I write this letter to counteract some of the solutions that Western politicians are recommending for China to cope with its buildup of excess foreign-exchange reserves. Raising the renminbi’s exchange rate against the dollar will not cure the China-US payments imbalance. The dollar glut will continue, and so will the currency fluctuation among the dollar, euro and sterling, leaving no stable store of value. The cause of this instability is that each of these three currency areas has grown top-heavy with by debts in excess of the ability to pay.
What then should China should it do with its buildup of excess reserves, if not recycle its inflows into their bonds? Four possibilities have been suggested: (1) to revalue the renminbi, (2) to flood China’s economy with credit (as Japan did after the Plaza Accord of 1985), (3) to buy foreign resources and assets, and (4) to use excess dollars to buy back foreign investments in China, given US reluctance to permit Chinese investment in America’s own most promising economic sectors.
I explain below why China’s best course is to avoid accumulating further foreign exchange reserves. The most workable solution is to use its official reserves to buy back US and other foreign investments in China’s financial system and other key sectors. This policy will seem more natural as a response to an escalation of US protectionist moves to block Chinese imports or block China’s sovereign wealth funds from buying key US assets.
China’s excess reserves will impose a foreign-exchange loss (as valued in renminbi)
Every nation needs foreign currency reserves to ward off currency raids, as the Asia Crisis showed in 1997. The usual kind of raid forces currencies down. Speculators see a central bank with large foreign currency holdings, and seek to empty them out by borrowing even larger sums, selling the target currency short to drive down its price. This is the tactic that George Soros pioneered against the British pound when he broke the Bank of England.
Malaysia’s counter-tactic was not to let speculators cover their bets by buying the target currency. Its Malaysia’s success in resisting that crisis showed that currency controls prevent speculators from “cashing out” on their exchange-rate bets, blocking their attempt to…
We’ve often noted the fact that China’s equity market has served as a very reliable leading indicator over the last few years. They led the way with a dramatic market crash that started in 2007 and they bottomed several months in advance of the 2009 bottom in the S&P. We recently highlighted the bearish action in Chinese stocks while U.S. investors continued to pile into the S&P (one of three primary reasons we built short positions for the first time in 2 years prior to the recent stock collapse). Ultimately the market faltered and China’s equity market is once again looking prescient. China is displaying classic post-bubble market action. Our friends at Bondsquawk ask the important question that should be on everyone’s mind:
"Could the Chinese markets lead the rest of the world back down?"
China’s Shanghai Composite Index has led the rally in the global markets after sinking in late October 2008, almost 5 month ahead of the lows seen in the US markets. However, the rally has stalled as China’s equity markets have declined by 20.9 percent in 2010. Could the Chinese markets lead the rest of the world back down?
China’s Shanghai Composite Index 2-Year Historical Chart
After a spectacular rise last year, China’s stock market has plummeted on growing concerns about Europe’s debt crisis and expectations that Beijing is about to take strong action to slow the nation’s booming economy and prevent it from overheating, analysts say.
Investors are worried that Chinese exports to Europe will slow in the coming months and that government efforts to tame this country’s economy by tightening credit will hamper a wide array of industries, including the nation’s fast-growing real estate market.
Ran across this article posted in Jumping In Pools. Not sure how credible it is, but allegedly Barack Obama will provide the blueprints for the B-2 stealth bomber to China in exchange for $50 billion in debt relief. According to author Richard Hogarty:
According to the Administration, this proposal will help the United States resolve its debt issues. They point out their belief that the B-2 bomber is "strategically obsolete", according to a source in the White House Press Office. In addition, the source claims that the Chinese would be unable to create their own functioning stealth bomber fleet for "at least eight years."
American allies Taiwan, Japan, and South Korea are very wary of the proposal. Koo Syi, a geopolitical analyst from South Korea, points out that this technology could be passed to China’s allies. This was the case when Chinese nuclear technology was transferred to Pakistan and North Korea. According to Koo, Obama has rendered US allies’ opinions as "irrelevant."
While this proposal is controversial, it is not being presented to Congress, where it could meet with stern opposition. Instead, the State Department has been informed to assisted the Defense Department with the transfer of materials.
A little skeptical here as frankly $50 billion is less than a drop in the bucket of Chinese Treasury holdings which are easily well over $1 trillion. The economic impact of this transaction would be negligible to zero. On the other hand, if this ends up being true, it is quite frightening, as it merely demonstrates, aside from all the scary geo-political considerations, just how bad of a dealmaker our President is.
In other China-related news, Reuters reporting that Tim Geithner’s soothing words from his Beijing whirlwind tour that "Chinese assets are very safe," drew loud laughter from the audience.
"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.
