How accurate have these experts been...

...regarding China or other countries and markets?

Note the appeal to authority "highly respected...from prestigious" as applied to analysts who support the author's position.

"Prudent, forward-looking Chinese officials" describing those august cabinet members selflessly directing the economic policies of China.

(The FED's) "Short-sighted policies". How gracious.

Imagine all the conditions that must occur if the author's view is realized. Secret reserves, clandestine asset grabs, a dollar crisis if China does not buy Treasuries, etc.

The author has quite a sanguine view of China'a global position. Markets disagree.


China inoculates itself against dollar collapse
By W Joseph Stroupe
This article concludes a three-part report.

PART 1: Before the stampede
PART 2: The not-so-safe haven

There is mounting evidence that China's central bank is undertaking the process of divesting itself of longer-dated US Treasuries in favor of shorter-dated ones.

There is also mounting evidence that China's increasingly energetic new campaign of capitalizing on the global crisis by making resource buys across the globe may be (1) helping its central bank to decrease exposure to the dollar, while (2) simultaneously positioning China to make much greater profit on its investment of its reserves into hard assets whose prices are now greatly beaten down, while (3) also affording it greatly increased control of strategic resources and the geopolitical clout that goes with it. This is turning out to be a win-win-win situation for China as it capitalizes upon the important opportunities afforded it by the present global crisis.

The exact size and the precise composition of China's huge forex reserves, the exact degree of China's exposure to the dollar and its viable options, if any, in decreasing that exposure are matters of intense interest, because China's policies in this regard could have gargantuan implications for the US and the global financial systems and for the dollar.

One of the foremost experts who continues to research and track these matters is the highly respected Brad W Setser, a Fellow for Geoeconomics at the prestigious Council on Foreign Relations in New York. His work is providing significantly deeper insight into the size and composition of China's reserves and is affording the world a better view of that country's options in managing its reserves going forward and what the implications of those options might be.

Another expert whose ongoing work is also adding very important, deeper insight into such matters is the highly respected Rachel Ziemba, lead analyst on China and the oil exporting economies at the prestigious RGE Monitor, founded by Nouriel Roubini.

Drawing on the work of these two experts, let's examine the matter of the likely size and composition of China's forex reserves and its investment options going forward, and the probable implications of those options for the dollar.

The first issue is to determine the actual size of China's foreign exchange reserves. Its central bank officially confirms the current figure of about US$1.95 trillion. However, Setser's work reveals that China's actual reserves are significantly higher and may actually be as high as $2.4 trillion, according to his latest figures [1]. About $2.2 trillion of this total figure is easily identifiable, according to Setser, with the remaining $200 billion being his estimate of the amount currently held in China's state banks.

As for the issue of the composition of these reserves and its total exposure to the dollar, the most recent Treasury International Capital (TIC) report by the US Treasury has China's holdings of Treasuries at $696 billion as of the end of 2008. However, Setser's research indicates China's total holdings of US Treasuries is likely to be more than that figure, since some of the purchases of Treasuries by the UK and Hong Kong should actually be attributed to China's central bank. China also holds US government-sponsored agency debt (Fannie Mae and Freddie Mac paper) and corporate bonds, but the recent TIC reports indicate its central bank has been steadily divesting itself of these assets in favor of short-dated Treasuries.

As for China's purchases of Treasuries over the most recent three months (October - December of 2008), note this statement from Setser: And over the past three months, almost all the growth in China's Treasury portfolio has come from its rapidly growing holdings of short-term bills not from purchases of longer-term notes.
Setser goes on to make the point that China's central bank is unquestionably divesting itself of the comparatively less-safe assets such as agency debt in favor of very short-dated Treasuries. The best estimates of the total exposure of China's central bank to dollar-denominated assets of all kinds is about 70%, or somewhere between $1.5 trillion and $1.7 trillion depending upon whether you use the $2.2 trillion figure or the $2.4 trillion figure for the total sum of China's reserves.

That uncomfortably high level of exposure to the dollar is what has been causing concern to flare in China most recently. A much more desirable figure, from China's standpoint, of its total exposure to the dollar would be 50% or less of its total reserves. A reserve composition of 50% dollars to 50% everything else is much safer because an excessive decline in the value of the dollar would tend to be offset by corresponding increases against the dollar in the value of the non-dollar assets comprising the rest of the reserves.

In order to get to that more desirable composition fairly quickly over the next several months, China would have to somehow divest itself of as much as $450 billion of its existing dollar-denominated assets, not purchase a significant amount of new dollar-denominated assets, and accomplish all this without triggering a global dollar panic. That's a very tall order indeed - but it is not by any means impossible. How so?

If we stand back to look at Setser's work from a distance, we see what appears to be a clear strategy on China's part that is potentially very compelling. The country has its official reserves, which it acknowledges now total about $1.95 trillion, and it also has its unofficial or secret reserves, which Setser estimates at about $450 billion at present.

Coincidentally (or perhaps not merely coincidentally) the secret reserves total about the same sum that China needs to divest itself of in order to reach the desired composition of its reserves noted in the previous paragraph - about $450 billion. At this point, recall the intriguing and potentially very important statement quoted earlier (see DOLLAR CRISIS IN THE MAKING, Part 2), a statement made by Fang Shangpu, deputy director of the State Administration of Foreign Exchange and reported by the Xinhua News Agency on February 18, 2009:
Fang Shangpu, deputy director of the State Administration of Foreign Exchange, noted Wednesday that the report released by the US Treasury of the amount of government bonds held by China included not only the investment from the reserves, but also from other financial institutions. It might be a hint that Chinese government is not holding as much US government bonds. [Italics added]

China is managing its foreign exchange reserves with a long-term and strategic view, Fang told a press briefing. "Whether China is to purchase, and to buy how much of the US government bonds will be decided according to China's need," Fang said. "We will make judgment based on the principle of ensuring safety and the value of the reserves," Fang said.
Is Fang Shangpu hinting that China has intentionally, as a deliberate strategy, divided its reserves into two general holdings, official and secret, and that SAFE (the State Administration of Foreign Exchange) has ensured that the composition of the official (government) holdings of the $1.95 trillion is such that its exposure to the dollar is not the roughly 70% assumed in the West, but rather something much closer to the desired target of 50%, while the secret reserves hold predominantly dollar-denominated assets?

If this is the case, then China could employ a number of schemes to clandestinely further reduce its total exposure to the dollar, using its secret reserves, all the while maintaining safety for the official reserves. Note Fang Shangpu's recent statement to the Wall Street Journal regarding how carefully, and with what foresight, China manages its reserve holdings:
"Since the subprime crisis evolved into the international financial crisis in September last year, we have executed the central authorities' plans to cope with the international financial crisis and launched the emergency response mechanism. We have closely followed developments, made timely adjustments to risk management, taken decisive and forward-looking measures to evaluate and remove risks ... "
Chinese officials have been painfully aware, for several years now, of the increasing risks of too great an exposure to the dollar. It simply isn't believable that their level of prudence and foresight in this regard was so low as to allow them to fail to formulate and execute strategies designed to limit that exposure to safer levels than is presently assumed in the West. But if China has indeed prudently and deliberately structured its official reserves (now totaling $1.95 trillion) to be much less exposed to the dollar than is assumed in the West, while off-loading the riskier, dollar-denominated assets into its secret reserves, how might it propose to use those secret reserves to further decrease its exposure to the dollar?

Conversion into resource reserves
Enter China's resource buys. Several Chinese experts have been saying that China needs to spend a significant portion of its dollar-denominated reserves on hard assets, thereby further reducing its exposure to the dollar. It certainly appears that China is embarking upon just such a strategy.

According to research by Rachel Ziemba of RGE Monitor, in the first two months of 2009 alone China has already confirmed such deals for hard assets worth a total of over $50 billion [2]. Clearly, China is just now opening its global strategy of pursuing such resource buys at a time when the prices of hard assets are extremely attractive and many more such buys are in the offing. This is made evident by the recent February 23, 2009 report by China Daily which stated the following:
As part of the National Energy Administration's three-year plan for the oil and gas industry, the government is considering setting up a fund to support firms in their pursuit of foreign mergers and acquisitions, the report said.

