(snip)"More than India, it is China that faces the threat from investors chasing too few stocks. India's markets have a much longer history and, more important, many investors still remember the stock-market scandal of the early 1990s that wiped out the nest eggs of a few thousand people. China's problem is also one of magnitude: with more than 100 million investors directly participating in the markets, the impact of any downturn will be broad, and politically suicidal. As I wrote previously, problems encountered in the government of Hong Kong after a two-thirds decline in house prices since 1997 will help to guide policy direction in mainland China.

India's central bank has practiced vigilance on asset markets for a longer time, ensuring that banks are not providing easy loans for equity investing, and also tightening the guidelines on property loans in recent months. Rate rises have also played a part in keeping the equity markets below frothy valuations, although that is entirely relative to the excesses observed elsewhere in Asia. In contrast to the market behavior in India, Chinese investors have shrugged off recent rate rises, and banks have circumvented restrictions on lending through other means.

What will happen?
China will have to choose between the lesser of two evils, namely the protection of employment in its export-dominated industries or the safety net being created by investments in property and stocks by millions of its citizens. I believe it will choose to protect people's wealth more than lower-end manufacturing jobs; therefore a sharp revaluation of the Chinese currency, the yuan, is certain in the next few weeks.

In its aftermath, the economic cognate will have to shift from production to consumption; therefore we should see the stock prices of exporters falling even as those of companies servicing domestic demand will increase. Banks will have to absorb billions of yuan in defaults from the export sector, particularly to the many inefficient state-owned companies in northern China. That will cause a sharp decline initially in their stock prices, but I expect the outlook to improve rapidly thereafter.

For the rest of Asia, a yuan revaluation would set off increased volatility as investors try to take profits and other Asian countries adjust their currency values. In turn, their holdings of US and European government bonds as part of foreign-exchange reserves would diminish, sending up bond yields globally. That is how the adjustment in China would likely set off broader stock-market declines globally as investors come to terms with both higher interest rates and lower Asian appetite for Group of Seven assets. Sharp declines in stock prices would necessarily follow in most major Asian markets.

This correction would prove cathartic to the performance of Asian economies in the decades to come, but in the short term, pain is unavoidable. "(snip)


If this expected revaluation of the Chinese Yuan does come to pass in the next few weeks, it will translate into large and nearly immediate cost increases in all Chinese made products (and components) being imported into the USA and paid for with US dollars. This will cause significant price inflation affecting all 'low end' products being sold in the USA.