[OPE] Dollar Crisis in the Making ... because of ...China???

From: Gerald Levy <jerry_levy@verizon.net>
Date: Mon Mar 23 2009 - 08:10:42 EDT


> China Business
> Mar 18, 2009
> Page 1 of 2
> 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.
> Fang Shangpu, deputy director of SAFE, the State Administration of
> Foreign Exchange, said earlier this week that more measures will be
> introduced to support firms seeking to expand overseas.
> Veteran analyst Han Xiaoping said the time is now ripe for China to
> convert some of its capital reserves into resource reserves, as global oil
> prices have fallen 70% since last year, to about $40 a barrel. [Italics
> added]
> "We shouldn't miss this opportunity to use our foreign exchange
> reserves to build up our oil stocks," he said.
> Jiang Jiemin, chairman of PetroChina, said recently: "The low share
> prices of some global resource companies provide us with some fresh
> opportunities."
> RGE Monitor's Ziemba says the resource buys are a smart move now because
> they decrease the role of increasingly uncertain financial assets such as
> Treasuries, which now carry little profit appeal and diminishing appeal as
> safe stores of wealth, and increase the role of hard assets, which now
> carry an ever greater profit potential and a mounting appeal as safe
> stores of wealth: "For China, these investments seem to be a relatively
> efficient way to use its financial resources given the likely long-term
> appreciation of resource prices and uncertainty about financial assets."
> 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.
> However, it should be noted that almost no matter what currencies these
> resource buys are being transacted in, there does exist a potential
> negative impact for the dollar itself further down this path. How so?
> 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.
> Increased buying of Treasuries by US citizens and investors, and by
> various foreign investors other than China, as the global crisis rapidly
> deepens and increases risk aversion, may likely take significant pressure
> off of China to soak up the huge issuance of new sovereign US debt now
> getting underway. That will help to provide breathing room for China to
> address its problem of reducing exposure to the dollar.
> Whether China will approach the problem with a scheme of swaps amongst its
> various state-controlled entities and wealthy private Chinese investors,
> or by some other nearly opaque means, probably cannot be determined with
> any certainty at present. But it has undoubtedly worked out the problem of
> clandestinely converting significant sums of its dollar-denominated
> financial assets into hard assets without dumping Treasuries and
> triggering 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.
> Summarizing the escalating risks of a dollar crisis
> The bubble in US Treasuries is getting increasingly massive and unstable
> with each week that passes. Deepening global risk aversion is keeping
> investors lined up, so far, to buy Treasuries - especially short-dated
> ones. And the deepening economic crisis in the US is moving its own
> citizens to join in the buying spree.
> If the Treasuries bubble persists for much longer, and especially if it
> continues to mount, the massive and dangerous distortions in the global
> financial system and the Treasuries-induced strangulation of its credit
> markets will only become more severe, likely leading to a meltdown
> somewhere in the emerging markets, one of whose effects will almost
> certainly spread to engulf the severely weakened Western European and US
> financial sectors and plunge particularly the US economy into a deep
> depression, with potent negative effects upon the dollar.
> Such an eventuality will tend to force global investors to evaluate the
> safe-haven appeal of the dollar based much more on the fundamentals of the
> US economy, and that will portend a stampede out of the dollar and a
> potentially chaotic bursting of the massive Treasuries bubble. Hence, even
> if the US finds buyers for its huge sums of new sovereign debt now
> beginning to flood the markets, the picture does not look good for the
> dollar beyond the short term.
> 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.
> Notes
> 1. See "China's Record Demand for Treasuries in 2008", by Brad Setser, The
> Council on Foreign Relations.
> 2. See "China's Resource Buys" by Rachel Ziemba, RGE Monitor.
> W Joseph Stroupe is a strategic forecasting expert and editor of Global
> Events Magazine online at www.globaleventsmagazine.com
> ***
> The Not so Safe Haven
> Official and popular analysis of the predicament facing the US dollar has
> for the most part been distinctly unwilling to come fully to grips with
> the stark truth about the real nature of this deepening crisis and the
> escalating risks that are surfacing. Far too much optimism and wishful
> thinking, and scarce courageous realism, is a recipe for an even worse
> disaster than the one we're suffering at present.
