Time to Short China? Soros Says Chinese Missed the Boat

Billionaire George Soros spoke at a conference in Oslo, Norway on Tuesday. In his speech, he remarked that there was growing evidence that the Chinese government was losing control of the economic situation in the country. Soros stated that it appeared as if wage price inflation was beginning to infect the Eastern Asian powerhouse, and that there was a "bit of a bubble." In recent months, the People's Bank of China has been working valiantly to get a lid on the inflationary pressures that have spiraled out of the control in the (apparently) overheating economy. To some extent, it appeared to be working. In April, the annual inflation rate in China declined 0.10%. The inflation rate was still over 5%, but a decline was seen as evidence that the PBC's efforts were working. Not so fast. In May, inflation rose, up to 5.5%—an increase of 0.20%, effectively wiping out any gains the bank appeared to have made in taming the inflationary beast. Food inflation has been a problem in China for quite a while. Back in November of 2009, the price of vegetables in the country rose at a rate of 62.4% in a period of ten days, according to Business Insider. Food inflation is obviously a problem, but wage inflation can be a sign of something much worse. Ken Peng, an economist at Citigroup, stated that China's inflation was largely a reflection of rapidly rising wages, according to Business Day. If an increase in wages is becoming the dominant driving force behind China's recent inflation, it could be indicative of the fact that Chinese consumers are anticipating future inflation. That would mean inflationary expectations are rising, and if that is the case, Chinese inflation could quickly spiral out of control. If economic agents anticipate inflation in the future, they might demand higher wages in the present. That would effectively create the inflation by driving the price of goods up due to the rising cost of labor to produce them. That might create an inflationary positive feedback loop, where wage increases lead to price increases, which lead to wage increases. Such a situation is inherently unstable. If China finds itself in an inflationary spiral, it might be poised for an economic meltdown. Perhaps it is already starting. Reuters reported that riots have begun in Southern China. On Tuesday, as reported by Channel News Asia, the PBC raised reserve requirements 50 basis points. Chinese commercial banks now must hold 21% of their deposits as reserves. Will it be enough? Or is the Chinese economy poised for a meltdown? Action Items Bullish: Traders who believe that the PBC will be able to stem inflation and resolve the problems facing the Chinese economy might want to consider the following trades:

• Buy WisdomTree Dreyfus Chinese Yuan Fund CYB in a play on the strength of the chinese currency. Rapid inflation might cause the currency to depreciate, but the if the Chinese are able to contain inflation, that may be bullish for the yuan.
• Buy Market Vectors China A Shares PEK in a long play on the Chinese economy.

Bearish: Traders who believe that, as Soros stated, the Chinese government was losing control over its economy may consider taking positions in the following:

• ProShares UltraShort FTSE China 25 FXP in a short play on the Chinese market. If the Chinese economy weakens, FXP may rally.
• PowerShares DB US Dollar Bullish Index UUP in a long play on the U.S. dollar. If China collapses, traders may seek a safe haven in the greenback.

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