Ziemba, in response to questions e-mailed to her, also alerts us to watch for forthcoming details about the currencies employed in China's resource buys. If these deals are being transacted largely in dollars, then she notes that there will likely be no negative near-term effect upon the dollar's role as the world's reserve currency. But if they are arranged outside of the dollar, it might well serve to undermine the dollar's international role to some extent.

Obviously, with China's uncomfortably large present exposure to the dollar, it is in its interests to concentrate on converting much of the dollar-denominated portion of its secret reserves into resources reserves. In other words, China will undoubtedly spend dollars, whether directly or indirectly, to fund its resource buys. But it must do so in a largely opaque manner that leaves little, if any trace in official data such as the US Treasury's TIC report. It will also be likely to be a net buyer of Treasuries, though nowhere near its 2008 pace, or else refrain from selling significant amounts of Treasuries, while it clandestinely reduces its exposure to the dollar. Otherwise, its actions could spark a dollar panic.

It is most unlikely, therefore, that its actions in this regard will be sufficiently proved before it has already succeeded in accomplishing its goals. Furthermore, since resource prices are now very attractive, China will certainly expand and accelerate its resource buys while prices remain attractive, converting ever-larger sums of its dollar-denominated reserves into resource reserves.

If China averaged a conversion of only $35 billion per month from dollars into resources, it could convert the entire $450 billion in little more than 12 months' time. Hence, I predict that the next eight to 15 months will provide China with sufficient time to bring its total exposure to the dollar much more in line with its strategic goals.

What about the problem of dealing with any ongoing accumulation of dollars? A number of analysts note that China's trade surplus is worsening even in the global slowdown because, while China's exports are falling, its imports are falling much faster. However, Chinese officials have made clear that they will use their reserve holdings to bolster imports, and that measure should alleviate China's need to accumulate large sums of dollars and other currencies in order to keep the yuan stable.

China is extremely unlikely, therefore, to accumulate dollars at anywhere near the rate at which it did in 2008. China is also funding its domestic stimulus package designed to spur domestic consumption. All these measures denote a much wiser use of its huge reserves and a steadily decreasing focus on the dollar. All in all, China looks set to weather the storm quite well in spite of some significant hardships along the way...

...Obviously, if the US reaches the point where it fails to find sufficient buyers for its new flood of Treasuries, that will also become a perilous situation for the dollar and for the huge Treasuries bubble, which will almost certainly burst as global investors seek better stores of wealth in hard assets, following the lead of China's central bank.

Either way, the US is engaged in the implementation of extremely risky and potent inflationary, dollar-debasing policies, making a loss of global confidence in the dollar in the short to medium term a virtual certainty. Even if the massive spending does restore economic growth, the US economy is likely to remain very weak for some time. That will make it extremely difficult for the US Federal Reserve to tighten monetary policy to fight off the inevitable and potent inflation that will result from today's shortsighted policies.

When the Fed attempts to tighten, the US economy will likely be plunged into a second-round recession or depression, with obviously awful effects upon the dollar. But if the Fed fails to tighten sufficiently and quickly, runaway inflation will ravage the currency anyway.

Prudent, forward-looking Chinese officials have clearly assessed the entire situation as one demanding careful but swift action to ensure that its huge reserves are not imperiled by what has obviously become an untenable global rush into an unstable and perilous dollar bubble.

Hence, China's central bank is enacting with a sense of urgency prudent measures, both explicit and clandestine, to significantly decrease exposure to the dollar. If the details of such measures should become sufficiently public and should attract undue global attention before China accomplishes its goals, a dollar panic might be triggered.

This risk, though perhaps not major, does exist nonetheless, and it is significantly increasing as China undertakes new measures that might attract undue and unwanted global attention. However, it is also likely that China will enjoy cover and gain breathing space to enact its prudent measures while much of the rest of the world continues to rush into the bubble.

Bullseye.

Das hits the target. No link provided as I have reproduced this wonderful article in its entirety. He gets it.


China: The Future That Was?
Posted At : May 15, 2010 10:44 PM | Posted By : Satyajit Das
Related Categories: Emerging Markets
The Future That Was

China’s economic model is reminiscent of 17th century mercantilist policies. Thomas Mun, a Director of the East India Company, in England's Treasure by Foreign Trade (1664), wrote that the purpose of trade was to export more than you imported. At the same time, a country should amass foreign ‘Treasure’ that would be the basis of acquiring foreign colonies to allow control of essential natural resources. The strategy required reducing domestic consumption and imports and export of goods manufactured with imported foreign raw materials. China’s strategy coincides almost entirely with Mun’s views.

China’s mercantilist strategies have important implications for other developing countries. Chinese investment in and trade with Latin America and Africa is concentrated on securing access to resources forcing these nations to specialise in commodities. This reversion to a 19th century trend may not be compatible with Latin American and African long term development and stability.

The Chinese economic model may be unsustainable. It relies on global trade and investment (much of it export related), which together contribute a high proportion of China’s GDP. This trade entails importing foreign components that are then reassembled and then exported. Domestic consumption has been kept low. Treasure has been built up in the form of domestic savings and trade surpluses.

Recently, China announced that its $2 trillion+ treasure would be used to make foreign acquisitions to secure exclusive access to raw material. The problem is that China’s treasure is already invested in assets of dubious value and limited liquidity to finance global consumption.

Chinese Premier Wen Jiabao warned that the Chinese growth was becoming increasingly “unstable, unbalanced, uncoordinated and ultimately unsustainable”. That was two years ago! Currently, China may be aggravating the problems by massive liquidity-driven stimulus to perpetuate a failed strategy. Speaking at the meeting of the World Economic Forum in Dalian on 10 September 2009, the Chinese Premier Wen Jiabao repeated his message from two years ago without signalling any change in direction: “China’s economic rebound is unstable, unbalanced and not yet solid. We cannot and will not change the direction of our policies when the conditions aren’t appropriate.”

There is broad agreement that a key component of the GFC was the problem of global capital imbalances. A central feature was debt-funded consumption by the U.S. that allowed 5% of the global population to constitute 25% of its GDP, 15% of consumption and 48% of global current account deficit. Japan, China, Germany and the other savers funded the consumption.

Any lasting solution to the GFC requires this imbalance to be dealt with. The glib solution requires the U.S. to save more and consume less and the savers to save less and consume more. The problems in implementing the solution are considerable. Timothy Geithner’s recent discussion with Chinese officials, to assure his hosts of the safety of their investments in dollars and U.S. Treasury Bonds, reveals the dilemma.

On the one hand, America needs the Chinese to continue and increase their purchase of U.S. Government debt to finance its fiscal stimulus and bailouts. On the other hand, America needs China to cut the size of its current account surplus, boost government spending, encourage personal consumption and reduce savings. All this should also occur ideally without any major decline in the value of the dollar or U.S. Treasury bonds or the need for China to liberalise it currency and allow internationalisation of the Renminbi.

A cursory look at the respective economies also highlights the magnitude of the task. Consumption’s contribution to GDP in the U.S. is 71% while in China it is 37%. Given that the GDP of China is around $4-5 trillion versus $15 trillion for the U.S. and average income in China is around 10-15% of U.S. earnings, the difficulty of using Chinese consumption to drive the global economy becomes apparent.

During the last quarter of century, Chinese savings have risen and exports have been the engine for growth. Given that a significant portion of exports is driven ultimately by American and European buyers, lower global growth and declining consumption creates significant challenges for China.

Dealing with the global imbalance has not been a high priority in the various summits global leaders have shuttled to and from.

In March 2009 in advance of schedule G-20 meeting, the Chinese central bank proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund. In an essay posted on the Peoples’ Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, argued that creating a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”. Mr. Zhou wrote: “The outbreak of the [current] crisis and its slipover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system.”

The US predictably dismissed the proposal. The Wall Street Journal argued that: “For all its faults, the dollar is attractive as a reserve currency because it is the common language of global finance and trade. In other words, its appeal is proportionate to how many other market players use it. For decades, the dollar has been a convenient medium of exchange for everyone from a central bank seeking to buy US Treasury bonds to a business exporting commodities from Latin America to Asia.” The unstated reason was the loss of the ability to finance itself in its own currency would significantly disadvantage the US.