> We have seen in Part 1 the profound risks of a dollar crisis being
> triggered if global demand for US Treasuries remains high and that the
> debt bubble persistently and destructively sucks all the air out of the
> global credit markets. However, if global demand for Treasuries is not
> sustained at a very high level, there exists an entirely different, yet
> equally destructive set of impending and mounting risks that a dollar
> crisis might be triggered.
> Like it or not, the US dollar still constitutes the de facto central
> framework of the present global financial order - the dollar is its
> fundamental support structure, much like the steel framework that
> supported the Twin Towers in New York. The global crisis is sending
> shockwaves of ever increasing intensity throughout the present order. Few
> thought the shaking would reach its present intensity and scope, and no
> one really knows how powerful and destructive the shaking might get before
> the crisis is over.
> The initial, knee-jerk reaction in this situation has been to reach out
> and grab tightly onto the framework with both hands (that is, in an
> exceptionally risk-averse reflex, flee into the dollar for relative
> safety) and hold on for dear life. This reaction of global investors is
> motivated partly by logic but also in large part by the strong
> psychological components of uncertainty, fear and even panic.
> As China Banking Regulatory Commission deputy head Luo Ping stated on
> February 12, in his own reactive-style retort to the unfolding crisis,
> Treasuries are just about the only safe-haven option in perilous times.
> However, his clarification on the next day appeared a bit less knee-jerk
> and more rational, stating that gold and selected government bonds (but
> not those of the US) look more attractive to China from a risk assessment
> standpoint, because China rightly fears its dollar-denominated holdings
> will almost certainly be inflated away over time by the US policy of
> issuing huge new sums of dollar-denominated debt in the form of
> Treasuries.
> This brings us to the crux of the matter of escalating risks for the
> dollar. In the current fiscal year alone, the US is expected to issue
> somewhere between US$2 trillion and $2.5 trillion in new debt. It could
> conceivably exceed that amount if the crisis worsens and more money than
> anticipated is required to rescue the financial and economic sectors from
> ruin, or if virtually the entire financial sector has to be nationalized
> to prevent a total collapse. That is a prospect that is swiftly becoming
> more and more likely. A running estimate by Bloomberg News recently put
> the total so far of all the new sums of dollars the US government has
> spent, lent and/or committed to spend due to this crisis at about $9.7
> trillion and counting!
> To deal with a crisis that fundamentally arose, at length, out of the
> escalating risks of shortsightedly spending in colossal sums of
> dollar-debasing debt, the US government is attempting to "solve" the
> crisis by frantically spending gigantic additional sums of new
> dollar-debasing debt. Before this crisis spending binge was undertaken,
> the dollar's strength had already been greatly undermined over the past
> four decades by a combination of shortsighted dollar-debasing government
> policies and the accumulation of huge sums of debt since the 1980s.
> According to official calculations, it required $5.54 in 2008 to equal the
> purchasing power of just $1.00 in 1970. This comparison illustrates the
> potency of inflation in undermining the value of a mere fiat currency such
> as the dollar.
> But now, the US government is risking setting in motion inflationary
> forces that are profoundly more potent and difficult to manage. Virtually
> every economist on the planet calls this situation one that has the real
> potential for seriously and permanently damaging the dollar by inflating
> away too much of its remaining value not very far down the road. They also
> warn that, specifically due to the extremely risky monetary and budgetary
> policies now being embarked upon, the timing will be absolutely crucial
> for future Fed watchfulness and actions aimed at preventing a
> catastrophic, uncontrolled rise in dollar inflation.
> They further warn that the severely weakened US financial and economic
> systems will be very slow to recover strength and stability and will
> likely be unable to withstand the tightening measures that will be needed
> further down the road so as to keep inflation from running out of control.
> The US may therefore be condemning its own currency to collapse by
> enacting such shortsighted policies.
> In spite of such warnings, extremely potent inflationary, dollar-debasing
> policies are being enacted anyway. Is this the picture of a fundamentally
> sound global financial and economic superpower worthy of international
> respect, confidence and trust, or the picture of an erstwhile global
> financial and economic empire that is even now falling over the threshold
> into collapse? This is absolutely a valid question to pose at this
> juncture. Why?
> What's the salient point here? International trust and confidence in the
> monetary, financial and economic policies of the US government are far
> more crucial now, right in the midst of this deepening global crisis, than
> at any previous time in history because these policies will directly and
> indirectly affect the dollar, either for good or for bad. Since the dollar
> does still constitute the central framework of the present global
> financial order, and since the shaking of present order is only
> intensifying, international confidence and trust in the dollar as a safe
> store of wealth is absolutely essential.
