China -- Shanghai Composite

China's huge, nearly $600 bil. stimulus program focused heavily on its industrial base and on
further broadening its infrastructure and real estate development. The Gov. threw money at
these markets to avoid a deep recession in 2009 with the result that the broad money supply M-2
had jumped to a 30% yr/yr growth rate by mid-2010. This implied the development of 20%
inflation which mostly took place in the higher end residential and commercial real estate markets.
The stock market became a source of funds to feed real estate speculation. but as economic
expansion progressed, consumer inflation accelerated sharply, forcing China to tighten money and
credit to curb the faster CPI and  corral the excess real estate speculation. On a yr/yr basis, China
M-2 is now down to 12.4%, which for an economy with fast growth potential is a sensible level.

I had expected Chinese authorities to begin easing monetary policy over Half 2 '11 and the
stock market to rally as a deceleration of inflation reduced the investment return hurdle rate. China
did not begin to ease until late in 2011, and then, only slightly. There has been a bounce in a very
weak stock market, but it is hard to tell whether the bounce is simply a move in sympathy with a
global recovery of share prices or whether players are coming around to believing that China is
set to ease monetary policy further. (Naturally, the Half 2 '11 market recovery did not happen as
the market kept in a southerly direction.)

Lord knows They have the real estate developers on the run, with only middle and lower priced
residential properties getting any play from lenders. They also have monetary policy at a near
critical juncture, since further significant tightening of liquidity would not only freeze out more
real estate, but would do harm to China's output base and employment. Obviously, it would do
China little good to pump up liquidity sharply from here which could re-arouse the overbuilt
real estate sector and lead to further inflation down the road.

As many have noted, China needs badly to rebalance its economy in favor of consumption and
away from its profound over-dependence on industry and upscale property development. As well,
it needs to better control the diversity of its banking sector loan portfolios to include far more
emphasis on the development of small and mid-size business. But first, it needs to put its monetary
policy on a far more even keel.

A turn to a rather moderate monetary policy of accomodation seems needed as China passes
through 2012. Its stock market is quite reasonably priced and might benefit from a more balanced   policy which does not tilt the investment players right back to the real estate and private credit
markets.

China's presumptive new leader, Xi Jinping will be in the US next week and is expected to take
up the reins of power later this year. This development could be a risk element for the Shanghai
Composite near term as Xi might want the authorities to squeeze out more inflation pressure
before he ascends. All to be seen.

Shanghai Stocks