In July 2009, at the G8 Summit in the earthquake damaged town of L'Aquila in Italy, Dai Bingguo, Chinese state councillor, was again openly critical of the dominant role of the U.S. dollar as a global reserve currency: “We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system,”

Western leaders expressed concerns about even raising the issue fearing that discussion of long-term currency issues could undermine the nascent recovery in markets and economies. Gordon Brown, Britain's prime minister, spoke on behalf of the West: “We don't want to give the impression that big change is around the corner and the present arrangements will be destabilised.” The West it seems was heeding Deng Xiaoping’s advice to: “Keep a cool head and maintain a low profile.”

In September 2009, the Americans and Europeans proposed an effort to tackle global economic imbalances at the G20 summit in Pittsburgh. Against a background of rising trade tensions, China’s ambassador to the U.S. Zhou Wenzhong expressed scepticism about the proposals, seeking focus instead on avoiding protectionism.

Still heavily reliant on exports, China was wary of a global push on imbalances that would focus of its large trade surplus (which reached nearly 10 per cent of GDP in 2008). Zhou pointedly blamed the crisis on “the lack of supervision and abuse of the openness of the market, very risky levels of leverage and too much speculation.” He proposed improving global financial supervision, strengthen bank capital and create global early warning systems to identify threats but resisted action to address the imbalance.

Ironically, recent modest improvements in the global economy potentially risked increasing the same imbalances that were one of the factors that caused the current financial crisis. China’s and the world’s economic future requires resolving fundamental global imbalances that lie at the heart of the GFC.

Turning Japanese

China’s problems, to a degree, mirror earlier problems of Japan, its neighbour and competitor for global influence.

Japan’s export driven model successfully generated strong growth of 10% average in the 1960s, 5% in the 1970s and 4% in the 1980s. This growth was driven by a number of factors, including an artificially low exchange Yen rate.

On 22 September 1985, Japan, the U.S., the U. K., Germany and France signed the Plaza Accord agreeing to depreciate the dollar in relation to the Japanese Yen and German Deutsche Mark by intervention in currency markets. The Accord had limited success in reducing the U.S. trade deficit or helping the American economy out of recession.

The Plaza Accord signalled Japan’s emergence as an important participant in the international monetary system and global economy. The effects on the Japanese economy were disastrous.

The stronger Yen triggered a recession in Japan’s export-dependent economy. In an effort to restart the economy, Japan pursued expansionary monetary policies that led to the Japanese asset price bubble that collapsed in 1989. Economic growth fell sharply and Japan entered an extended period of lower growth and recession, generally referred to as ‘The Lost Decade’.

In the 1990s, Japan ran massive budget deficits to finance large public works programs in a largely unsuccessful attempt to stimulate growth to end the economy’s stagnation. Only structural reforms in the late 1990’s and early 2000’s restored modest rates of growth. Japan’s public debt is now approaching 200% of Japan’s GDP.

Significant shifts in economic strategy are now necessary. Chinese President Hu Jintao recently noted: “From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies.”

China can try to continue its existing economic strategy, which looks increasingly difficult. Changing its economic model is also difficult if it means a slower rate of growth. China’s challenge will be to learn from and avoid the problems and fate of Japan.

History and cultural issues compound China’s dilemma. The 1842 Treaty of Nanking entered into at the end of the first Opium War awarded Britain war reparations, eliminated the Chinese Hong monopoly, set Chinese exports and imports at a low rate, provided British access to several Chinese ports and transferred Hong Kong to the English. The humiliation of the Treaty is deeply etched into China’s dealing with the West.

China should have heeded the warning of Kang His, emperor of China, on the British presence at Canton in 1717: “There is cause for apprehension lest in centuries or millenia to come China may be endangered by collision with the nations of the West.”

The tradeoff between economic and political liberalisation may also be problematic. As Fang Li, a renowned astro-physicist often called China’s Andrei Sakharov, remarks in dissident author Ma Jian’s novel about China “Beijing Coma”: “Without a democratic political system in place, [China’s] economy will eventually flounder. The people’s wealth will be eaten up by the corrupt institutions of this one party state.”

There is an apocryphal story about a visiting world leader drawing back the current of his hotel room to be stunned by the futuristic skyline of Shanghai’s Pudong Financial District. “How long has this being going on?” He asked. Today, the question might be: “How long can this go on?”

© 2010 Satyajit Das

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives - Revised Edition (2010, FT-Prentice Hall).

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The Chinese Recovery: Stepping on A Bounding Mine
Posted At : May 9, 2010 5:11 AM | Posted By : Satyajit Das
Related Categories: Emerging Markets
Fall & Rise

In 2007, unsustainable levels of debt in many economies triggered a near collapse of the global banking system that, in turn, triggered a major slowdown in growth.

The unprecedented external demand shock, with sharp decreases in consumption and investment from synchronous deep recessions in the developed world, affected the Chinese economy. The sudden and precipitous fall in exports led to a significant slow down in China’s stellar growth rates in 2008 triggering sharp declines in stock and property markets.

Job losses in export-intensive Guangdong province were in excess of 20 million migrant workers. Workers and students entering the workforce were unable to find work. Fearful of social instability, the Beijing government moved quickly to restore rapid growth.

Panicked government spending and loose monetary policies increasing available credit is currently driving China’s recovery, contributing between 75-90% of China’s growth of 10+% in 2009. In the Great Recession, Chinese exports (around 35-40% of the economy) decreased by around 20% implying that the non-export part of the economy grew strongly.

In 2009, new loans totalled around $1.5 trillion. This compares to total loans for the full 2008 year of around $600 billion. New lending peaked at a staggering 25% of China’s GDP. Once, the budget deficit is included the Chinese economic stimulus effort was around 15% of GDP.

The availability of credit fuelled rampant speculation in stocks, property and commodities. Estimates suggest that around 20-30% of new bank lending found it way into the property and stock market, driving up values. China’s recovery, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. In parliamentary testimony, Reserve Bank of Australia Assistant Governor Philip Lowe highlighted the extent to which Australia, a major trading partner of China, was reliant on Chinese demand. Lowe noted that 23% of Australia’s total exports went to China in the most recent quarter, up from 4% 10 years ago. China now also takes 80% of Australia’s iron ore exports and 20% of coal exports.

While a significant part of the importation of commodities is restocking depleted inventory, abundant and low cost bank finance combined with a deep seated fear of the long term prospects of U.S. Treasury bonds and the dollar has encouraged speculative stockpiling artificially boosting demand.

Lock & Load

Government spending and bank loans has resulted in sharp increases in fixed asset investments (over 30% up on 2008). A major component is infrastructure spending which accounts for over 70% of the Chinese government’s stimulus package. In 2009, investment accounted of over 80% of growth, approximately double the 43% average contribution over the last 10 years.

Infrastructure investment is adding to production capacity in a world with sluggish demand and major over-capacity in many industries. In the absence of sufficient domestic demand, the production may be directed into exports increasing the global supply glut and creating deflationary pressures.

Progress on shifting the emphasis to domestic consumption has been disappointing. Government incentives, in the form of rebates for purchases of high value durables such as cars and white goods, has increased consumption in the short run (up 15% on 2008). But, over the last 25 years, Chinese consumption has declined from around 50% to its current levels of 37%.

The current expansion in lending also risks creating China’s own home grown banking crisis with a rise in non-performing bank loans. The problems of bad debts from loose lending are not new. In the 1990s, similar credit expansion led to an increase in bad debts. The big state-owned Chinese banks had to be substantially recapitalised and restructured at significant cost to the State in a series of steps that ended as recently as 2004.

Chinese bank regulators are concerned that new lending is being used to finance real estate and stock market speculation rather than productive purposes. They have moved to try to reduce speculative lending but it is likely that the central bank will resolutely maintain its moderately loose monetary policy because of uncertainties in the external and domestic environment.

On 24 August 2009, Chinese Premier Wen Jiabao was reported as saying: “China will maintain its stimulative policy stance because the economy, far from being on solid footing, is facing fresh difficulties, … Beijing would ensure a sustainable flow of credit and a ‘reasonably sufficient’ provision of liquidity to support growth… ‘We must clearly see that the foundations of the recovery are not stable, not solidified and not balanced. We cannot be blindly optimistic…Therefore, we must maintain continuity and consistency in macro economic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering.’”