> If that trust and confidence in the dollar should be sufficiently
> undermined anytime soon by risky policy, then the present global crisis
> will almost certainly turn into a global catastrophe - the perfect storm
> against the dollar alluded to in the introduction of this article. The
> importance of international trust and confidence cannot be over-emphasized
> for the dollar, a mere fiat currency that is backed by no hard assets at
> all (such as gold), but only by the pledge of the US government to stand
> by it and not to default on its international debt.
> # The massive global rush into the dollar as a safe haven would appear to
> indicate that we don't have much to worry about respecting international
> trust and confidence in the dollar. That might well be true if it could be
> clearly established that such a global move has been strategic in nature
> and well thought-out and as such has come as a result of rationality,
> logic and reason much more than being merely a tactical move as a result
> of fear and panic. Some important questions must be posed here: Are
> investors such as China, which likely holds 70% of its reserves in
> dollar-denominated assets, satisfied to remain in the dollar for the
> foreseeable future, and satisfied to increase exposure to the dollar, or
> do its central bank governors increasingly find themselves having to hold
> their noses, as it were, with respect to their exposure to the dollar? Is
> their concern flaring?
> # Are global doubts and fears mounting with respect to the appeal of the
> dollar as a safe store of wealth beyond the short term?
> # If the answer to the question above is yes, then is the appeal of the
> dollar being undermined mostly because of fears over the potential effects
> of the dollar-debasing policies that are now irreversibly being
> implemented in Washington?
> # Are key investors like China's central bank increasingly looking for
> ways to reduce exposure to the dollar?
> # Is the dollar facing significantly increasing competition from other
> safe haven stores of wealth, such as gold?
> Gold's increasing appeal as a safe haven, demonstrated by its ongoing
> surge, adequately answers the last question. From the start of January
> 2009 until mid-February, gold has surged from around $800 per ounce to
> near $1,000 per ounce and is likely to rise further. This surge coincides
> with the raft of official data releases since the start of 2009 that
> demonstrate the US and global financial systems and economies are moving
> deeper into crisis. Investors increasingly see the value of investing in
> hard assets, and in times of uncertainty and crisis gold and other
> precious metals are usually the ultimate investment in that category.
> As for the answers to the remaining questions posed above, even before
> Premier Wen Jiabao last week publicly warned the US of his government's
> concern about the safety of China's US holdings (see Wen puts US honor on
> the debt line, Asia Times Online, March 14, 2009) consider the recent
> comments of Luo Ping, China's Banking Regulatory Commission deputy head,
> referred to above:
> "We hate you guys. Once you start issuing $1 trillion-$2 trillion ...
> we know the dollar is going to depreciate, so we hate you guys but there
> is nothing much we can do."
> Also note the recent comments of Yu Yongding, a prominent former advisor
> to China's central bank, as reported by Bloomberg News on February 11,
> 2009:
> China should seek guarantees that its $682 billion holdings of US
> government debt won't be eroded by "reckless policies", said Yu Yongding,
> a former adviser to the central bank. The US "should make the Chinese feel
> confident that the value of the assets at least will not be eroded in a
> significant way," said Yu, who now heads the World Economics and Politics
> Institute at the Chinese Academy of Social Sciences
> Also, as reported by Bloomberg News on February 11, 2009:
> China may voice its concerns over US government finances and the
> potential for a weaker dollar when Secretary of State Hillary Clinton
> visits China on February 20, according to He Zhicheng, an economist at
> Agricultural Bank of China, the nation's third-largest lender by assets.
> "In talks with Clinton, China will ask for a guarantee that the US will
> support the dollar's exchange rate and make sure China's
> dollar-denominated assets are safe," said He in Beijing. "That would be
> one of the prerequisites for more purchases."
> Now, note the clarification offered by Luo Ping on the next day, as
> reported by Reuters News Service:
> Buying US Treasury bonds is an option - but not the only option - for
> China, which is aware that huge debt issuance by Washington would reduce
> the value of China's existing portfolio, a banking regulator said in
> remarks published on Friday. In an elaboration of his remarks, the China
> News Service paraphrased Luo as saying: "Compared with gold or bonds
> issued by other countries and regions, US Treasury bonds are still an
> option (for China). But if the US government issues a large amount of
> Treasury bonds amid efforts to deal with the economic crisis, all
> investors who hold US Treasuries will suffer losses."
