Let’s talk about China.
China is the US’s largest creditor. All told, the People’s Republic has $700+ billion in US Treasuries. However, if you account for other dollar denominated investments, China is believed to have 70% of its $1.7 trillion in foreign reserves sitting in green backs.
That’s an unbelievable amount of money invested in the US dollar. Needless to say, the Chinese are not too happy about our Central Bank’s decision to print TRILLIONS of dollars propping up the US financial system.
Indeed, the initial rumblings of what will eventually turn into outright conflict (either economic or war) have already begun. China’s Premier Wen Jiabao recently commented, "We have lent a huge amount of money to the US…Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried."
Other, former Chinese officials have been less polite in their public statements. Yu Yongding, a former Chinese central bank adviser, recently referred to the US Federal Reserve “as the world’s biggest junk investor… ridden with rubbish assets,” and to Chairman Ben Bernanke as “helicopter Ben.”
The situation has gotten intense enough that Secretary of the State Hillary Clinton flew to Asia to plead with China and other US creditor nations to continue buying US Treasuries. “By continuing to support American Treasury instruments the Chinese are recognizing our interconnection. We are truly going to rise or fall together," Clinton said at the US embassy there.
In simple terms, China owns a TON of dollar denominated assets. And the Fed is doing everything it can to devalue the dollar. Thus China has a few options:
1) Openly sell the dollar, thereby destroying the value of its reserves and inviting open war with the US.
2) Quietly shift away from the dollar without openly attracting attention or threatening the US publicly.
The Chinese government, particularly its Premier, has been floating option #1 in the media, discussing the potential for dropping the dollar standard along with Russia and Brazil.
However, this boils down to nothing more than grandstanding. The Chinese are not idiots. And they know that dropping the dollar standard would destroy a HUGE portion of their foreign reserves, since everyone and their mother would follow suit.
Indeed, abandoning the dollar for another currency (say the yen or euro) would serve no benefit from an economic standpoint. It would crush China’s Treasury denominated reserves as the dollar plunged. It would also be akin to trading one problematic investment for another: no major world currency is backed by gold or any asset of real value.
No, to my way of thinking, the Chinese are merely posturing with these statements, trying to draw attention away from the fact that they’re already begun pursuing option #2 (diversifying away from the dollar in private). Indeed, China has already begun moving into a new currency, one that is neither fiat nor flawed. And they did it in their usual manner: under the radar with great focus and determination.
That new currency is natural resources.
Throughout 2009, China has been buying up natural resources, commodities, and other real assets at a break-taking pace: copper imports hit a record 329,000 tons in February, only to be eclipsed by a new record of 375,000 tons in March.
The copper story is just the latest and most obvious display of China’s new currency binge. The Chinese have been buying up mines, metal ore (57 million tons of iron in April alone), and other resources for years now. The headlines were right under the world’s collective nose, but no one was thinking “diversification away from the dollar.” Instead they were thinking, “purchases needed to fuel economic growth.”
Truly, it wasn’t until the world noticed that China was still buying commodities in record amounts even after its economy took a hit that the media began to connect the dots.
Here’s a few dots to consider…
Feb.10, 2009: China buys Oz Minerals, the world’s second largest zinc miner for $1.7 billion
Feb. 12, 2009: China buys $20 billion worth of Rio Tinto, one of the three largest iron ore producers, giving it the potential to raise its stake to 19%.
Feb. 24. 2009: China buys 16% of Fortescue Metals an Australian iron ore company.
April 1, 2009 China buys $46 million worth of Terramin Australia’s lead and zinc supplies in Algeria.
April 15, 2009: China buy 51% of Ontario’s Liberty Mines: a nickel producer.
One should also consider that these are merely the transactions that are publicly displayed. The Chinese government has proved adept at buying assets below the radar via foreign holding companies and other complicated business structures. Informal accounts posit that China has in fact scooped up even more natural resources and mines via these methods today.
The reasoning here is simple. Unlike paper currencies, natural resources and commodities cannot be reproduced ad infinitum by central banks. Thus they are inflation proof. In addition, natural resources actually offer a direct benefit to China’s economy whereas an investment in a foreign currency (the dollar or otherwise) is merely a means of parking cash for a return.
Finally, and most notably, natural resources allow the Chinese to diversify away from the dollar without damaging their current dollar holdings: or their relationship with the US: if word got out that the Chinese were dumping Treasuries, the Treasury market would implode, destroying the value of China’s current investment.
Make no mistake, the Chinese have already begun diversifying away from the dollar. They just haven’t advertised the fact openly. Chinese students openly laughed at our Treasury Secretary Tim Geithner when he gave a talk there promising that “Chinese assets were safe” in the dollar. If Chinese STUDENTS can figure the Fed’s moves out, what do you think the Chinese GOVERNMENT is doing?
I think we both know the answer to that.
Best Regards,
Graham Summers
