Bill Gross clone could be answer to China's inflation crisis

Yet China's central bank remains hamstrung by the depth of the secondary market. A more liquid market would be a vital shock-absorber in times of crisis and offer investors clues about China's outlook.

Now that vast amounts of capital can be moved across the world with just a keystroke, functioning bond markets are more important than ever. So is having a group of influential, globally known bond buyers who can help remind the government its policies are wrong, either by dumping its debt or speaking out.

If traders felt, for example, that China's stimulus efforts were too aggressive and inflation loomed, they could push yields higher. Or if they sensed deflation was afoot, they might buy debt. Either way, market rates would offer vital information for government officials and investors.

The trouble is, China's financial system is still more about transferring funds from one part of the economy to another rather than the pricing of risk, said Marshall Mays, director of Emerging Alpha Asset Management Ltd. in Hong Kong.

“As such, the levels of interest have never mattered that much,” he said.

That's fine for Indonesia or the Philippines, less so for an economy as important as China's. When it comes to the bond market, we can no longer give China a pass because of its status as a developing country.

Financial strength in 2010 involves more than having US$2.4 trillion of currency reserves. It comes from being able to borrow in the yuan and allow foreign companies to sell locally- denominated debt. Only then will China be able to let the yuan trade freely and take a crack at replacing the dollar as the reserve currency.

A stronger currency might take the pressure off China as it raises its bond-market game. Not only would it clamp down on inflation, but it would reduce frantic speculation in markets.

Bets on such a move are manifesting themselves in increased hot-money inflows that are wreaking havoc with the money supply. China could reverse the dynamic by announcing a revaluation with language that makes it clear it won't act again for a while.

China needs a multifaceted approach to slowing the economy and deflating asset bubbles. Administrative decrees to reduce credit creation aren't enough in the long run. Building a bond market with a cadre of Gross-like players in the game is more important.

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