> Now, note these statements made by Chinese officials, advisors and experts
> as reported by the official Xinhua News Agency on February 18, 2009:
> "To rescue the ailing US economy by increasing government borrowing
> will create a record-high federal deficit," said Yu Zuyao, economist with
> the Chinese Academy of Social Sciences, a government think tank. "This can
> further lead to catastrophic consequences such as serious inflation and US
> dollar depreciation," he said Tuesday. China faced high depreciation risk
> to its foreign exchange reserves, US Treasury bonds and other US
> dollar-denominated assets, Yu said.
> With regard to whether Chinese advisors and experts think the US
> government is creating a dangerous and unstable Treasuries bubble, note
> this statement:
> "Buying US government bonds amid an economic downturn, [a purchase]
> that is not based on the sound performance of the US economy itself,
> indicates a huge bubble," said Zuo Xiaolei, chief economist of China
> Galaxy Securities. [italics added]
> Chinese officials express mounting alarm at the likely negative
> near-to-medium term effects upon the dollar, and upon their huge reserves,
> of the spend-spend-spend policy emanating from Washington:
> The huge deficit would not immediately lead to inflation, since banks
> were likely to curb lending as the financial system remained weak, Zuo
> said. "It might be two or three years before the huge deficit leads to
> serious inflation." Analysts noted that if the stimulus plan didn't
> accomplish its goal of restarting growth, the US government would have to
> ease its large fiscal burden by borrowing more and issuing more dollars,
> instead of relying on economic growth.
> Huge Treasury bond issues would exacerbate the depreciation of the US
> dollar and world wealth. Such developments would be more catastrophic than
> the global financial crisis, according to Zhang Yansheng, head of the
> International Economic Research Institute under the National Development
> and Reform Commission, the chief economic planning body in China.
> A weaker US dollar would hurt that currency's international status, he
> said, which would "not be in the interests of the United States and other
> countries and would exacerbate the crisis." Said Zuo: "US dollar
> depreciation is inevitable in the long run. China should prepare and
> reduce its holdings of US Treasuries to a proper size."
> In a strong hint that China's central bank won't be adding to its holdings
> of Treasuries at anywhere near the rate it did in 2008, that it may
> already have clandestinely achieved more diversification out of the dollar
> than is widely known, and may well find ways to further decrease its
> holdings without explicitly telegraphing its moves, note this statement:
> 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.
> The foregoing quotes beg the following questions:
> # What about the widely held view, which is even at times recited by
> Chinese central bank officials themselves, that says China has no choice
> but to maintain its holdings of Treasuries and to keep buying more, lest
> any significant slowdown in its rate of purchases risk triggering a global
> dollar panic?
> # Is that view correct, or does China's central bank actually have other
> viable options, as Luo Ping and other officials insist that it does?
> # What might those other options be, are they really viable, and what
> might happen to the dollar if China's central bank began to exercise its
> professed "other options"?
> # What kind of scenario might prompt China's central bank to attempt to do
> so?
> # Could its enactment of "other options" be carried out in a way that
> would be difficult to trace, so that China would avoid triggering a dollar
> panic while it steadily reduced its exposure to the dollar over the coming
> months?
> Saying "goodbye!" sooner, not later
> With respect to whether China will continue to purchase Treasuries at
> anywhere near the same rate at which it has in the recent past, a new and
> fundamental problem is arising. Its significantly slowing economy is
> causing a rapid slowing of the rate of growth of its reserves, which makes
> much less new reserve accumulation available, and therefore also
> undermines the need for the purchase of Treasuries. Experts state that
> even if China's central bank uses all of its new accumulation of reserves
> each month to purchase Treasuries, the sums it would purchase would still
> fall.
> Additionally, China must now fund its new $585 billion domestic stimulus
> package, and that will only further decrease funds available for the
> purchase of Treasuries. Therefore, its rate of purchase of Treasuries will
> almost certainly decline significantly from here forward.
