Posted on 01/27/2011 9:39:07 PM PST by FromLori
I’m surprised how persistently I see the dubious assertion that the Chinese “can’t move away from the dollar because they own so many of them”. A related argument is that they are “stuck in dollars because of the trade deficit”. They certainly can move away from the dollar, though, by continuing to do what they are already doing. This will bring them to a point where they will be positioned to transition away from the dollar, possibly rapidly. Here is what I mean.
Assume China has $2 trillion in total dollar reserves. By “dollar reserves” I mean mostly Treasury securities (Treasuries) and to a lesser extent Agency securities (Fannie and Freddie) and cash dollars. However, for the purposes of this discussion, they will be considered one and the same, and can just be called “Treasuries”.
At the same time many observers are closely watching the US-China trade balance, and China’s purchases of Treasuries, we know the Chinese are buying gold and every sort of natural resource they can get their hands on around the globe. Some of this is public, but probably not all (maybe not even a majority). Yet, those pointing to China’s holdings and accumulation of dollars rarely mention it.
This can be considered “cashing out” of the dollar, in a sense. As for the current level, I’d be surprised if they’ve even “cashed out” $500 billion worth of their dollar holdings–or about a quarter of the total assumed here.
So, that’s a mere minority of their total dollar holdings, China-US “status quo” trumpeters say. The impression I get is that these people think it’s basically pointless for China to be buying hard assets. Yet, this minority share of their total portfolio doesn’t imply that the Chinese are a huge support for the dollar going forward.
That’s because what they are buying — precious metals and natural resources — are inherently valuable, regardless of what happens to the dollar. That is the key part — no one is considering what happens if the dollar’s value changes radically… downward. Yet that is exactly the situation one would want to prepare for in the long term, if one expected a major global “portfolio rebalancing” away from a dominant reserve currency like the dollar.
To see why this matters, let’s imagine the Chinese reach $750 billion in hard assets, valued in today’s dollars.
Then imagine that at this point, they decide they have plenty, and are tired of propping up the dollar, so they “pull the plug” in one of a myriad of ways (probably a statement saying they will simply cease buying Treasuries would be enough, but it could also involve some outright selling in unexpected, large quantities).
A 50% fall in the dollar wouldn’t be out of the question in such event. Horrible for the Chinese, right? They hold so many dollars…
But look what happens to their “portfolio”… the $750 billion in hard assets becomes worth $1.5 trillion, and the Treasuries (while they have the same nominal value) shrink in buying power on a relative basis from $1.25 trillion to $625 billion. The overall portfolio is now nominally valued at $3.75 trillion. That sure doesn’t seem so bad for the Chinese.
Using a more meaningful comparison, imagine that gold starts out at $1000/oz, and the entire $750 billion in hard assets is in gold. Then the Chinese hoard is valued at 2 billion gold oz equivalent before the devaluation. After devaluation, it would (if purely in dollars) be valued at only 1 billion oz. But since they were wise enough to “cash out” $750 bln into gold prior to devaluation, they end up with 750 mln oz of gold + $1.25 trillion, worth 625 mln oz of gold, for 1.35 bln oz gold equivalent value.
You see where this is going. The Chinese can easily capture a large portion of the “value” of their present dollar holdings through devaluation by moving them into hard assets … arguably even if the (dollar) value of the hard assets a priori is a minority of the total portfolio.
One a deeper level, there is no realistic way to move all of the dollar portfolio into hard assets. Commodities and precious metals markets are simply too small (that even goes for currency markets… nothing comes close to the dollar paper market for depth). There is a maximum practical amount that can be “cashed out” before the dollar starts plummetting and its real value approaches zero. Put another way, it’s impossible to buy 2 billion ounces of gold with the $2 trillion in dollars we started with. China’s challenge, then is to buy as much as they can before the devaluation process gets along too far.
Given that, I think they are doing amazingly well. Most commodities are not even back to 2008 peak levels (gold and silver are a weak point, at new highs since then). But the dollar value “lost” from their holdings can be seen simply as a hidden premium to converting their stash to hard assets. In truth, they will be doing immeasurably better than any nation dumb enough to still hold primarily dollars in its Forex account when this moment comes.
I’m not claiming the Chinese are actually at the tipping point now. But it is obviously the direction in which they are going. Should this trend continue (and there is no reason to believe it will not), a point will come in the near future at which the Chinese benefit more from ditching the dollar (letting it collapse) than propping it up.
The current impact on the market is likely muted — intentionally — by the manner in which the Chinese are going about their hard assets deals. Many are taking the form of long-term contracts where dollars are pledged in exchange for resources (such as oil), as they are output. The impact of such a deal is not felt immediately on the dollar or commodity market, yet the Chinese can basically “earmark” portions of their dollar portfolio as “allocated to hard assets” every time they do such a deal. As a result, in the future, the commodity will be marginally more scarce, and the dollar marginally less desired, which suits China fine from their perspective.
Mining and agricultural deals are similar, as future supply is bought up in the present, at a fixed dollar price. Should the dollar fall, China has both secured a portion of production the commodity involved in the deal, and they don’t care a whit what the dollars are worth which they previously used to purchase the producing property.
