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About 85% of Liaoning province’s 184 financing companies defaulted on debt service payments in 2010 according to a report from the province’s Audit Office. The report also noted that 120 of these borrowers, de facto government agencies, operated at a loss last year.

Since 1994, provinces and lower-tier governments have not been permitted to issue bonds or borrow from banks. Despite the strict prohibition, their debt has skyrocketed as local officials incurred obligations through LGFVs, local government finance vehicles. The central government’s National Audit Office said these companies, at the end of last year, had taken on 10.7 trillion yuan of debt. No one, however, knows the true amount of LGFV indebtedness, and some have calculated the real amount to be more than double the official figure.

Why the disagreement as to the amount of debt? Local governments have gone out of their way to hide borrowings, perhaps in part because of their doubtful legality. As famed economic journalist Hu Shuli points out, new local officials sometimes do not know the extent of obligations left by their predecessors. There have been a number of stratagems employed, from the issuance of illegal government guarantees to the transfer of funds in roundabout routes.

The case of China Zhongwang Holdings, a giant aluminum producer, illustrates how Liaoning province effectively went into debt in a roundabout manner—and concealed the borrowing. As disclosed in a footnote in its 2009 financial statements, Zhongwang had borrowed 2.3 billion yuan from two Liaoning banks and, as reported by Naomi Rovnick of the South China Morning Post, had “given the money” to a government-owned entity. Zhongwang, based in Liaoning, kept the loan on its books but disclaimed any responsibility for repayment. Apparently, the series of money transfers among Liaoning’s government-owned entities through Zhongwang was intended to facilitate development of the local economy.

The debt problems of northeastern Liaoning may be worse than those of other provinces because it is in the heart of China’s “rust belt,” but LGFVs in other parts of the country are also beginning to experience difficulties. Yunnan Investment Group, the largest financing vehicle of southwestern Yunnan province, has just put restructuring plans on hold after China’s most widely followed rating agency warned of a downgrade in July. Most LGFVs, however, are not rated and so there is virtually no public scrutiny of their activity.

LGFVs can continue to meet existing debt obligations as long as they can borrow new funds. “If the government doesn’t tighten its policy too much, there shouldn’t be any problem,” said Tianjin Vice-Mayor Cui Jindu on Friday. “But if we end up not getting a single new loan, there could be problems.” The problems Cui was referring to, according to the official China Daily, included non-completion of projects. And if projects are not completed, there will be no sources of repayment.

The problem is that Beijing, to control inflation, is in fact putting the brakes on the money supply. The growth of M2 is the slowest it has been in six years—less than half of what it was two years ago—and central government regulators are trying to restrict new loans with periodic increases in bank reserve requirements and direct administrative measures.

As a result, China’s debt-fueled growth is slowing fast, probably faster than official GDP figures indicate. Electricity usage, perhaps the best barometer of economic activity, was essentially flat this summer on a month-to-month basis. Moreover, export and shipbuilding orders are down. The closely watched HSBC purchasing managers’ index, at its record lowest point, is close to negative territory and headed south.

Xu Lin, a senior official at the National Development and Reform Commission, says there is no need to “panic,” but there are plenty of reasons to think that China’s economy is already landing hard. And a hard landing will soon cause LGFV defaults around the country, which will roil banks. Fitch early this month put China’s local-currency debt on downgrade watch due to concerns about bank asset quality and general concerns about financial stability.

Many analysts, thinking Beijing has plenty of cash, don’t worry. Yes, it is sitting on $3.2 trillion in foreign exchange reserves, but for various reasons dollars, euros, and yen are of little use in a local-currency crisis. Of course, the central government can print more renminbi to pay off LGFV creditors, but that, by increasing the money supply, would only aggravate what is China’s most serious economic problem, inflation.

Everyone now wants to know whether Beijing will buy Greek and Italian debt to save Europe. Yet the better question to ask at the moment is this: “Can China save itself?”

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In a rare interview, one of the Street’s most influential strategists sounded the alarm about the next leg down.

And the trouble will likely start overseas, that’s according to Marc Faber, author of the “The Gloom Boom & Doom Report"

You may know Dr Faber by his moniker of "Dr. Doom", and when this man talks, markets listen. He correctly identified the tech bubble, and now he's setting his sights on China.

Specifically, Dr. Faber is concerned about the way in which Beijing’s decided to slam the brakes on growth -- via a sharp reduction in lending.

That he says, will drag down any and every company that soared higher during the recent China boom.