> This potentially potent new fundamental comes into play at the most
> inopportune time for the US, when it intends to sell perhaps as much as
> $2.5 trillion in Treasuries this fiscal year alone. The question that begs
> an answer, and that is increasingly being asked around the globe, is who's
> going to buy this huge new supply of debt? Certainly not Japan, for its
> exports are plunging, as is its new reserve accumulation, as it suffers a
> severe economic contraction at an annual rate of 12.7% according to the
> latest figures.
> It certainly appears likely that as new Treasuries flood the market, the
> point could soon be reached where supply outstrips demand, causing yields
> to rise. The Fed is trying to keep yields as low as possible so as to
> attract big buyers that already have large holdings of Treasuries, such as
> China. For such holders of Treasuries, rising yields would ravage the
> value of their holdings, making the purchase of yet more Treasuries
> distinctly unattractive. Yet, lower yields tend to be less attractive for
> new buyers, except in the case where such a buyer is suffering from strong
> risk aversion and is looking, not so much for profit, but rather for a
> safe haven.
> Therefore, minus the environment of extreme risk aversion that still
> plagues the markets, the US is caught between multiple contradictory
> interests. On the one hand, it wants to keep yields low so as to attract
> buyers such as China to purchase significantly more Treasuries. On the
> other hand, it needs higher yields to attract many new buyers because the
> big buyers are becoming much less able to keep up their purchases, let
> alone increase them. But those higher yields would almost certainly force
> investors such as China's central bank to begin to more quickly divest
> themselves of Treasuries - or risk seeing the value of the
> dollar-denominated portion of their reserves eaten away.
> The biggest factor that has so far prevented a destructive collision of
> all these conflicting interests is the persistence of extreme risk
> aversion in the markets, causing a global rush into Treasuries as a safe
> haven.
> If that extreme risk aversion were to subside, then investors holding
> Treasuries and prospective new buyers of Treasuries would be lured instead
> to investments that offer greater profit potential. The yields on
> Treasuries would have to rise in order to attract buyers, but that would
> undermine the value of investors' holdings of Treasuries, which would in
> turn drive them to sell out in favor of better safe stores of wealth. As
> yields rise rapidly, prospective buyers would likely stay on the sidelines
> to wait for the best deal rather than jump in too soon only to see their
> holding ravaged by yields that continue to rise.
> The yields would rise yet further on the falling demand for Treasuries,
> and the downward spiral would feed into itself in a stampede out of
> Treasuries and the dollar. What I am describing here is a bursting of the
> Treasuries bubble. It would most likely be disorderly and chaotic.
> But such a bubble burst for Treasuries could come about even if risk
> aversion persists, or perhaps intensifies, in this deepening global
> crisis. What if investors become more worried about the safety of
> Treasuries, fearing, as China's central bank increasingly does, that the
> flooding of the market with huge new sums of US debt will inevitably
> inflate away the value of their Treasury holdings? Or what if the costly
> new US stimulus package and bank rescue fail, and the US descends into a
> much deeper recession or a full-blown depression and is forced to
> nationalize virtually the entire financial sector, stoking fears that the
> US government may have no choice but to default on at least a portion of
> its gargantuan debt?
> In that case there is a real threat that investors will begin to transfer
> their risk aversion strategy from focusing on Treasuries and the dollar to
> focusing on something else that is deemed much safer - perhaps including
> hard assets like gold and other precious metals and commodities. If US
> gross domestic product (GDP) deteriorates significantly further than it
> has already, the dollar will become much more vulnerable and will likely
> fall as investors begin to value the safe haven currency more in line with
> the fundamentals of the US economy. Then, the same self-reinforcing
> downward spiral described above would likely come into play, and the
> Treasuries bubble would burst in chaotic fashion in an investor stampede
> to havens safer than the shaky dollar.
> One can begin to see how very tentative is the dollar's recent appeal as a
> safe haven in the mounting storm. In verification of that fact, investors
> have been piling into short-dated Treasuries for the most part, for two
> reasons. First, these assets are less vulnerable to the ravages of higher
> yields, which tend to hit the long-dated Treasuries earliest and hardest.
> Second, the short-dated assets facilitate a quick exit in the event that
> it is deemed justified. When taken together, these two factors are not a
> very solid vote of confidence in Treasuries and the dollar.
> Next: China Inoculating Itself against a Dollar Collapse
> W Joseph Stroupe is a strategic forecasting expert and editor of Global
> Events Magazine online at www.globaleventsmagazine.com
> (Copyright 2009 Global Events Magazine. All Rights Reserved.)
