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All Eyes Are on a Sinking China

NEW YORK ( TheStreet) -- The China bulls were shocked. The country's central government is tightening real estate restrictions. Yes, on March 1, China's Cabinet decided to get tough on real estate speculation to prevent another bubble from forming. It told cities with "excessively fast" price gains to:

1. Raise down-payment requirements.

2. Hike interest rates on second-home mortgages.

3. Impose a 20% capital-gains tax on real estate profits.

Some of these have already been in effect for one or two years, but municipalities were ignoring them. The new government is basically saying, "Do what we say, or else."

As a result of the announcement, the Chinese stock market had the worst daily decline in about two years. This smells like the government is taking the proverbial punch bowl away just when the party got going again. History shows that the rest of the economy usually follows real estate, either up or down.

The 20% capital-gains tax on the sale of existing homes, higher down payments and higher interest rates have been in effect for some time, but these restrictions haven't been enforced. The Cabinet made it clear that enforcement is coming. China stock markets have turned bearish.

On March 11, the Shanghai index continued its decline on disappointment over economic growth, marking the longest losing streak in three months. Loan growth remains low and growth in retail sales in the first two months of the year was the weakest since 2004.

The chart below is the SPDR S&P CHINA ETF (GXC). Note how the indicator gave a "sell" signal in late January. That was very timely.

China weakness is having a ripple effect. The Australian and Canadian dollars have fallen since mid-January. Analysts say the weakening in China will be restricted to the real estate sector. Well, that's exactly what Fed Chairman Ben Bernanke said in 2007. We know how that turned out. The fact is that condo prices in the major cities of China are rising again and in many cases even reaching new records. That forces the government to become more restrictive until finally the property market breaks again as it did in early 2012.

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