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.

Usually the rest of the economy follows real estate. An intensified credit crunch would assure that. China's stock markets are reflecting those concerns.

More bad news for China from Europe. On March 21, we got the manufacturing survey numbers (PMI, or Purchasing Managers Index) for the U.S. and Europe. The U.S. is doing fine, with the PMI rising from February. But what about Europe? The PMI numbers are now below 50 in the EU, and even Germany has now dropped below 50, which is the dividing line between expansion and contraction. In other words, manufacturing is contracting in even the strongest European economy.

Why is this important? Because Europe is a big customer for Chinese goods. It means that there won't be a recovery in the important China export market. And that's bad for China and the globe.

The big question is this: Will the government be able to accomplish its goal of fueling the consumer sector to take up the slack from exports? It tried to boost consumer consumption over the past seven years. However, that portion actually declined from around 45% to 34% of GDP. That's the wrong direction. Perhaps the government will be more successful in the future. If so, it would be bullish for the world.

The hope for China is that there will eventually be a global economic recovery led by the U.S. This would fuel the most important economic sector of China: exports.

For now, investors should keep a careful eye on the charts. In our CHINA BOOM-BUST ANALYST letter, we have a more extensive analysis with a variety of charts. If you agree that China's fate is important for the globe, read more at that link.

Written by Bert Dohmen.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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