> ***
> Before the stampede
> By W Joseph Stroupe
> Increasingly ominous clouds are gathering in what could soon be the
> perfect storm against the United States dollar and against the present
> dollar-centric global financial order.
> This is not shaping up to be a storm that anyone is trying to initiate,
> not even those who are actively driving for a new global financial order
> that is no longer centered on the dollar. Instead, it will result from a
> correlation of forces arising out of the deepening global financial and
> economic crises, coupled with recurring and conspicuous miscalculation on
> the part of some of the world's political, financial and economic leaders.
> The storm has the potential to cause upheaval on a grand scale, opening
> the door to swift, and largely uncontrolled, fundamental transformation.
> As is widely recognized, the present financial order that is inordinately
> reliant on the US dollar must some day give way to a new order that is
> more balanced, stable, resilient and reliable, one that is based on
> multiple currencies and that therefore won't be plagued by the extremely
> dangerous structural drawback of an increasingly worrisome elemental
> single point of failure (the dollar).
> But if the current dollar-centric financial order should become more
> seriously shaken than it already has been, perhaps even suffering a
> collapse, as a casualty of the present deepening global crisis, then the
> transition to any new global financial order is most likely to be
> disorderly, disruptive and unmanageable rather than gradual and orderly.
> We can hope - but cannot be at all confident - that world leaders and
> global investors will act coherently, cohesively and intelligently enough
> in this crisis so as to ensure that the policies and actions being
> undertaken will not put at further serious risk the fundamental structure
> of the current dollar-centric financial order, and that they will instead
> be effective in bolstering deteriorating global confidence in the present
> order and in the safety of the dollar, at least until we get through this
> crisis.
> Unfortunately, we cannot be confident that world leaders know what they
> are doing in seeking to resolve the crisis. Are their measures attacking
> the heart of the problem, or only its periphery? Are they exacerbating the
> crisis, either by enacting certain misdirected measures, or by failing to
> enact certain required measures? Are they setting up conditions that make
> a dollar crisis and radically increased financial upheaval virtually
> inevitable, by blindly pushing ahead with a simplistic agenda of trying to
> spend their way out of the present crisis?
> If the dollar is being put at significant short- and medium-term risk by
> such measures, then we're seriously risking plunging the global financial
> order into a depth and breadth of transition that we cannot adequately
> control.
> Investment, finance and economics are a complex mix of at times downright
> illogical human psychology with the pure logic of mathematical science,
> introducing possibilities for potent wild-card factors that must be taken
> into consideration in any calculation.
> History provides many unfortunate examples of how the psychological
> components of uncertainty, fear and panic can, at crucial times, trump the
> components of logic, reason, knowledge and discipline to give impetus to
> shortsighted and risky policies and actions that create a full-blown
> crisis. Humans simply don't always act in a rational and logical way that
> is in their best strategic interests. And institutions, regulatory
> agencies and governments, being composed of humans, don't always act
> rationally either.
> All are subject to the potent influence of human psychology, which can at
> times be quite defensive, knee-jerk, irrational and somewhat
> unpredictable. In a crisis situation such as we presently find ourselves,
> the darker side of psychology's influence is often and unfortunately
> magnified.
> Added to this is the fact that global investment, financial and economic
> systems have become increasingly complex and interrelated much faster than
> the ability of experts and leaders to adequately comprehend them. This
> makes it much easier to make mistakes of real consequence. This complexity
> also at times prevents governments and other institutions from taking
> requisite bold, comprehensive actions in the midst of crisis for fear that
> these may backfire by producing some unforeseen and intolerable effects
> and repercussions.
> Further complicating matters, investment, finance and economics are nearly
> always deeply intertwined with politics, adding to potential uncertainty -
> especially so in a time of deepening global crisis, when individual
> governments invariably lean toward self-interest, nationalism,
> protectionism and self-preservation.
> To illustrate the disturbing truthfulness of the foregoing, remember when
> experts and leaders confidently concluded that the free markets could
> mostly regulate themselves with success; when they concluded that no
> housing bubble existed in the US, but only some "regional froth"; when
> they insisted that complex new mortgage-backed securities, including
> high-risk mortgage paper, dispersed throughout the financial and
> investment system, would decrease default risk.