The centralised control structure of the Chinese economy has allowed rapid action to be taken to avert the slowdown in growth. In July 2009, Su Ning, Vice Governor of the Chinese Central Bank People’s Bank of China observed: “… ‘the mind and action’ of all financial institutions should ‘be as one’ with the government’s goal, and financial institutions should properly handle the relationship between supporting the economy’s development and preventing financial risks.” Even if execution is not in question, the appropriateness of the policy measures and the sustainability of the recovery are unclear.

Statistical Feelings

There are also concerns that Chinese statistics are unreliable and frequently manipulated by officials to meet political and personal objectives. One unexplained and nagging discrepancy is the difference between reported growth figures and electricity consumption. It is difficult to reconcile falls in electricity consumption with continued robust economic growth.

Even China’s state-controlled media has become increasingly skeptical about the accuracy of statistics. In recent polls, a high percentage of the population doubted official data.

International commentators have become concerned about the quality of the economic data. Commenting on the time taken by China’s National Bureau of Statistics (“NBS”) to compile growth data, Derek Scissors, from the Washington-based Heritage Foundation, wryly observed: “Despite starkly limited resources and a dynamic, complex economy, the state statistical bureau again needed only 15 days to survey the economic progress of 1.3 billion people.”

In response, the NBS launched a campaign - “Statistical Feelings: We have walked together – Celebrating the 60th anniversary of the founding of New China” - to increase confidence in its work. The campaign has already produced memorable slogans and poems. “I’m proud to be a brick in the statistical building of the republic.” “I can rearrange the stars in the sky because I have statistics.”

The problems extend to financial information as generally accepted accounting principles are not generally accepted in China. Writing in the 17 August 2009 New York Times, Mark Dixon, a mergers and acquisition advisor in China, expressed surprise that revenue and cost gymnastics were not included as an official event at the Beijing Olympics.

Bounding Mines

China’s $2 trillion foreign currency reserves, a large proportion denominated in dollars, is generally cited as a sign of economic strength. It may have limited value. They cannot be liquidated or mobilised without massive losses because of their sheer size. Increasingly strident Chinese rhetoric reflects rising concern about the security of these dollar investments as the U.S. issues massive amounts of debt reducing the value of Treasury bonds and the currency.

China’s Premier Wen Jiabao has expressed concern: “If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…” In December 2008, Wang Qishan, a Chinee vice-premier, noted: “We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US.”

Yu Yindong, a former adviser to the Chinese central bank castigated the U.S. over its “reckless policies”. He asked Timothy Geithner, the U.S. Treasury Secretary to “show us some arithmetic.” At the University of Beijing, Mr. Geithner obliged indicating that the U.S. intended to reduce its budget deficit to 3% of GDP from its current level of 12% eliciting sceptical laughter from students.

China’s position is similar to that of a bank or investor with poor quality assets. China is trying to switch its reserves into real assets – commodities or resource producers where foreign countries will allow.

In the meantime, China continues to purchase more dollars and U.S. Treasury bonds to preserve the value of existing holdings in a surreal logic. On the other side, the U.S. continues to seek to preserve the status of the dollar as the sole reserve currency in order to enable the Treasury to finance America’s budget and trade deficit.

Every lender knows Keynes’ famous observation: “If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours.” Almost 40 years ago, John Connally, then the U.S. Treasury Secretary, accurately identified China’s problem: “it may be our currency, but it’s your problem.”

The Chinese used to refer to dollars affectionately as mei jin, literally “American gold”. Chinese investments may not be the real thing – merely iron pyrite, fool’s gold.

China’s position is like that of an unfortunate who has stepped on a type of anti-personnel mine, known as a ‘bounding mine’. The mine does not explode when you step on it. Instead, it trips when you step off it as a small charge propels the body of the mine into the air where the explosive charge bursts and sprays fragmentation at a height of around 3 to 4 feet (1 to 1.3 metres). China, in building and investing its massive foreign exchange reserves in dollars and U.S. Treasury Bonds, has stepped onto the mine and it cannot step off without serious damage!

© 2010 Satyajit Das

Mexico

Arizona illustrates a dangerous new trend regarding Mexico. In addition to its U.S. dollar funding needs, competition with China for U.S. market share, and its failing government, it now faces a rise in protectionism from neighboring U.S. jurisdictions.

This could not come at a worse time for a country which is gradually being phased out by China, who has realized very quickly that Mexico is an easy mark from which to gain export market share and has most likely "suggested" that U.S. policy be balanced to a more malevolent bent south of the border. This will be obvious to me if China surprises and revalues the Yuan. If China faces decreasing profits by revaluing the Yuan, they WILL attempt to make it up on VOLUME by increasing market share. There is a large volume of business literature on the subject of market share capture, and this activity is not for the faint of heart or weak of stomach. China has no choice but to engage as its entire model of social cohesion is based on export-driven mercantilism. Of the top five U.S. trading partners, Mexico is the weakest hand and China must sense this.

So Mexico is now being squeezed economically and geographically. It is losing connectivity while internal strife erodes the ability to govern. This is not good.

Mexico's exports to China are comprised mostly of building materials and services related to the construction industry. The level of export in this area will subside with the popping of the construction bubble.

More ominously, China has taken great pains to build its own construction materials enterprises and is now directly competing with Mexico. Businesses who supply China suddenly find themselves in direct competition for market share in the U.S.

And now, logistic concerns and risks will increase costs and uncertainty with the import of Mexican goods. A container from China and a container from Mexico will receive very different treatment from customs officials (on average). This unfortunately is a socialized cost to Mexico and the U.S. from the disaster of drug prohibition.

The Peso, Bonds, and select equities will see precipitous declines in the coming months.

MEXICO CITY, Apr 14, 2010 (IPS) - China has replaced Mexico as the top supplier of goods to the United States, and experts say that a specific trade strategy is needed for this Latin American country to compete successfully with Beijing in the U.S. market, the world's largest.

"What is lacking is an active trade policy to try to cut down imports of many inessential articles, and a policy to boost national exports," Arturo Ortiz, of the Institute of Economic Research at the state National Autonomous University of Mexico, told IPS.

Since 2003, China rather than Mexico has been the chief source of U.S. imports, a situation maintained by the artificially low value of China's currency, the yuan, which drives that country's exports, according to local and international analysts.

The U.S. Department of Commerce reported Tuesday that China had a trade surplus of 16.5 billion dollars with the United States in February, having sold 23.4 billion dollars' worth of goods and purchased 6.9 billion dollars' worth.

Mexico also had a positive trade balance with the United States, of 4.8 billion dollars in February, with exports worth 16.4 billion dollars and imports worth 11.6 billion dollars from its northern neighbour, according to the report.

"Mexico can regard China as a partner, and not necessarily as a competitor," Chilean economist Osvaldo Rosales, head of the Division of International Trade and Integration at the Economic Commission for Latin America and the Caribbean (ECLAC), told IPS. "There is room to sell any category of goods, but the relationship must be approached with a forward-looking vision, for the medium term."

Also on Tuesday, ECLAC published its report, "La República Popular de China y América Latina y el Caribe: hacia una relación estratégica" (The People's Republic of China and Latin America and the Caribbean: Towards a Strategic Relationship), just ahead of Chinese President Hu Jintao's trip to Brazil, Venezuela and Chile, this Wednesday to Sunday Apr. 18.

Hu visited Mexico in 2005 and Mexican President Felipe Calderón travelled to Beijing in 2008.

The report says that over the present decade, Latin America and the Caribbean have recorded an overall trade deficit with China, mainly due to the increasingly negative trade balances of Mexico and Central America with the Asian giant.

Ironic

It is somewhat ironic that the Chinese version of dialectical materialism is now fraying at the edges due to geo-political and economic concerns.

Hu Sees China Losing Its Competitive Edge
President Cites Reduced Global Demand
By Maureen Fan
Washington Post Foreign Service
Monday, December 1, 2008; A12

BEIJING, Nov. 30 -- Chinese President Hu Jintao warned at a weekend meeting of the Communist Party's elite Politburo that China is losing its competitive edge as international demand for its products is reduced, according to official state media reports Sunday.