It is also rumored that Chinese agents are going to the commodities exchanges, using their Treasuries as collateral to control commodities contracts. This indirectly secures ownership of the commodity, without having to actually sell Treasuries.
The above analysis leaves one thing unaccounted for: the value of the Yuan, and the ongoing US-China trade deficit. Should the Chinese ditch the dollar with gusto, they will need to let the Yuan float (or at least readjust its value upwards). This will remedy the US-China trade deficit, as well as quell inflation in China. Most analysts point out that China stubbornly is not revaluing the Yuan (some even argue it isn’t undervalued, a claim the Big Mac Index belies).
That is true… now. But should China be in recognition of the “tipping point” I am describing, such a point would naturally be a good one to start revaluing the Yuan. Then the infamous Chinese stubbornness against letting the Yuan rise would magically change. Perhaps that stubbornness is precisely because they are waiting for this point — the Chinese authorities are not stupid; they know the Yuan is fundamentally valued too low.
Seem unlikely? Then I will close by pointing out that virtually every major world power has announced its arrival on the global scene with a strong currency, not a weak one. And many influential Western analysts and power brokers, not to mention the Chinese, have made no secret of the fact that they expect China to truly “arrive” soon.
Perhaps, then, it is all planned out.
or we can just give China the middle finger when they try to claim their assets.
ping
Ping. There might be some interesting points in the piece re. strategy.
First of all, most of those assets are not in the USA. They are more likely to be in Africa and Asia, where minerals and oil are produced. What assets do you see in the USA, other than the Treasury debt, that China can even remotely claim?
But more importantly China is a home for many US companies. They have factories there, and those factories are producing top notch products. In case of any hiccup on the international scene all these companies will be for sure seized for debts, and probably sold to Chinese businesses. The USA will be left with no offshore industry, with no money, with no oil, and with no credits for a long, long time. The only resource that the USA will still have is its military, and the nukes. The meaning of the word "diplomacy" may radically change.
That's the chance you take when you operate in a communist oligarchy. Too bad, so sad.
This guy misses the point completely. China could dump the dollar, but it would hurt them. Not just because of their reserves, but because they can’t sell their products to the U.S. if they are too expensive.
The only resource that the USA will still have is its military, and the nukes.
And our military is likely to be cut to the bone. I fear a nuclear strike on our country.
I don’t know about that China’s new play ground seems to be Europe
China devalues US buying power by 30%, Protects US Treasury Holdings
http://www.zerohedge.com/article/china-devalues-us-buying-power-30-protects-us-treasury-holdings
The End of the Dollar
http://www.thetrumpet.com/?q=7874.0.132.0
Any nuclear strike on US which could neutralize us would result in devastation to the environment (read nuclear winter) and vulcanization (volcanoes all over the place; the planet rings like a bell). The planet only commits suicide if the insane mooslim’s are allowed to continue their present course. Sadly, it looks like the progressives have not a clue on that!
China will wait until it will hurt us far more than them. In the meantime, we wear out our materiel without replacing it in sufficient numbers to fend off swarms of low tech adversaries and our own government is working against us using our own resources, much less developing the self-sufficiency that could maintain a major war footing.
They cannot afford to play the currency game, they prefer commodities. That may be one reason Jim Rogers moved to Singapore and deals these days in commodities only.
Yitbos
Point of consideration for your thoughts,
Articles I’ve read show China is at a tenuous point regarding being able to feed its population, due to lack of fresh water for crops.
I would think if this becomes a trend, all the other resources they have become worth much less, as they become dramatically dependent on those imports to sustain life, let alone growth.
I aslo saw an article calling fresh water “blue gold”, noting that Canada holds 20% of the world’s freshwater reserve, and is moving rapidly to protect it as an export item.
All in all, it looks like a very tricky relationship.
Everyone is also ignoring their demographic time bomb.
It is too early for China to dump the dollar because the world does not have another reserve currency to replace it with. China however can take this time to develop the means to dump the dollar if the situation arises. Little reported in the press is China has set up third party accounts in Britain to make some of their US T bill buys. It hides the Chinese efforts thru other national banks. Reason for setting up this capability is if China chooses in the future to dump US dollars they do not want to alert the market and cause a panic. Thus China when she decides to dump the dollar without triggering a panic may use these third party bank accounts as the first wave of initial selling.
Before she can even dump the dollar and destroy her export markets, China needs to replace the US buyers.
Thank you. The situation makes a little more sense now.
MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES
The TIC homepage is here:
And don't forget, these guys are getting greenback interest every 6 months.
yitbos
China is taking our fresh water from the great lakes. Fresh water is the new oil and China doesn’t have enough of it.
China is taking our fresh water from the great lakes. Fresh water is the new oil and China doesn’t have enough of it.
I’d like to know more about this.
But abandoning the dollar (and by extension, the US) loses them their primary export customer and causes a cascade of recessions around the world. Of course, they can get out of the dollar if they want -- but they are not a foolish people.
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