> Empty reassurances
> Remember when the present crisis broke in 2007, the reassurances that it
> would not spread beyond the confines of subprime; when it did spread, the
> forecasts that Wall Street banks' losses would amount only to a total of
> about US$200 billion. Remember when "experts" insisted no widespread
> credit crunch would result. Remember when they insisted that the crisis
> was unlikely to spread from Wall Street to the real economy on Main
> Street?
> Remember when they said the hundreds of billions of dollars of liquidity
> thrown into the system would free up the credit seizure. Remember when
> they said the October 3, 2008, $700 billion stimulus package and the many
> more hundreds of billions of dollars in bank and corporate bailouts would
> move the system out of crisis. Where are all these pseudo-intellectual
> ideas, beliefs, ideologies, assessments and assurances now? On the trash
> heap, precisely where they belonged in the first place.
> The record inspires little confidence in the ongoing efforts of
> governments to resolve the crisis, or even that they know how to resolve
> it. The damage and outright destruction inflicted on vital components of
> the present global investment, finance and economic orders just keeps
> piling up while governments keep trying their various "solutions".
> As for the newly passed $787 billion stimulus package, and its
> accompanying sketchy bank rescue plan, economists and the markets widely
> doubt whether the two measures are potent enough and targeted accurately
> enough to come anywhere near accomplishing their stated aims.
> The same is true of the perpetually disjointed and half-hearted efforts of
> the Group of Seven (G-7) leading industrialized nations, whose most recent
> confab in Rome ended with the customary whimper. In addition to its
> historic impotency, the G-7 is now being almost totally emasculated by the
> broader Group of 20 nations, to which has fallen the task of designing and
> constructing a new global order to replace the present broken one. If you
> concluded based on the hard facts that this crisis is spinning
> increasingly out of control in spite of, and in some important ways due
> to, the efforts of governments to resolve it, you would not be far wrong.
> Investors, both private and official, around the globe have generally
> given in to a crisis reflex psychology of extreme risk aversion and have
> been clutching the US dollar ever more tightly, massively running into
> Treasuries as a refuge in the mounting storm. This fact would seem to
> imply that global confidence in the dollar is still fundamentally sound,
> despite the well-documented bruises it has received over the past few
> years.
> The truth is that the potential for a global dollar panic is becoming
> greatly heightened, in spite of (and in part, actually because of) the
> dollar's recent significant gains as a refuge for investors, the bulk of
> whom continue to be distinctly risk-averse. Ironically, this massive
> piling onto the dollar opens yawning new vulnerabilities and risks that
> either did not exist before, or were at most very minimal.
> For example, a number of experts warn that US Treasuries are increasingly
> taking on the characteristics of a bubble, and they remind us that bubbles
> inevitably deflate, and they rarely, if ever, do so in an orderly fashion.
> When this one deflates there could be uncontrolled, perhaps even chaotic,
> repercussions for the dollar.
> Much discussion and debate is currently underway as to whether the US will
> find sufficient global demand for the more than $2 trillion in new
> Treasuries coming online this fiscal year alone. But the fundamental risks
> for the dollar aren't only arising out of that fear over whether demand
> for Treasuries will be sustained.
> Serious risks for the dollar also arise if global demand for Treasuries is
> sustained. Why? Because that would only thrust the present Treasuries
> bubble to even more gigantic proportions, further warping the structure of
> the already severely deformed present global financial order, magnifying
> the dangerous distortions that already exist and increasing the likelihood
> of amassive second wave of damage and destruction in this present crisis,
> and an eventual burst in the Treasuries bubble.
> The emerging markets and their banks and governments are suffering under
> increasingly tighter credit strangulation and mounting financial and
> economic losses, with skyrocketing risks of default, due to the tightening
> global credit seizure. And US and European commercial credit not
> explicitly backed by governments is also suffering likewise. As if that
> dangerous situation were not bad enough, the massive spending and debt
> issuance policies being embarked on by the US government only greatly
> exacerbate the increasingly unstable situation for all these players.
> By facilitating and encouraging the massive global flight into Treasuries,
> and by issuing a huge new supply of US sovereign debt, emerging markets,
> their governments and banks, and US businesses are deeply suffering. As
> the US government sucks all the air out of the global credit markets via
> the unstemmed growth of its latest in a series of dangerous asset bubbles,
> namely the Treasuries bubble, these other entities find it extremely
> difficult to issue debt (obtain credit) at feasible costs, if at all.