China's growth rate has been forecast to be about 9 percent in 2008, down from 11.9 percent the year before and close to the 8 percent that economists say China must maintain in order to keep the labor market stable.

"China is under growing tension from its large population, limited resources and environment problems, and needs faster reform of its economic growth pattern to achieve sustainable development," Hu said, according to the People's Daily, the official Communist Party newspaper. He did not provide specifics.

"External demand has obviously weakened, and China's traditional competitive advantage is being gradually weakened" as international demand is reduced, Hu told members of the Political Bureau of the party's Central Committee, according to the state-run New China News Agency.

Protectionism has also started to increase in investment and trade, Hu added. China's export growth in October was 19.2 percent, down from 21.5 percent in September.

His comments came as China prepares to celebrate next month the 30-year anniversary of the opening and reform policies begun by Deng Xiaoping, who led the country from the late 1970s to the early 1990s. The anniversary has prompted both hard-liners and reformers to weigh in on the path China must now take, and Hu is striving to strike a balance.

A recent editorial in the People's Daily, for example, urged China to master information technology in order to get its message out and "safeguard the nation's ideological security." The piece, by a general named Xu Tianliang, underscored a deep debate within the party about how to commemorate the anniversary, said David Bandurski, a researcher at Hong Kong University's Journalism and Media Studies Center.

The Paper Dragon assumes a threatening posture...

...which is an empty threat. Again, the I remind the reader that selling into declining prices, when everyone else knows what you are doing, will only lead to severely declining prices on the assets that have not been sold yet, leading to massive wealth drain and a decline in the national balance sheet. Another wonderful example of attempting to cause hysteria and worry for political gain, which is something of a national sport in China.

Readers here are directed to the book "The Three Kingdoms" for more on the Chinese aptitutde for deception - its simply part of the game and represents their cultural and historical answer to Machiavelli and Richelieu.

In any case, below is the news article in all of its silly splendor. One must ask: Why would the Chinese do this now, and who profits from a perceived increase in the animosity between our nations?

China threatens to trigger US dollar crash


By Ambrose Evans-Pritchard

Last Updated: 9:23am BST 08/08/2007



The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US Treasury bonds if Washington imposes trade sanctions to force a yuan revaluation.

Two Chinese officials at leading Communist Party bodies have given interviews in recent days warning, for the first time, that Beijing may use its $1,330bn (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession.

It is estimated that China holds more than $900bn in a mix of US bonds.

Xia Bin, finance chief at China's Development Research Centre (which has cabinet rank), kicked off what appears to be government policy, with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US.

"Of course, China doesn't want any undesirable phenomenon in the global financial order," he said.

He Fan, an official at the Chinese Academy of Social Sciences, went further yesterday, letting it be known that Beijing had the power to set off a dollar collapse, if it chose to do so.

"China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US Treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency," he told China Daily. "Russia, Switzerland and several other countries have reduced their dollar holdings. China is unlikely to follow suit as long as the yuan's exchange rate is stable against the dollar.

"The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar."

The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being "held hostage to economic decisions being made in Beijing, Shanghai or Tokyo". She said foreign control over 44pc of the US national debt had left America acutely vulnerable.

Simon Derrick, currency strategist at the Bank of New York Mellon, said the comments were a message to the US Senate as Capitol Hill prepares legislation for the autumn session.

"The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the sub-prime troubles," he said.

A bill drafted by a group of US senators, and backed by the Senate Finance Committee, calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.

The yuan has appreciated 9pc against the dollar over the last two years under a crawling peg but it has failed to halt the rise of China's trade surplus, which reached $26.9bn in June.

Henry Paulson, the US Treasury secretary, said any such sanctions would undermine US authority and "could trigger a global cycle of protectionist legislation".

Capitulation.

Very close now.

March 24 (Bloomberg) -- Chinese executives are joining U.S. President Barack Obama in backing a stronger yuan, even as Premier Wen Jiabao says the currency isn’t undervalued.

Yang Yuanqing, chief executive officer of Beijing-based computer maker Lenovo Group Ltd., said appreciation would boost consumers’ purchasing power. Qin Xiao, chairman of China Merchants Bank Co., said an end to the yuan’s 20-month peg to the dollar would let lenders set market-based interest rates. Chen Daifu, chairman of Hunan Lengshuijiang Iron & Steel Group Co., said a stronger currency would cut import costs.

While the comments conflict with Wen, who said March 14 that criticizing the exchange-rate policy amounted to “protectionism,” they are in line with traders who expect the government will let the yuan appreciate later this year. U.S. lawmakers have called on Obama to use the threat of trade sanctions to force an end to a currency regime that they blame for making their nation’s manufacturers uncompetitive.

ALSO (note my emphasis as China gets a Director of Fed Ex to say "hey, it does not really mean anything to carry this label):

US likely to label China 'currency manipulator'
By Ding Qingfen (China Daily)

BEIJING - The US Treasury Department is highly likely to label China a currency manipulator in a report due out in mid-April, but the move will be "more symbolic than substantive" to win mid-term Congressional elections in the fall, former US trade representative Susan Schwab told China Daily on Tuesday.

US likely to label China 'currency manipulator'

"There is a high possibility, definitely (that China will be labeled as a manipulator), but it is very important to remember the decision is largely symbolic and does not force any actions, other than consultations," she said.

If that were the case, it will be the first time in 16 years. By declaring China a currency manipulator, the US could slap additional tariffs on imports from the country.

Some Chinese experts strongly doubt the US will do so as it will provoke Beijing and jeopardize its most important trade relationship, while others believe that even if China were declared a currency manipulator, Washington will not follow up with punitive measures.

The Paper Dragon is getting restless...

Interesting article below. It confirms my suspicions that China is in far more trouble than it is officially letting on. It is still "growing" only according to its own dubious statistics that a decreasing number of market participants believe are accurate. The incentives are there to fudge the numbers and inject whatever capital is needed into favored zombie banks...without any transparency or knowledge by the rest of the world...especially its own citizens.

"A sharpening urgency" indeed.

SHANGHAI (AP) -- The only major economy still growing at a fast clip, China is being unusually forthright in challenging the U.S.-led global order ahead of an April 2 summit on the financial crisis.

In his second rebuke of U.S. leadership this past week, the central bank governor, Zhou Xiaochuan, said China's rapid response to the downturn -- including a 4 trillion yuan ($586 billion) stimulus package -- proved the superiority of its authoritarian, one-party political system.

"Facts speak volumes, and demonstrate that compared with other major economies, the Chinese government has taken prompt, decisive and effective policy measures, demonstrating its superior system advantage when it comes to making vital policy decisions," Zhou said in remarks posted on the People's Bank of China's Web site.

In the approach to the London summit of 20 leading economies, Zhou called on foreign governments to give their finance ministers and central bankers broad authority so that they can "act boldly and expeditiously without having to go through a lengthy or even painful approval process."

China has made its agenda clear: It wants a stable U.S. dollar, and has even advocated the creation of another global currency altogether. It is leery of protectionism. And it is demanding a larger say in how financial systems are regulated and rescued, while holding back on any promises for new rescue or stimulus measures of its own.

"So far, China has been playing a game set up by other powers. Now China wants to be part of the agenda or rules-setting," said Ding Xueliang, a China expert at Hong Kong's University of Science and Technology.

Whether Beijing has a workable alternative vision for the future of world finance remains to be seen.

But China's growing assertiveness also suggests a sharpening urgency over its vulnerability to the global financial meltdown.

Fearful of any moves that might weaken the dollar and imperil China's estimated $1 trillion in Treasuries and other U.S. government debt, Chinese Premier Wen Jiabao has urged the United States to remain "a credible nation." In other words, Beijing wants Washington to avoid spurring inflation with excessive government spending on bailouts and stimulus packages.

To keep the value of its own currency steady -- some say undervalued -- the Chinese government must recycle its huge trade surpluses. The biggest, most liquid option is U.S. Treasuries. But a weakening dollar saps the value of those investments.

The Chinese "are being hurt more than anyone else by the mismanagement of the dollar," said William Overholt, an expert with Harvard University's Kennedy School of Government.

