A very interesting article on alt-market asks a question I have been contemplating these past few weeks. In my view, America’s economic health is totally dependent upon two things: the flow of dollars to the middle east in exchange for oil, and the flow of dollars to China for consumer goods. Any disruption to either or both of these flows would result in sustained and significant disruption to America’s economy. That’s why America — absent of any real plan to move its energy generation, and its supply chains back to America — spends so much money policing the world.
So, that brings us onto the question: What would happen if China liquidated its dollar and bond holdings and moved its wealth into harder assets? And is China on the verge of doing just that?
From alt-market:
There are two mainstream market assumptions that, in my mind, prevail over all others. The continuing function of the Dow, the sustained flow of capital into and out of the banking sector, and the full force spending of the federal government are ALL entirely dependent on the lifespan of these dual illusions; one, that the U.S. Dollar is a legitimate safe haven investment and will remain so indefinitely, and two, that China, like many other developing nations, will continue to prop up the strength of the dollar indefinitely because it is “in their best interest”. In the dimly lit bowels of Wall Street such ideas are so entrenched and pervasive, to question their validity is almost sacrilegious. Only after the recent S&P downgrade of America’s AAA credit rating did the impossible become thinkable to some MSM analysts, though a considerable portion of the day-trading herd continue to roll onward, while the time bomb strapped to the ass end of their financial house is ticking away.
The debate over the health and longevity of the dollar comes down to one very simple and undeniable root pillar of economics; supply and demand. The supply of dollars throughout the financial systems of numerous countries is undoubtedly overwhelming. In fact, the private Federal Reserve has been quite careful in maintaining a veil of secrecy over the full extent of dollar saturation in foreign markets in order to hide the sheer volume of greenback devaluation and inflation they have created. If for some reason the reserves of dollars held overseas by investors and creditors were to come flooding back into the U.S., we would see a hyperinflationary spiral more destructive than any in recorded history. As the supply of dollars around the globe increases exponentially, so too must foreign demand, otherwise, the debt machine short-circuits, and newly impoverished Americans will be using Ben Franklins for sod in their adobe huts. As I will show, demand for dollars is not increasing to match supply, but is indeed stalled, ready to crumble.
We know from insiders in the Chinese government that China are looking at “liquidating more of our holdings of Treasuries once the US Treasury market stabilizes”, and “buying stakes in Boeing, Intel, and Apple and these types of companies… in a proactive way”, and of course gold. But does that mean China will be liquidating as soon as possible? After all Bernanke won’t stop printing, the dollar won’t stop being devalued, and America won’t stop burning through its productive capital on military spending.
I don’t believe they will. Wen Jiabao’s subtle and supportive public remarks during Joe Biden’s recent visit suggests that China wants a controlled and managed transition away from the dollar as the global reserve currency. Withdrawing support for the dollar right now would send China’s remaining dollar pile crashing into the earth.
From the Council on Foreign Relations:
China has accumulated a massive stock of U.S. dollar reserves in recent years. Statements of concern from China regarding the risk that U.S. economic policy might undermine the future purchasing power of these assets has fuelled the market’s concern that China may shift away from dollar purchases. Yet in the 12 months ending in July 2009 China accumulated more dollar-denominated assets, mainly U.S. Treasuries, than foreign assets in total. Despite its rhetoric, China has thus far taken no actions to wean itself off of the dollar.
And as I have noted numerous times, China has no interest in upsetting the global balance — under the current circumstances it is very rapidly strengthening, whilst America falters. And why change something that is working for China?
So when will China pull the plug? There are a few relevant pictures to watch:
- China’s gold reserves: currently at 1,000 tonnes, these would have to go significantly higher.
- China’s acquisitions of American industry: this would signify Chinese dollar-outflows.
- China’s holdings of U.S. debt: if Bernanke keeps printing, these would have to remain stable, or more likely tip-toe lower.
- Flotation of the yuan: if China wishes to curb domestic inflationary pressures, they will float the yuan on global markets. A successful yuan flotation would cut the relative value of China’s dollar holdings, lessening the incentive to hang onto U.S.-denominated assets
I expect all of these developments to take place over years, not months. And, in my view, the greatest threat to the dollar’s status as global reserve currency is a global oil shock, triggered by a new middle eastern war, or some black swan. And it is an oil shock that is precisely the event that might force China to accelerate offloading its dollar hoard.
azizonomics 
Aziz,
I have been enjoying your stuff, keep it up!
Off topic. Here is a portion of an e-mail sent to me from a family member in Hungary. Just another brick in the hyperinflationary wall being built in the Western World (And Japan.)
