This is an update to an article I posted a week or so ago:


 A couple of weeks ago, you may remember the report by one of our most astute readers in China who predicted with fair accuracy the panic developing in Chinese markets.  Today, we've got the old "good news - bad news" report to share.  The good first:  The  Chinese markets recovered overnight and as one report has it, a key index was up 2.6% in a big-ish 'dead cat bounce' from the previous day's 7.7% decline.

So much for the good news.  Here's the same reader's follow-on report which goes to the idea of these markets are not out of the woods by a country mile...

    "Hello,

    You may remember about a week or so ago I emailed you about your 5 W's on how the next depression will begin. You quoted my email the next day. I was happy to see you thought my humble observations on my take on China was worth sharing with your readers.

    I suggested in my email that your prediction of things beginning to hit the fan in September may be wrong, that it would start earlier than that. Well, it may be beginning already.

    Today China's markets fell aobut 8 percent. That comes on the heels of last week's drops attributed to almost overnight imposition of an increase in the "stamp tax".

    Judging from what I hear on the street here in China, those declines are likley to continue and get worse. Right now, the clever investors are bailing. They are getting out of the market ahead of the stampede to come in the next few weeks as the cognoscenti expect that when the naive first time stock investors here fully realise what is happenning there will be panic selling.

    The impetus for the market declines in China's stock markets in the past week was prompted by the increase in the so-called stamp tax. One thing Chinese people hate is paying any kind of tax. Smart investors are getting out of securities to avoid having to pay more taxes. They'll happily bank the money they have in some low yield Bank of China account earning interest of 3 percent rather than pay a few Yuan to the government. Tax avoidance is an art form in China.

    But it wasn't just the increase in the "stamp tax" increase that is responsible for the declines, but how it was implemented.

    China is a society ruled by complex obligations and responsibilities developed through quanxi or relationships and connections. The more quanxi you have, the richer and more powerful you are. You get favours mere peasants don't. Information and favours are doled out from the top down. Those at the top share what they know with people they owe favours to. It's like insider trading.

    Investors got spooked with the imposition of this tax increase because they weren't in the quanxi loop this time around. The government seemed to raise the tax without consulting the players. Usually, because of quanxi, they are given a heads up on new government policy before it is announced and implemented and can act in their best interests before it becomes known to the general public. From what I hear, the tax increase was a surprise to even the most connected investors. Their faith in the power of their quanxi was shaken. The government didn't tell them what it was going to do before it happened. They are reacting out of fear that the next move by the government to regulate markets will be done in a similar fashion and may hurt them more.

    And like sheep, the less connected investors are following the lead of the movers and shakers by selling. Soon it will be the average Zhou investors who start panicking.

    Some foreign reports like one from the Associated Press suggest: "the effect of the Chinese decline on markets abroad was expected to be limited because Beijing keeps its markets largely isolated from global financial flows. Most Chinese shares are off-limits to foreign investors and financial controls prevent most Chinese from investing abroad."

    I say hogwash!

    There are regulations in China which are easily ignored by anyone with enough money. Sure its hard for foreigners to invest here. But the Chinese investors who are selling off, probably have money invested in overseas markets too. Rules don't apply to the rich in China.

    With their RMB parked in China in those low interest bank of China accounts to avoid paying taxes on stocks, they will turn to making bad plays with their overseas stock portfolios which will start some kind of weird crap to start happening on markets in places like the Philippines, Hong Kong, Thailand, and even New York,

    I will predict you will see really big sell offs in China in one to three weeks. In about a month other markets will feel the affects.

    My Chinese friend, a financial advisor, told me today he expects things to get worse too. But he's optimistic that there will be a lot of stock bargains in a few months once the dust has settled. He's an optimist.

    Once again, keep up the good work!"

Although we should be a few weeks (and maybe longer) from the Big One for global markets (Around September 19th wouldn't surprise us, with new US all-time-highs before that) it still could result in a global rattling mess.