"I would not buy Chinese stocks here," Faber tells the Fast Money desk.

If you agree with Faber’s thesis you might want to short ACH [ACH 23.32 -0.79 (-3.28%) ] or some of the refineries in China, adds Tim Seymour.

But it's not just China-based companies that will get hit.

"I would be careful of any asset that benefited greatly from the China boom in 2009 because (their earnings) are not sustainable," he tells Fast Money.

That includes a slew of US multi-nationals.

And to make matters worse, Faber thinks as growth slows in China "we will see a lot of excess capacities," and as a result the market could be flooded with excess supply. "Industrial commodities have become quite vulnerable."

Faber expects to see the Dow and S&P “fall 20% from the January highs” in the near-term and perhaps more than that as developments unfold.

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An investment strategist at China's $300-billion (U.S.) wealth fund said the world's third-largest economy now had a say in the exchange rate of the U.S. dollar, which it expects to rise while the yen should fall further.

The comments by Peng Junming, who works in the asset allocation and strategic research department at China Investment Corp, triggered a rally in the U.S. dollar.

“I think the dollar is at its bottom now. There will be very limited space for the dollar to drop further,” he told an academic forum. “The yen is what, I think, has the worst outlook. The yen will continue to drop, unlike the dollar, which will not serve for long as a source of funding carry trades.”

The U.S. dollar rose more than half a yen close to 92.40 yen on the news, then pared gains after Mr. Peng said his speech at the Chinese Academy of Social Sciences reflected personal views. The euro slid against the dollar and gold dropped before rebounding slightly.

The market reaction to Mr. Peng's comments shows the sensitivity to clues on how China and its state fund view the markets.

“A U.S. government official recently said that the dollar is ours but the problem is China's. But China now has a voice in influencing the dollar's exchange rate and the interest rate on U.S. government debt,” Mr. Peng said.

“Although the dollar belongs to the U.S., China has a role to play in determining the dollar's exchange rate.”

No Need for Gold

Mr. Peng noted that China's stash of dollars enabled it to influence commodities markets. Commodities like oil are priced in dollars and the prices tend to move inversely to the dollar.

“We can weigh down or push up the dollar exchange rate, which will have an impact on the global commodity futures market.”

Mr. Peng was explicit in his view on gold: “China should have the right attitude about investing in gold. There is no urgent need for China to increase gold buying for now, because prices are high.”

He defended U.S. Treasury investments, arguing they had offset losses in stocks and helped swell currency reserves in 2007 and 2008.

About two-thirds of China's reserves, the largest stockpile in the world at $2.27-trillion, are estimated to be invested in dollar assets.

Lou Jiwei, CIC's chairman, has been careful not to say much about how the fund invests its money. In October 2009, he said the fund was putting more money into commodities, real estate and infrastructure to hedge against medium- and long-term inflation and a fall in big currencies.

Mansoor Mohi-uddin, currency strategist at UBS in Singapore, said sovereign wealth funds are returning to prominence after losing influence during the financial crisis.

However, private sector U.S. portfolio managers have the ultimate say on the dollar, he noted.

“The portfolios of both sovereign wealth funds and central banks globally remain dwarfed by U.S. asset managers. It is the latter, as the largest holders of dollars in the world, who will continue to determine the ultimate direction of the greenback,” he said note to clients.

Turning to interest rates, Mr. Peng, who previously worked in the New York office of the Chinese central bank, said he expected that both the United States and China would raise rates in the second half of the year.

Many in the market have assumed that China will wait for the United States to raise rates before doing so out of fear that a bigger rate differential will attract speculative capital, adding more money to the Chinese economy already awash with cash.

But Mr. Peng said that the People's Bank of China may have to move first to raise rates in order to combat asset bubbles at home. Officials have repeatedly warned that property prices are rising too rapidly, but so far have relied largely on land and tax policies to calm the market.

China Investment Corp. was set up in late 2007 with $200-billion hived off from the foreign exchange stockpile, with a mandate of seeking higher returns than the more cautious reserve management agency.

Thanks largely to investments in domestic banks, its assets under management reached $300-billion at the end of 2008.

Chinese media have reported that CIC might be in line to receive as much as $200-billion extra from the foreign currency pot.

Mr. Peng said he had heard that the government will probably give CIC more money to manage, but that the size of the capital injection was unclear.

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SHANGHAI — James S. Chanos built one of the largest fortunes on Wall Street by foreseeing the collapse of Enron and other highflying companies whose stories were too good to be true.

Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point.

