Liquidity is plentiful in the market these days, both here and abroad, thanks to multiple rounds of QE by the Fed and their European counterparts and extremely accommodative monetary policy across the entire developed world. The US housing market is on the ropes despite all of this cheap money, in fact housing data is still setting new lows in the face of 4.75% 30-year mortgages.

Government spending has become a larger percentage of the US economy, with deficits funded by healthy demand for govys from overseas investors seeking the safety of the dollar and the full faith and credit of the US Treasury. This is not so much the case in Europe… I mean they have mastered the art of massive government spending… it’s just the ease of borrowing that they are having trouble with. This week’s spike in Greek CDS to all time high’s doesn’t improve the situation. But what about that €1 trillion bailout? I’m not sure you can throw enough money at Greece’s problem to solve the deeply entrenched entitlement issues that are plaguing the country.

Now on to something new. One of the greatest beneficiaries of liquidity over the past decade has been China. Their economy has continued to roll along with $586 billion in government stimulus, which in percentage of GDP terms dwarfed the size of the US stimulus plan. In addition to simulative fiscal policy, cheap money and loose credit fueled private spending and investment throughout the high growth period… sound familiar?

Short term rates in China have crept higher, both in government bonds and in the credit sensitive markets. A broadly used measure of credit risk in the US is the TED Spread. It compares 3-month Treasury Bills to 3-month Libor. The wider the spread the more of a premium over the risk free rate creditors require from private borrowers. The Libor equivalent in China is called Shibor. As far as I can tell there is no official Chinese equivalent for TED Spread, so invented one, I call it the SHED Spread.

The measurement is far from perfect. The main caveat is the currencies for the two rates aren’t identical. They are both Chinese, but Shibor is an internal rate, so it uses the domestic Chinese currency (Renminbi), and the bills are denominated in China’s international currency (Yuan).

What can’t be ignored is the potential for China to repeat the exact same cycle of deleveraging the Western world is still struggling with. Foreign capital is still feeling the burn from the US credit crisis, and is probably a little more sensitive to credit problems as a result. I think this measurement will be important to watch going forward.

Have a good weekend.