Underscoring that grievance, earlier this week Zhou, the central bank governor, called for a new global currency to end the dollar's dominance in trade, foreign reserves and commodity pricing.

Shocking.

Who would have ever predicted such a set of outcomes?

Aug 16 (Reuters) - China's long-term plan to cut reliance on investment as a growth engine is clashing with its short-term need for protection against a worsening global outlook.

Beijing has made it clear that consumption, not investment, must eventually do more of the work to drive the world's No. 2 economy.

But with debt troubles in the United States and Europe casting doubt on worldwide demand, it's likely China will keep investing by the billions for now, even if that takes Beijing further from its ultimate goal.
Chinese consumers are a long way from becoming big spenders, so massive investment is still the fastest and easiest way for China to prop up its economy if push comes to shove.

"China's investment carriage continues to race along," the China Securities Journal, an official Chinese paper, said in a front-page story on Monday. "Our investment-led growth model will not falter in the short term."

Data published on Tuesday underscored expectations that China's investment will keep growing at a healthy clip in months ahead. It showed that China pulled in $69.2 billion of foreign investment direct in the first seven months of this year, which is 19 percent above a year ago, and putting the country on track for another year of record foreign direct investment.

Without doubt, having heavy investment carries a price. Analysts say it generates waste and excess capacity, fuels inflation and produces diminishing economic returns. State investment is like an unsustainable life-support system that China needs to wean itself off.

In 2009 -- the last year for which figures are available -- investment made up 65 percent of China's gross domestic product, a far higher share than in other major or Asian economies. Household consumption, however, accounted for just 35 percent, compared with 70 percent in the United States.

UNSTABLE, UNBALANCED, UNCOORDINATED
In the words of China Premier Wen Jiabao, the Chinese growth model is on all counts unstable, unbalanced, uncoordinated and ultimately unsustainable.

Some of the more bearish economists argue that wasteful investment is inflating a property price bubble and saddling banks with bad loans, sowing the seeds of a future crisis.

A beautiful anecdote...

...about economic realities within the belly of the Paper Dragon. You simply cannot make this stuff up.

(from the FT)

Before his arrest on corruption charges, Wang Yi was not only a powerful financial official in the Communist party but also one of China’s most celebrated modern classical music composers.

But since his detention and arrest last year, Mr Wang’s magnum opus – a symphony called Ode to China – has been dropped as a repertoire staple of the China National Symphony Orchestra and his compositions derided by formerly adoring media commentators and critics.

Mr Wang is described now as someone who has trouble reading music, had no formal training and was reliant on ghost writers to produce what was once hailed by state media as “China’s answer to Mozart” and “music for rejuvenation of the nation”.

Official reports suggest that most of the millions of renminbi spent on tickets to see Mr Wang’s works came from businesspeople and officials hoping to curry favour with him.

The case is one example of the extraordinary influence senior party officials with few or no artistic credentials wield over the Chinese arts.

Critics say these factors are the main reason China, the world’s biggest exporter of manufactured goods, has produced relatively few cultural or artistic exports in recent years – despite a multibillion-dollar global campaign and regular exhortations from leaders to develop the “cultural industries” and “soft power” of the nation.

“The officials want China to be seen as a cultured, creative nation, but in this anti-liberal political society everything outside the direct control of the state is seen as a potential threat,” says Ai Weiwei, a well-known contemporary artist and a bold critic of Communist party rule.

“The people who control culture in China have no culture, and in this system art provides a hugely lucrative source of corruption.” Mr Ai notes that artistic works, because they are not officially included in the assets of officials, have become popular as bribes, and many officials have learnt to paint, write or compose music so they can sell their works to people who expect favours in return.

Because of the patronage and benefits officials can bequeath, their work is lauded as genius, unless they fall from grace, as in Mr Wang’s case. Two weeks ago a Beijing court handed him a death sentence suspended for two years, so he is likely to remain in prison for the rest of his life.

Mr Wang served first as vice-chairman of China’s securities regulator in charge of share issuance and fund management, and later as vice-governor of the powerful state-owned China Development Bank, which owns part of Barclays in the UK.

Although he had never studied music and had not heard a full symphony until eight years ago, Mr Wang decided to nurture his latent talent after a trip to Tibet, during which he was struck with an overwhelming urge to sing.

In retrospect...

...it will seem obvious to historians that this was a plutocratic oligarchy that was able to convince its populace (via censorship and propaganda) that its platonic theory of justice ("everyone know their place") just long enough to create a fully-fledged export economy and concentrate wealth almost exclusively among the ruling communist party...then things went very, very wrong...

China’s economic growth since the turn of the 21st century has been staggering. The values of some of its largest companies, both publicly-traded or solely government-controlled, are equally staggering. But according to a recent study by an independent Chinese think-tank called the Unirule Institute of Economics, China’s economic miracle may not be all its cracked up to be, at least as far as some of its largest companies are concerned.

Massive state-controlled Chinese companies like China National Petroleum Corp., or CNPC; China Petroleum and Chemical Corp. (NYSE: SNP), or Sinopec; Aluminum Corporation of China Ltd. (NYSE: ACH), or Chalco; China Mobile Ltd. (NYSE: CHL); China Telecom Corp. Ltd. (NYSE: CHA); and China United Network Communications Group Co. Ltd. are among the 10 state-owned enterprises (SOEs) that account for 70% of all net profits for SOEs for the years 2001-2008. Just two companies, Sinopec and China Mobile, account for a third of the profits

Chinese fingercuffs...

Even Geithner's gaff about currency manipulation (or even more direct accusations of mercantilist policies employed by China) cannot deflect them from reality. It is a Faustian bargain, only we have their tangible goods and they have paper which ostensibly grants them the right to purchase our real goods at price levels we set in the future.

Of course they will buy our bonds...and the only function for all this "helping the U.S. out by buying their bonds" talk is to garner political points from the CPC, which is, or is very shortly to be, scrambling to hold its power.

China to heed Clinton's call on buying US bonds: economists
1 hour ago
SHANGHAI (AFP) — China has little choice but to follow Hillary Clinton's call and continue buying US Treasuries, as reversing course would lead to the value of its investments plunging, economists said Monday.

While in Beijing on her first overseas trip as US secretary of state, Clinton urged China on Sunday to keep buying US debt, saying it would help jumpstart the flagging US economy and stimulate demand for Chinese exports.

In fact, China has to keep investing in the United States if it wants to protect the value of its trillions in dollar holdings, said Lu Feng, an economist at Peking University's China Center for Economic Research.

"China is sitting on huge piles of foreign exchange and it will increase its holdings of US Treasuries," Lu said. "Objectively speaking, helping the US economy is good for both China and the US."

China overtook Japan last year as the United States' biggest foreign creditor, and had 696.2 billion dollars of Treasury Bills in December, according to the latest official data from Washington.

Its world-largest foreign exchange reserves, which stood at 1.95 trillion dollars as of the end of December, also mean it is the world's biggest foreign holder of the US currency.

Clinton sought to highlight the importance of the ever-building inter-dependency between the world's biggest and third biggest economies.

China as America's "Banker"

This myth should not be allowed to propagate. Unfortunately, by definition, simple messages are the most likely to flourish and reach the greatest proportion of the populace. We humans have mastered compartmentalization and categorization.

A friend sent me the following nonsense:

Why would the Chinese be so interested in our deficit? Well, for all intents and purposes, China is the official banker of the United States government. China is the number one foreign holder of U.S. Treasury securities.
And, as the Times reports, “like any banker, they wanted evidence that the United States had a plan to pay them back.”
Somehow, I doubt the President had any such evidence to give them in Beijing this week.
The Chinese are nothing if not clever. One investment banker told me that they had converted all of their debt from 30-year maturity to one year. The hard questions they are asking right now are about how much the health care bill will raise the deficit. And make no mistake, if the Chinese decide not to continue financing our debt, the dollar could drop through the floor. America could have a huge financial crisis.
Isn’t it ironic that the communist Chinese are more concerned about the cost of socialized medicine than the President and the Congress? That the Chinese communists are more concerned about the U.S. government printing money like it’s going out of style than we are?
If that isn’t a wake-up call to the politicians, the media, and to the American public, I don’t know what it’s going to take.

to which I replied:

I completely disagree with the assumptions of this article, although I tend to agree with its conclusion (that Health Care "reform" should never be passed)

First, some theory:

China cannot, will not, "call in" the "debt" of the U.S. If they did so, it would require an immediate and massive appreciation of theYuan vs. the U.S. dollar, effectively destroying the Chinese economy as its export-driven model shrinks to zero.