“Our government has just came out with a new anouncement wich will affect the mortgages based on CHF or EUR. It might be possible to pay back the mortgage on a fixed CHF/HUF rate which will be fixed on 180HUF/CHF. Now the existing currency rate is 239HUF/CHF…. So, if it will be possible I will win a huge amount….. Of course the banks are against it because they have to swallow the loss…. I don’t know what will happen but I hope…..”
And what will my family member do with that “win a huge amount”? Why he is going to go a buy stuff.
Great article Aziz. It’s so refreshing to read informed, well-balanced analyses of the current state of world economics. Keep up the good work!
I was with you until “whilst”.
Your analysis is good enough that you don’t need psuedo-intellectual words like “whilst”.
Still, I wonder if Bernanke is trying to get the dollar so widely disbursed (for example with the lending facility announced this week for Europe) that everyone will be too invested in it to allow even China to disrupt it.
It’s just a US vs Brit style of english thing. Chill out dude, as they say in the USA.
As we have discussed previously, we don’t know the extent to which China’s dollars will really allow them to purchase hard assets in the U.S. and other places. Time will tell on that one, but it seems fairly certain that much of the world’s gold will flow to China. No doubt they are well aware of the price suppression efforts, and have no problem using them to their advantage. My guess is they already have much more gold than they say they do.
They have many problems, and their culture exerts zero pull on the rest of the world, but they do have a five year plan, whereas the U.S. has a five minute plan.
Thanks guys.
I didn’t know “whilst” was a pseudo-intellectual word. I suppose it means the same thing as “while”. I didn’t actually sit on it and internally debate which to use. I just wheel off my posts free-style.
http://en.wikipedia.org/wiki/While#Whilst
justsayin
Having grown up in England, and used British English all my life, I type in British English —but thanks for the tip. I guess I should switch to while to alienate less Americans.
China has to buy dollars to finance the US purchases of their products. They are funding their own economic boom by purchasing our debt–this is a balance of payments issue.
China could very easily choose to send their products elsewhere — they have a rapidly developing domestic market, then there is Russia, India, Europe, East Asia, Australasia, Africa — billions of consumers with labour and hard assets to sell to fund consumption.
They will not desert America yet, but the sad truth is that America is more dependent on China than vice verse.
China has recently been buying a lot more treasuries — but I would argue that this is actually because there is no market other than US treasuries that has enough liquidity to match the massive hoard of dollars they are now sitting on.
None of those economies even add up to the US economy. China knows that its success depends on the US consumer, that is why they buy dollars.
An old saying goes something like this: “Owe the bank $100,000, it is my problem. Owe the bank $100,000,000, it is theirs.” This is China’s situation.
China has a little problem with their economic model, it is called communism. Why everyone believes the numbers about their economy is beyond reason, they are liars. There have only been two economies in the world that have advanced beyond a “developing” economy: South Korea and Malaysia, both of which are democracies.
Stop looking at the figures, start looking at the real underlying economy: the flow of goods and services.
China controls America’s supply chains of consumer goods, electronics, hardware, circuitry, rare earths and various basic materials — even their financial supply chain (dollars for treasuries) — so-called American manufacturing is often assembling Chinese components.
More worryingly for America, OPEC nations (other than NATO puppets Saudi Arabia, Iraq and now Libya) are increasingly bunching up with China — because they understand China’s role as the spider at the heart of the global supply chain. A Chinese-orchestrated oil shock — ostensibly to force Benny to stop printing — (like OPEC demanding gold or RMB for oil) would be devastating to the American economy.
I know China itself has real problems, and I don’t think it’s a good place for Westerners to park their capital. But they have a number of things in their favour in the global game for power: supply chains, massive cheap labour, natural resources, land, favourable relations with other authoritarian Eurasian energy powers. America might have the edge militarily, but let’s imagine that China went full-on trade war with America, floated the yuan and cut off the flow of goods from China to America ’til its demands were met. America would face a choice: long, slow difficult invasion (the American economy would hyperinflate without the Chinese supply inputs) or accession to Chinese demands.
America’s best hope is a CIA-backed colour revolution in China, either re-installing the KMT, or installing some hope-changey CFR Facebook executive like Wael Ghonim. Do I think that will happen?
Nope — they ain’t Commies — they’re Confucians.
The underlying economies are well documented in the figures, that is why I look at them. The US and other Western economies have shown their mettle in setting up supply chains in countries very quickly. Previously, it was Mexico, Taiwan, Singapore, etc. China is not special and India’s economy (a democracy) is starting to breathe down their neck. Companies can shift their supply chains in months. While there might be a disruption, the only catastrophe will be for China. They know this, that is why they peg their currency, buy US treasuries and continue to steal secrets (because they have zero ability for R&D).
