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China Shock!

Stocks in this article: IBMGSGECOHYUM

(Editor's note: This article was submitted on January 22 before the China economic data were released.)

NEW YORK ( TheStreet) -- International Business Machines (IBM) came out with a shockingly disappointing earnings report, with sales in China down a whopping 23%. It blames the lack of orders from the large SOEs (state owned enterprises). According to the Wall Street Journal, that consists of a 17% drop in sales of its hardware group last quarter, and "a stunning 40% drop in Chinese hardware sales."

The Wall Street Journal reports that last quarter, sales in its "growth markets" (international) fell 9%. "IBM doesn't think business in China will improve for another quarter or two." Perhaps IBM should be planning on "a year or two."

The China bulls are very much surprised. They shouldn't be if they had been observing the China scene more closely. Two years ago, I wrote The Coming China Crisis, which was not a popular topic because China was touted as the big growth engine for the world. However, to me the current situation has similarities to 2007 when I cited all the "canaries in the mine" in the U.S. financial markets in my book of that year, Prelude to Meltdown, which predicted a global crisis in 2008. The bulls on Wall Street didn't like that book either because it shattered their bullish story for investors.

In June 2013, when China experienced a severe credit crunch and overnight interest rates soared from 7% to 25% in one day, I warned in our Wellington Letter the invisible, subsurface erosion in China's financial system was emerging. Such a credit crunch does not go away by itself. It sets off a chain of events, shutting off credit to private companies, which then accelerates into an avalanche of loan defaults.

The lack of credit creates a private-sector recession. Money printing usually helps companies with good connections to the government but it doesn't do much for the general economy.

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