Michael Shulman

How to Play the Great China Crash

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As a short seller or put buyer, you should never get in the way of a runaway market segment, stock or ETF. That's why I want to talk to you about China today.

The country and its stock market are currently runaway trains, but they are headed for a train wreck. It's too early to say whether that will be a slow-motion or abrupt one, but be prepared to cash in when they do.

"No, no," you say, "China is the future of the world."

Sure, it's a world of poison toothpaste, the murder of plant managers announcing layoffs, the denial of medical treatment until cash is paid upfront, state-sponsored piracy of intellectual property and explicit support for the creation of a nuclear weapons capability in North Korea, all ruled by a gerontocracy using force, censorship and credit to maintain stability and therefore power.

But what does this have to do with the Chinese economy and stock market?

In the short term -- here I mean the next 18 minutes to 18 months -- it matters a lot.

I Hear the Train a Coming

In the first half of 2009, Chinese banks lent $1.1 trillion, a rate of lending four times that of the previous year (depending on how you measure this). A good deal of this money went into the Chinese stock market, commodity purchases and the building of more industrial capacity the world does not need.

When a mid-level Chinese official said lending should be pulled back to prevent a bubble, the Shanghai market sold off more than 5%. The Chinese government disavowed the statement the next day and the market rose. (Maybe that guy was shorting the market? Nope, that's illegal in China.)

My point here is that China is creating a massive bubble in real estate, the stock market and industrial capacity using state-owned banks and their credit lines -- and a day of reckoning is coming.