As America’s pre-eminent short-seller — he bets big money that companies’ strategies will fail — Mr. Chanos’s narrative runs counter to the prevailing wisdom on China. Most economists and governments expect Chinese growth momentum to continue this year, buoyed by what remains of a $586 billion government stimulus program that began last year, meant to lift exports and consumption among Chinese consumers.

Still, betting against China will not be easy. Because foreigners are restricted from investing in stocks listed inside China, Mr. Chanos has said he is searching for other ways to make his bets, including focusing on construction- and infrastructure-related companies that sell cement, coal, steel and iron ore.

Mr. Chanos, 51, whose hedge fund, Kynikos Associates, based in New York, has $6 billion under management, is hardly the only skeptic on China. But he is certainly the most prominent and vocal.

For all his record of prescience — in addition to predicting Enron’s demise, he also spotted the looming problems of Tyco International, the Boston Market restaurant chain and, more recently, home builders and some of the world’s biggest banks — his detractors say that he knows little or nothing about China or its economy and that his bearish calls should be ignored.

“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China,” said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. “China is not in a bubble.”

Colleagues acknowledge that Mr. Chanos began studying China’s economy in earnest only last summer and sent out e-mail messages seeking expert opinion.

But he is tagging along with the bears, who see mounting evidence that China’s stimulus package and aggressive bank lending are creating artificial demand, raising the risk of a wave of nonperforming loans.

“In China, he seems to see the excesses, to the third and fourth power, that he’s been tilting against all these decades,” said Jim Grant, a longtime friend and the editor of Grant’s Interest Rate Observer, who is also bearish on China. “He homes in on the excesses of the markets and profits from them. That’s been his stock and trade.”

Mr. Chanos declined to be interviewed, citing his continuing research on China. But he has already been spreading the view that the China miracle is blinding investors to the risk that the country is producing far too much.

“The Chinese,” he warned in an interview in November with Politico.com, “are in danger of producing huge quantities of goods and products that they will be unable to sell.”

In December, he appeared on CNBC to discuss how he had already begun taking short positions, hoping to profit from a China collapse.

In recent months, a growing number of analysts, and some Chinese officials, have also warned that asset bubbles might emerge in China.

The nation’s huge stimulus program and record bank lending, estimated to have doubled last year from 2008, pumped billions of dollars into the economy, reigniting growth.

But many analysts now say that money, along with huge foreign inflows of “speculative capital,” has been funneled into the stock and real estate markets.

A result, they say, has been soaring prices and a resumption of the building boom that was under way in early 2008 — one that Mr. Chanos and others have called wasteful and overdone.

“It’s going to be a bust,” said Gordon G. Chang, whose book, “The Coming Collapse of China” (Random House), warned in 2001 of such a crash.

Friends and colleagues say Mr. Chanos is comfortable betting against the crowd — even if that crowd includes the likes of Warren E. Buffett and Wilbur L. Ross Jr., two other towering figures of the investment world.

A contrarian by nature, Mr. Chanos researches companies, pores over public filings to sift out clues to fraud and deceptive accounting, and then decides whether a stock is overvalued and ready for a fall. He has a staff of 26 in the firm’s offices in New York and London, searching for other China-related information.

“His record is impressive,” said Byron R. Wien, vice chairman of Blackstone Advisory Services. “He’s no fly-by-night charlatan. And I’m bullish on China.”

Mr. Chanos grew up in Milwaukee, one of three sons born to the owners of a chain of dry cleaners. At Yale, he was a pre-med student before switching to economics because of what he described as a passionate interest in the way markets operate.

His guiding philosophy was discovered in a book called “The Contrarian Investor,” according to an account of his life in “The Smartest Guys in the Room,” a book that chronicled Enron’s rise and downfall.

After college, he went to Wall Street, where he worked at a series of brokerage houses before starting his own firm in 1985, out of what he later said was frustration with the way Wall Street brokers promoted stocks.

At Kynikos Associates, he created a firm focused on betting on falling stock prices. His theories are summed up in testimony he gave to the House Committee on Energy and Commerce in 2002, after the Enron debacle. His firm, he said, looks for companies that appear to have overstated earnings, like Enron; were victims of a flawed business plan, like many Internet firms; or have been engaged in “outright fraud.”

That short-sellers are held in low regard by some on Wall Street, as well as Main Street, has long troubled him.

Short-sellers were blamed for intensifying market sell-offs in the fall 2008, before the practice was temporarily banned. Regulators are now trying to decide whether to restrict the practice.

