down 3.4%. South Korea’s Kospi dropped another 1.8%.

Latin America is as well caught in troubling dynamics. Brazil’s currency (real) traded to a four-year low against the dollar this week – despite currency interventions and the removal of taxes on financial flows and currency derivatives. Brazilian equities were hit for 4.4% this week, increasing y-t-d losses to 19.1%. Mexican stocks dropped 2.4%, boosting y-t-d losses to 10.2%.

The Shanghai composite dropped 2.2% in a holiday-shortened week. China pegs its currency to the U.S. dollar, so we can’t look to the performance of the renminbi for much of an indication of flows or mounting financial market stress.

I have posited that China is in the midst of an historic Credit Bubble. I have over the years tried to explain how interrelated their Bubble is to ours. Our mismanagement of the world’s reserve currency led to 20 years of huge Current Account Deficits. A significant portion of the Trillions of associated IOU’s have made it onto the balance sheet of the People’s Bank of China, especially over recent years. And no Credit system and economy has gone to greater excess during the post-2008 global reflation. It was the “fledgling” Credit Bubble spurred to “terminal phase” excess.

If the “developing” economy Bubble has passed an important inflection point, then China is vulnerable. If “hot money” is leaving EM [emerging markets] then China should be susceptible. And, let there be no doubt, when China finally succumbs global economic prospects really dim – and prospects for some fellow EM economies turn downright dismal. Recall how the tightening of subprime finance gravitated to “Alt-A” and then worked its way to the “conventional” core. And when housing in general began to falter the bottom fell out of subprime.

This week provided a bevy of notable China-related headlines: From the Financial Times: “China Debt Auction Failure Raises Liquidity Fears;” “Fresh Data Highlight China’s Sluggish Growth.” From Bloomberg: “China Debt Sale Fails for First Time in 23 Months on Cash Crunch;” “China Local Debt Audit ‘Credit Negative,’ Moody’s Says;” “China’s Leaders Face Test of Growth Resolve After May Slowdown;” “China Export Growth Plummets Amid Fake-Shipment Crackdown.” From Reuters: “Fitch Warns on Risks from Shadow Banking in China;” “China Estimates Fake Trade Invoicing at $75 billion in Jan-April;” “China State Auditor Warns Over Local Government Debt Levels.”

The price of Chinese sovereign Credit default swap (CDS) “insurance” jumped from 92 to 113 in three sessions, before dropping back down to 98 on Friday. Chinese interbank lending rates have recently spiked higher – and there were even reports of several borrowers forced to pay up for increasingly scarce liquidity. There were debt auctions that did not go smoothly. The currency forwards market is showing some atypical downward pressure on the renminbi.

Many believe this newfound tightness in Chinese money markets can be easily resolved by liquidity injections from the People’s Bank of China. And perhaps Chinese monetary and economic managers still have things under control. If so, the same clearly cannot be said for many of their fellow “developing” policymakers. Capital flight is always extremely difficult to manage.

I worry that the world has never faced the possibility for such destabilizing flows and speculative de-leveraging. To be sure, global markets have never been as dependent upon the power of central bankers. And in my mental tallies of risk and complacency, I never envisaged they could so elevate in tandem.

So can the US stay placid when the rest of the world turns chaotic? Highly doubtful. There’s a market phenomenon in which one investment play blows up and forces those on the wrong side of the trade to dump their liquid assets to raise cash. Which causes the high-quality assets to fall as much or more than the junk. As Noland notes, the world’s premier liquid asset is the Treasury bond.

If the developing world’s need to raise cash is a factor in the recent spike in US interest rates, this implies a feedback loop in which rising US rates further destabilize emerging markets, forcing the sale of more Treasuries, and so on. Can the Fed stop this? Not unless it wants to buy up not just the newly-issued Treasuries as it does now, but the trillions of dollars of bonds that might be dumped once things really get going.

It’s important to understand that we’re here because for years the developed world in general and the US in particular have been exporting their problems to the developing world via monetary policy. We fund our overspending by creating a bunch of new dollars,  many of which flow beyond our borders looking for higher yields. They land in, say, Brazil, pushing up both local asset prices and the exchange rate of the real. So individual Brazilians see their cost of living rise while Brazilian exporters are priced out of global markets. This is the currency war that Brazil’s government has been complaining about.

Then the hot money flows back out, causing a different set of problems for a country that has spent the past decade trying to adjust to excessive capital inflows.

The result: some seriously fragile banks and over-leveraged companies and investors, any of which could trigger a nationwide crisis.

The same general process is at work in other major emerging markets, with each in its own way now posing a threat to the global financial system — at the pinnacle of which sit the S&P 500 and the Treasury market, looking an awful lot like Southern California real estate circa 2007.