A friendly client reminded us recently of a statement we had made in the aftermath of China's monetary response to its 2005 yuan appreciation. In order to make sure that a potential export slowdown (which never materialised) did not derail growth, China flooded its economy with money. M2 money supply growth jumped from 14% year-on-year in early 2005 to more than 18% year-on-year in the months following the revaluation. Our comment afterwards was that “we did not foresee how willing the Chinese would be to inflate their system.”

• Central banks, led by the US Fed, begin to exit asset purchase programmes. Equity markets immediately relapse and treasuries rally.
   
• Credit spreads begin to widen in mortgage-backed securities and municipal debt. Risk aversion increases in all credit markets. Emerging-market debt sells off.
   
• Volatility in markets increases with 2009’s leading asset classes the most vulnerable. Consensus has already bet heavily on continued appreciation of commodities and emerging markets as well as a further fall in the dollar. These are correlated bets. Rising risk aversion equates to a strengthening dollar and a reversal for consensus.
   
• Problems that have been pushed to the background while cash has been abundant will re-emerge. Residential mortgage defaults will continue to rise, Fannie Mae and Freddie Mac will re-enter crisis. Commercial property defaults in the U.S. will grow to crisis proportions. Eastern Europe currency pegs will come under increased pressure and eventually break. Defaults associated with the shipping industry will increase.