Mr. Chanos often responds to critics of short-selling by pointing to the critical role they played in identifying problems at Enron, Boston Market and other “financial disasters” over the years.

“They are often the ones wearing the white hats when it comes to looking for and identifying the bad guys,” he has said.

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As you read this, the Chinese government is doing an extraordinary thing... something nearly unheard of in the modern world.

It is encouraging citizens to put at least 5% of their savings into precious metals.

The Chinese government is telling people gold and silver are good investments that will safeguard their wealth. After last year's meltdown in the stock market, people believe it. After all, Chinese citizens don't receive government retirement money... and they don't have company pension plans like people in many other countries do.

This is why folks in China are lining up outside of banks, post offices, and the new official mint stores to buy gold and silver (they especially like silver because it's cheaper per ounce).

The Chinese attitude toward gold and silver is a striking contrast to the American attitude right now. I don't recall a TV or radio ad from my congressman or President Obama encouraging me to buy gold or silver. Does your bank sell silver bars? Are gold mints popping up in your neighborhood? Are any of your friends, family, or coworkers scrambling to buy precious metals?

In spite of a few ads on television and satellite radio, buying gold and silver in the U.S. is still largely seen as a fringe-group activity. That's not the case in China. And in the big picture, there are three distinct trends occurring in China today that many in the Occidental world are not paying attention to.

more HERE

Jim Chanos, head of investment firm Kynikos Associates and famous for his call to short Enron in 2001, has found his next big target.

Chanos and other China bears say the country has overcapacity in just about every sector of its economy, and the government's massive stimulus isn't working. They think China is simply covering things up with faulty statistics.

For example, they point to the huge reported increases in car sales in contrast to numbers showing little growth in gasoline consumption, which suggests state-run companies are buying huge numbers of cars and putting them in storage.

Chanos thinks the collapse of China could be just as bad for the global markets as the U.S. housing crash.

Traders interested in playing this trend could consider shorting big names like China Life Insurance, China Mobile, and PetroChina, or buying the UltraShort FTSE/Xinhua China25 Proshares ETF (FXP).

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Politico reports that Jim Chanos is a big China Bear:

But there’s a growing group of market professionals who see a different picture altogether. These self-styled China bears take the less popular view: that the much-vaunted Chinese economic miracle is nothing but a paper dragon. In fact, they argue that the Chinese have dangerously overheated their economy, building malls, luxury stores and infrastructure for which there is almost no demand, and that the entire system is teetering toward collapse.

A Chinese collapse, of course, would have profound effects on the United States, limiting China’s ability to buy U.S. debt and provoking unknown political changes inside the Chinese regime.

The China bears could be dismissed as a bunch of cranks and grumps except for one member of the group: hedge fund investor Jim Chanos Read Story Here

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On 5:20 am EST, Thursday November 12, 2009

BEIJING (AP) -- China signaled Thursday that it's ready to allow its currency to rise just days ahead of a visit by President Barack Obama.

China's central bank said in its quarterly monetary policy report that it will improve the yuan exchange rate formation mechanism by taking into account changes in major currencies and not just the dollar.

By omitting its often-used language of keeping the yuan "basically stable at a reasonable and balanced level," the bank is suggesting a policy shift on yuan's exchange rate, analysts said. Beijing has held down its currency for more than a year.

The comments came three days ahead of Obama's visit to China. The president has said he would raise the issue of China's currency during his trip.

"The reference to changes in major currencies could signal a shift from the current de facto dollar peg to include other currencies such as the euro and yen," Alaistair Chan, an associate economist of Moody's Economy.com, said in a note.

The yuan's appreciation started in July 2005. But after rising nearly 20 percent, the currency has hovered around 6.83 to the dollar for more than a year as China took measures to protect local exporters battered by the global economic crisis.

"The yuan will certainly rise but not by a big pace. It is facing double-folded pressure," said Lu Zhengwei, a senior economist at China's Industrial Bank Co. in Shanghai.

Because the yuan is pegged to the dollar, which has weakened against other major currencies recently, Beijing faces increased pressure from other emerging economies that complain the weaker yuan means Chinese products were cutting into their share of the global marketplace.

But Lu said if China lets the yuan appreciate, it will hit exporters as business starts to pick up.

China's trade surplus in October totaled $24 billion, nearly double from September, while the slump of exports was the slowest in 10 months.

The central bank's report came after China reported improving industrial output, retail sales and trade figures for October, showing the country's economic recovery is on track.

Chinese central bank: http://www.pbc.gov.cn (in Chinese)

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