His answer drew loud laughter from his student audience, reflecting scepticism in China about the wisdom of a developing country
Another global financial crisis triggered by a loss of confidence in the dollar may be inevitable unless the U.S. saves more, said Yu Yongding, a former Chinese central bank adviser.
It’s “very natural” for the world to be concerned about the U.S. government’s spending and planned record fiscal deficit, Yu said in e-mailed comments yesterday relating to a visit to Beijing by U.S. Treasury Secretary Timothy Geithner.
The Obama administration aims to reduce the fiscal deficit to “roughly” 3 percent of gross domestic product from a projected 12.9 percent this year, Geithner reaffirmed today. The treasury secretary added that China’s investments in U.S. financial assets are very safe, and that the Obama administration is committed to a strong dollar.
It may be helpful if “Geithner can show us some arithmetic,” said Yu. “We need to know how the U.S. government can achieve this objective.”
The deficit is projected to reach $1.75 trillion in the year ending Sept. 30 from last year’s $455 billion shortfall, according to the Congressional Budget Office.
The U.S. needs a higher savings rate and a smaller deficit on the current account, which is the broadest measure of trade, or “another financial crisis triggered by a dollar crisis could be inevitable,” the Chinese academic said.
Referring to the Federal Reserve “as the world’s biggest junk investor,” and to Chairman Ben S. Bernanke as “helicopter Ben,” Yu said the Fed has dropped “tons of money from the sky since the subprime crisis.”
“The balance sheet of the Federal Reserve not only has expanded like mad but is also ridden with ‘rubbish’ assets,” he said
Yu Yongding is not the only one questioning Geithner’s math. How about it Tim, can we see your scribbles?
The posse of fools in the Eccles Building is so petrified of a stock market hissy fit that it has more or less created a Wall Street doomsday machine.
After trolling on the zero bound for 89 straight months now, the FOMC falsely believes that it has levitated the U.S. economy to the cusp of full-employment via massive liquidity and wealth effects pumping.
As a consequence, it refuses to let the market have breathing room for eve...
The ECB said in the latest edition of its twice-yearly Financial Stability Review that a rise in political risk “pose[s] a challenge to fiscal and structural reform implementation and, by extension, public debt sustainability”.
Note: In response to an email, I've updated the data in this article through the March month-end numbers and at the launch of the Q1 2016 earnings season.
When I initiated the dshort web page in late 2005, one of my routine topics was equity valuations, initially inspired by Nobel laureate Robert Shiller's book, Irrational Exuberance, the second edition of which was published earlier that year. I gradually expanded my focus from his cyclically adjusted price-to-earnings ratio (CAPE) to include Ed Easterling's Crestmont P/E, Nobel laureate James Tobin's Q Ratio and m...
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Do you remember when you were growing up and all your friends were allowed Atari game consoles but you weren’t?
Well, I do and the things seemed as foreign to me as Venus. Mostly because the little time I managed to spend on the gaming consoles when my friends weren’t hogging them I found it all a bit silly. I never “got” computer games, and to this day still have poor comprehension of things like Angry Birds.
I suspect that many people around the world view Bitcoin in the same way as I view Angry Birds: with mild amusement and a general lack of understanding as to what the hell all the fuss is about.
I was thinking of this since a buddy of mine recently started ...
After a three-year bull run that more than quadrupled its value by its peak last July, IBD’s Medical-Biomed/Biotech Industry Group plunged 50% by early February, hurt by backlashes against high drug prices and mergers that seek to lower corporate taxes.
Although we try to stay focused on finding and managing promising trade ideas, the comments in the comment section sometimes take a political turn (for access, try PSW — click here!). So today, Jean Luc writes,
The GOP debate last night was just unreal – are these people running to be president of the US or to lead a college fraternity! Comparing tool size? The only guy that looks semi-sane is Kasich. The other guys are just like 3 jackals right now.
And something else – if Trump is the candidate, that little Romney speech yesterday is probably already being made into a commercial. And all these little snippets from the debate will also make some nice ads! If you are a conservative, you have to be scared now.
Phil writes back,
I was expecting them to start throwing poop at each other &n...
This is a non-trading topic, but I wanted to post it during trading hours so as many eyes can see it as possible. Feel free to contact me directly at firstname.lastname@example.org with any questions.
Last fall there was some discussion on the PSW board regarding setting up a YouCaring donation page for a PSW member, Shadowfax. Since then, we have been looking into ways to help get him additional medical services and to pay down his medical debts. After following those leads, we are ready to move ahead with the YouCaring site. (Link is posted below.) Any help you can give will be greatly appreciated; not only to help aid in his medical bill debt, but to also show what a great community this group is.
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