China is not "the bank" of the U.S. All of the paper they own is denominated in U.S. dollars. We don't NEED to "get" any money from anyone. Their holding reflect their DESIRE to hold safe assets in a safe jurisdiction. The important point is not this histrionic talk of China being able to destroy the U.S. economically, rather, its WHY ARE THEY CHOOSING TO HOLD SO MUCH OF THEIR WEALTH IN ASSETS DENOMINATED IN DOLLARS. My view on this is that their banking system is insolvent, and should the rest of their economy implode, it would require massive bail-outs by the IMF and other multi-lateral organizations. They are not saving for a rainy day. They know the rainy day is coming and are preparing accordingly.

Now, some facts:

China did not convert all their duration from long to short term.

The major foreign holders of U.S. securities can be found here. You will note that Japan holds nearly as much as China, but no-one talks incessently about how they are our "bankers".

I also note here that China has certainly not lost its appetite for U.S. dollar denominated securities. They bought 12.5 Billion of LONG TERM securities (duration 10+ years) against 4 Billion in Short-term securities ( >1year duration) in SEPTEMBER ALONE. Does this sound like they have now "converted" all their debt?

Now, I don't discount the possibility they have entered into derivative contracts to sythetically convert their bond duration to one year, but this is HIGHLY, HIGHLY, unlikely as only 1-2 banks in the world could handle such a transaction, and we would have seen U.S. long-term yields move substantially as that bank would have to hedge their own risk. Instead, the 30 year sits implacably below 3.5%.

Far more likely that the "banker" this guy spoke with did not know what he was talking about.

Foreign Policy

Comparing the Chinese to the Soviet Union has always been interesting, but the method they use to project power are very different.

Foreign Policy has gone down hill in recent years as a heavyweight, but then most publications have gone down similar paths.

This much chatter regarding China leaves me convinced that difficult times are imminent for the Paper Dragon. These issues were known in detail 5 years ago by, among others, the U.S Navy.

Undoubtedly, Chinese war planners see a future in which China will be able to defend itself offshore and its navy will operate beyond what is sometimes referred to as the "first island chain" (an imaginary line stretching from Japan, through Okinawa and Taiwan, and south to the Philippines and the South China Sea), eventually encompassing much of the Western Pacific up to the "second island chain" that runs from Japan southward past Guam to Australia. But whether Beijing envisions one day establishing overseas bases, or simply having the capability to project power globally when needed, is unclear.

Some wonder whether China and the United States are on a collision course. Kaplan raised the ominous possibility in the Atlantic that when the Chinese navy does push out into the Pacific, "it will very quickly encounter a U.S. Navy and Air Force unwilling to budge from the coastal shelf of the Asian mainland," resulting in a "replay of the decades-long Cold War, with a center of gravity not in the heart of Europe but, rather, among Pacific atolls." Unquestionably, there is deep strategic mistrust between the two countries. China's rapid economic growth, steady military modernization, and relentless nationalistic propaganda at home are shaping Chinese public expectations and limiting possibilities for compromise with other powers.

This does not make conflict inevitable, but it is cause for long-term concern and will shape U.S. efforts to avoid hostilities with China. Military-to-military contacts lag far behind the rest of the U.S.-China relationship. Taiwan is an obvious point of disagreement and the one place where the two powers could conceivably come into direct conflict. U.S. maritime surveillance activities inside China's exclusive economic zone are another contentious point. There is, however, a growing recognition that the United States and China should engage one another and seek to avoid a conflict that would almost certainly be destructive to both sides.

The Red Giant

In stellar evolution, a Red Dwarf is a late stage star that has exhausted its supply of hydrogen in its core and has begun to fuse hydrogen (and anything else) outside the core...in effect a desperate attempt to prevent its demise. Unfortunately fusion will eventually become impossible, and without the ability to switch to other means of energy creation, the star will die.

Looking to the east we see a very large Red Giant in the form of China. It has risen to prosperity via exports. The point has passed where China should have focused on domestic demand, and instead has focused on even more export activity...even in the face of a significant financial crisis. Like the stellar Red Giant, China is dependent on one source of energy.

Thus, I would want U.S. Commerce Secretary Locke to focus on repatriating U.S. assets before its too late. The Gravity of History is going to have predictable effects on this Red Giant.


WASHINGTON, May 4 (Reuters) - U.S. Commerce Secretary Gary Locke accused Beijing on Wednesday of discouraging foreign investment to protect its own companies and promised to push against those barriers if confirmed as the next ambassador to China.

Locke, in the text of a speech for delivery at the Woodrow Wilson Center, said the United States saw Chinese investment as a "good thing" for American business and workers and only blocked it in a few cases for national security concerns.

"Unfortunately, that is not the case for American companies operating in China, where they are frequently shut out of entire industries, or they are forced to give up propriety information as a condition of operating in China," Locke said.

"This imbalance of opportunity is a major barrier to continued improvement of the United States and China's commercial relationship. And it is part of a broader trend of China recently narrowing its commercial environment after a long and fruitful period of opening."

Waking up next to the Paper Dragon...

...mainstream media is quickly "getting it". Original article here.

By Ambrose Evans-Pritchard
Published: 5:38PM BST 28 Jun 2009

China's banks are veering out of control. The half-reformed economy of
the People's Republic cannot absorb the $1,000bn (£600bn) blitz of new
lending issued since December.

Money is leaking instead into Shanghai's stock casino, or being used
to keep bankrupt builders on life support. It is doing very little to
help lift the world economy out of slump.

Fitch Ratings has been warning for some time that China's lenders are
wading into dangerous waters, but its latest report is even grimmer
than bears had suspected.

"With much of the world immersed in crisis, China appears to be one of
the few countries where the financial system continues to function
largely without a glitch, but Fitch is growing increasingly wary," it
said.

"Future losses on stimulus could turn out to be larger than expected,
and it is unclear what share the central and/or local governments
ultimately will be willing or able to bear."

Note the phrase "able to bear". Fitch's "macro-prudential risk"
indicator for China threatens to jump from category 1 (safe) to
category 3 (Iceland, et al). This is a surprise to me but Michael
Pettis from Beijing University says China's public debt may be as high
as 50pc-70pc of GDP when "correctly counted".

The regime is so hellbent on meeting its growth target of 8pc that it
has given banks an implicit guarantee for what Fitch calls a "massive
lending spree".

Bank exposure to corporate debt has reached $4,200bn. It is rising at
a 30pc rate, even as profits contract at a 35pc rate.

Fitch traces the 2009 bubble to the central bank's decision to cut
interest on reserves to 0.72pc. Bankers responded to this "margin
squeeze" by ramping up the volume of lending instead. Over half the
new debt is short-term. Roll-over risk is rocketing. China's monetary
stimulus since November is arguably more extreme than the post-Lehman
printing of the US Federal Reserve, though less obvious to the
untrained eye.

Under the Taylor Rule, US policy remains tight (for the US). China's
policy is loose (for China). New loans doubled in May from a year
earlier, almost entirely to companies.

Roach...

Gets many things right in this article.  Like this observation:

China’s seemingly open-ended purchases of US government debt are at the heart of a web of codependency that binds the two economies. China does not buy Treasuries out of benevolence, or because it looks to America as a shining example of wealth and prosperity. It certainly is not attracted by the return and seemingly riskless security of US government paper – both of which are much in play in an era of zero interest rates and mounting concerns about default. Nor is sympathy at work; China does not buy Treasuries because it wants to temper the pain of America’s fiscal brinkmanship.

China buys Treasuries because they suit its currency policy and the export-led growth that it has relied on over the past 33 years. As a surplus saver, China has run large current-account surpluses since 1994, accumulating a massive portfolio of foreign-exchange reserves that now stands at almost $3.7 trillion.