China is in a catch-22: they must crush any and all uprisings as this might scare away any FDI. But, by doing so, they will never move to a regime type that is favorable to bring them in line with the rest of the world’s economies. Their leaders are not just going to give up power and start elections. No matter how “big” China’s economy becomes, it will never have any credibility in the West.
I agree that China is not a place to park capital. I stay as far away from them as possible. Many companies that market quality goods are moving back to the states or other quality-goods producing countries because much of the goods that China is producing is crap. We buy their crap, but it is still mostly consumable crap. Indigenously made quality goods from China? Not so much. When they can break the mold by producing something worthwhile from their own soil (that is not under license from or produced by a foreign company–currently about 60% of their production is foreign companies that have set up shop there), then I will worry about them. Right now, they are a textbook example of comparative advantage.
Let the OPEC nations buddy up with China, they will suck them dry like they have the US. We get less than 20% of our oil from the Middle East, this is mainly a European concern. OPEC demanding gold/silver? The banking systems in the Middle East cannot support this, they do not have the infrastructure, credibility or following. Many of the Middle Eastern countries pegged their currency to the dollar and are not far away from doing it again if the need should arise.
China is a house of cards waiting for a strong gust of wind. As is their brilliant internal propaganda machine, their external one doesn’t seem to be too bad either for people to believe that they are actually legitimate.
I believe the real house of cards is America and Europe — the consumption capitals of the world, and not China – the production capital of the world. I believe we are in a Roman/Barbarian deathlock. They make the goods, we live through bread and circuses. For the last 1,000 years China has been the global superpower for something like 700. You could call it reversion to the mean.
I guess the next five years will show us which one of us is right!
Personally, I think we are in/nearing the bottom of a Schumpeter cycle, looking to come out in the next five to ten years or so. I think we are on the same page as to a possible meltdown at some point and it may not matter the cause. Good debating with you!
Yes — I see you subscribed — please stick around as we watch the collapse — I need people around this blog with different but similar views to my own to hold me to account.
Absolutely.
Cheers!
Here is my prediction: (10 years from now) I believe the only option is to create governmental efficiencies, through consolidation. Economic collapse will allow Politicians to form the following Trade Blocs. Monetary Union will be required, and free trade/immigration.
1. All Western European countries will create a fiscal union. “United States of Europe.
2. Russia, Ukraine, Serbia, Bulgaria, Belorusia will form a CIS (Or Pan Slavic State)
3. Islamic Countries will form a Caliphate, with Turkey (Shiite) and Saudi Arabia (Sunni) as the centre administrators. This will include the Stan states.
4. North Central and South America will form a “PanAm” Trading Bloc
5. Africa will be a basket case with Tribalism, ruining all hope for an African Union .
6. China, Mongolia, Vietnam and other South East Asian Nations will Unite.
7. Australia, New Zealand, PNG, and Indonesia will form a Confederate economy.
It makes sense, in a resource constrained environment.
A number of other commentators agree with you. I think a lot of those predictions are likely to come to pass, but I should note that I believe Britain will retain pounds sterling.
I wonder what would happen to Israel if the middle-east united under a kind of caliphate…
Dear Aziz,
You have great insight for your age, keep up the excellent work, i have been following you now for a few weeks, but this is the firts time i have posted, i am also going to recommend you on a few other blogs etc that i follow..
Because more people need to understand, whats happening in the world.
I agree with with your take on China, people tend to forget that China has been a power for a long time, long before the west came on the scene.
However China to has its problem , the 200 million migrant workers are a huge problem and so is the ethnic conflicts in Xinjiang province and Tibet and more recently in Inner Mongolia.
Dont be surprised if the west exploits this, its only a matter of time before these regions are free from Beijing, but that may not be a huge loss, as they are not that economically productive, but they do have some resources, plus all the oil and gas pipelines that China has funded from central Asia come through this region.
And when that split happens, they will want to be paid.
As for the USA does it not import more Oil from Canada and Mexico, i agree with one of the other posters that China has yet to make the great leap in R&D and create something that would wow the world, i am sure they are working on this, its only a matter of time that they will experience the great leap forward and then we may all want those goods.
A strong China is not bad for Asia, its a market on our door step and China has many friends, eventhough at the moment most Asian economies are struggling against this giant, sooner or later it will have to open up to Asia, but that could take another 10 years.
This also holds true for the rest of the developing world.
The USA is in decline now, 9/11 just has brought that reality home, Al Qaeda spent $500k on the attacks, the US has spent close to $2TN everyday the US spends in Iraq or Afghanistan is a good day for the China and the rest of the developing world.
A reduced role for the states is not bad thing..
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