But then borks up the conclusion:

With rebalancing will come a decline in China’s surplus saving, much slower accumulation of foreign-exchange reserves, and a concomitant reduction in its seemingly voracious demand for dollar-denominated assets. Curtailing purchases of US Treasuries is a perfectly logical outgrowth of this process. Long dependent on China to finesse its fiscal problems, America may now have to pay a much steeper price to secure external capital.

The U.S. does not need to "secure external capital" from anyone, and it certainly does not need China to "finesse" its fiscal problems.  Its all about the pricing, gentlemen, and given the U.S.'s strategy of market control via military dominance (like being the prime mover in Africa,  etc.), the U.S. has the initiative once again.

Strange analogy of the week...

The U.S. and China are locked in an "unhealthy embrace"...

April 1 (Bloomberg) -- Presidents Barack Obama and Hu Jintao meet for the first time today to discuss a global economic crisis each is trying to combat with policies that may further complicate U.S.-China relations.

As they meet ahead of a gathering in London with other leaders from the Group of 20 advanced and emerging economies, the two presidents are directing a combined $1.4 trillion of stimulus spending.

While their efforts will soften the impact of the global recession, analysts say U.S. spending to stimulate demand and China’s focus on investment in public works are likely to exacerbate the global imbalances that inflated asset bubbles and brought on the collapse of credit that helped trigger the current crisis.

The two countries remain locked in “an unhealthy embrace,” said Charles Freeman, a U.S. trade negotiator who is now at the Center for Strategic and International Studies in Washington. “How we ease that embrace so we can stay embraced but not choke ourselves to death in the process is going to be a serious thing that we deal with in the next decade.”

Obama’s $787 billion stimulus package runs up budget deficits to be financed by more Chinese purchases of U.S. debt. Such a prospect leaves Chinese Premier Wen Jiabao “worried” about the safety of China’s $740 billion holdings of U.S. Treasury securities, the world’s largest, he said March 13.

China’s Stimulus

Meanwhile, Hu’s 4 trillion yuan ($585.4 billion) stimulus plan doesn’t help build the domestic consumer demand that China needs to support its own industries and reduce its reliance on exports, says Ha Jiming, chief economist at China International Capital Corp. in Beijing.

The plan will “delay a rebalancing toward greater consumption-driven growth because about 75 percent of its spending is for infrastructure,” Ha says.

Unless the two countries break a cycle that requires China to continue lending so the U.S. can keep spending, “we’re headed to another major crisis, and it could be worse than this one,” Stephen Roach, Morgan Stanley’s Asia chairman in Hong Kong, said in an interview.

Obama administration officials say that, with the global economy forecast to shrink in 2009 for the first time in more than 60 years, this isn’t the time to address such issues.

"Control"...

...is a brittle, somewhat fictive thing when it concerns national interests.

The cycle of life continues...just as Cuba has been ruined by totalitarian rule via "freedome fighters", so to has China's idustrial output been appropriated by "communists".

Labels are useless when analyzing these societies. It is a simple matter of power and the means of production. It is a strange truth that China is much closer to the Bourgeoisie/proletariat dichotomy than the U.S., so I guess they follow their philsophical master in at least one respect...

from a Foreign Affairs article outlining some of the "challenges" the Paper Dragon faces:

Increased misappropriation of land, rising income inequality, and corruption are among the most contentious issues for Chinese society. China’s State Development Research Center estimates that from 1996 to 2006, officials and their business cronies illegally seized more than 4,000 square miles of land per year. In that time, 80 million peasants lost their homes. Yu Jianrong, a senior government researcher, has said that land issues represent one of the most serious political crises the CCP faces.
From 1996 to 2006, Chinese officials and their business cronies illegally seized more than 4,000 square miles of land per year. In that time, 80 million peasants lost their home.

China’s wealth gaps have also grown; according to Chinese media, the country’s GINI coefficient, a measure of income inequality, has risen to about 0.47. This level rivals those seen in Latin America, one of the most unequal regions in the world. The reality may be even worse than the data suggest. Wang Xiaolu, the deputy director of the National Economic Research Institute at the China Reform Foundation, estimates that every year about $1.3 trillion in income -- equivalent to 30 percent of China’s GDP -- goes unreported. More than 60 percent of the hidden income belongs to the wealthiest ten percent of China’s population, mostly CCP members and their families. The use of political power to secure inordinate wealth is a source of considerable resentment, and the wealthy are keenly aware of it. They now employ more than two million bodyguards, and the private security industry has grown into a $1.2 billion enterprise since it was established in 2002.

Relative value

Recall the excessive (read: tulip-mania levels of reality bending) prices Japanese investors were willing to pay for U.S. real estate during its boom years. Note how the story for gold demand is revolving around several narratives, whilst never seriously discussing the possibility of a collapse like every other commodity market whose values have appreciated by 100% or more. Name ONE, dear reader, that has achieved this type of price sustainability since 1972, in real or nominal currency.

There is none.

(From the WSJ)
Chinese investors are snapping up gold bars and coins, buying more than ever before in the first quarter of 2011 and overtaking Indian buyers as the world's biggest purchasers of the metal.

China's investment demand for gold more than doubled to 90.9 metric tons in the first three months of the year, outpacing India's modest rise to 85.6 tons, the World Gold Council said in its quarterly report on Thursday. China now accounts for 25% of gold investment demand, compared with India's 23%.

The report underscores the rising appetite for gold among the growing middle-class in China. Fears of the country's soaring inflation, as well as a search for new investments, is luring investors to gold, and marketing of the precious metal has also increased in recent months.

"I think people will be surprised by the strength in the Chinese demand, but we think this is a trend that is set to continue," said Eily Ong, an investment research manager at the gold council.

[More from WSJ.com: LinkedIn IPO Soars, Feeding Web Boom]

Historically, India has been the largest investment market for gold. In 2007, just before investing in gold began to take off globally, India's physical gold demand accounted for 61% of the world's total. China's was 9%. In terms of total consumer demand, which also included jewelry, India is still a bigger consumer of gold than China, taking in 291.8 tons in the first quarter, compared with China's 233.8 tons.

Still, the voracious appetite shown by Chinese buyers prompted the gold council to increase its forecast for the nation's demand.

"In March 2010, we predicted that gold demand in China would double by 2020; however, we believe that this doubling may in fact be achieved sooner," said Albert Cheng, the World Gold Council 's managing director for the Far East. "Increasing prosperity in the world's most populous country coupled with their high affinity for gold will serve to drive demand in the long term."

The Paper Dragon redux...

Markets are, as evidenced by the recent peformance of the Hang Seng, finally waking up to the Macro prospects for China in light of a depreciating dollar against a Yuan that the PRC will not allow to
appreciate. Something has to give, and it will. As I have said many times, China (which I have pejoratively called "The Paper Dragon") is in deep trouble. If it allows the Yuan to appreciate, its export industry will be "adversely effected". If it does not, rampant money creation (read: inflation) is the result.

Now, academics (in China, no less) are waking up to the facts of life as well. China will now face an immense challenge to its legal rule set as the temptation to keep politically connected (yet functionally bankrupt) businesses afloat...which is the "objective necessity" (to borrow from the incomprehensible Marxist lexicon) of central planning. Ruling with an Iron Hand on a sliding scale indeed.

Link: http://piaohaoreport.sampasite.com/default.htm

excerpt:

Not all of my readers will agree that large Chinese banks are basically insolvent, but I am very skeptical that the published figures correctly state the extent of bad loans. They almost certainly understate the extent of expected bad loans associated with the surge in new lending over the past three years.

The option framework predicts that in such a case investor perceptions of the quality of management or of levels of non-performing loans will have little to no impact on the share price performance of Chinese banks. Instead share prices will primarily reflect investor perceptions of changes in China’s underlying economic volatility. China’s banks are expensive, in other words, not because they are in good shape, but rather because there is so much future uncertainty about the Chinese economy, and it is increases in that uncertainty, not improvements in the quality of the banks, that are most likely to drive prices up.

This has happened in many countries undergoing reform besides China. For example when Mexico’s 18 banks were privatized in 1991-92 as part of the massive economic and political reforms the country was undergoing (I was part of the team at credit Suisse First Boston that advised the government on the privatization), their purchase prices far exceeded even the most optimistic estimates provided by the advisors, the government, and the banking industry, which were largely based on discounting expected earnings.