> Investors are demanding very high yields to exit the relative "safety" of
> Treasuries to invest in corporate and government bonds in the emerging
> markets and in large swaths of the US and Western Europe as well.
> These increasingly high yields demanded by investors translate into high
> costs and mounting losses by banks across the financial system. The
> situation is moving rapidly to a potential massive wave of bank, corporate
> and government defaults. Eastern Europe is on the very precipice as a
> result. If such already severely weakened emerging market governments,
> banks, businesses and US corporations do default, they will place enormous
> new pressures on European and US banks which are either heavily exposed,
> or not sufficiently immunized, to the risks.
> The global credit markets and financial systems are deeply interconnected,
> meaning that contagion spreading from an Eastern Europe default to the
> rest of Europe and the US is virtually assured. So those pressures will be
> felt by the entire global financial order, and such new and profound
> stresses upon an already extremely shaky order won't likely be endured
> without a genuine meltdown of the entire system.
> These huge and dangerous distortions in the global financial order are due
> largely to US government policies regarding Treasuries and the
> shortsighted willingness of global investors to participate in pumping up
> that profoundly harmful bubble. If the US succeeds in selling its greatly
> increased supply of Treasuries, then such distortions in the global order
> will only become more profound, their negative repercussions (credit
> strangulation) will only become much more potent, and the feared second
> wave will be virtually assured. And so far, demand for Treasuries has
> remained high, thereby ensuring the dangerous persistence of the credit
> strangulation referred to here.
> That second wave, if it comes, will also carry profoundly negative
> repercussions for the Treasuries bubble itself, because the US and Europe
> will be plunged into undeniable, full-blown depression via a financial
> meltdown by the heavy burden of the cascading effects of default in
> Eastern Europe. That eventuality will force global investors to finally
> begin to evaluate the safety and appeal of Treasuries and the dollar based
> much more on the swiftly disintegrating fundamentals of the US economy and
> much less on a psychological reflex, driven by extreme risk aversion, that
> at present corrals investors into Treasuries for their supposed safe-haven
> benefits.
> The stampede in the making
> Investors will begin to stampede out of financial assets such as
> Treasuries and into hard assets like precious metals and certain
> commodities whose price has been severely beaten down. These will offer
> comparatively much safer stores of wealth, ones with a real profit
> potential. China, via its resource buys, is already blazing the trail,
> going energetically into hard assets, rather than sustaining its 2008 rate
> of purchases of Treasuries and other financial assets.
> Replay the recent histories of the chaotic housing and the commodities
> bubble bursts. Global investors, at the behest of enthusiastic
> governments, largely ignored the inevitable risks and piled into these
> assets on a grand scale, with the hottest interest coming just before the
> burst occurred. The environment of very low global interest rates and a
> massive global credit excess set the stage for enormous investor profits
> on these gigantic and mushrooming asset bubbles.
> But when mounting inflation obliged the Fed to begin to steadily hike
> interest rates, the housing bubble began to burst in late 2006. As the
> dollar weakened under mounting inflation and loss of its appeal as a safe
> store of wealth, global investors piled ever faster into commodities for
> safety and for profit, inflating that bubble to gigantic proportions by
> the summer of 2008, when oil nearly reached $150 per barrel.
> Then, when the global recession emerged later that summer, investors
> realized global demand and prices for commodities would plunge, so they
> stampeded out of commodities and into Treasuries, and the commodities
> bubble burst. Both bubble bursts left a great deal of wreckage in their
> wakes, with asset values collapsing, pulling businesses, banks and even
> governments into the abyss.
> Though the present Treasuries bubble is more about safety than it is about
> profit, the fundamental risks associated with bubbles still apply to it.
> The bigger it gets, and the more reliant upon it as a safe store global
> investors become, the more unstable it turns out to be because it becomes
> more sensitive to various factors, both internal and external, both real
> and psychological.
> The bigger and hotter any bubble gets, the more prepared its devotees
> become to speedily abandon it in favor of the next one. That explains why
> investors have mostly piled into very short term Treasuries - they know
> they may well have to sell out even faster than they bought in.
> So, no one should assume that the present crisis will moderate or move
> toward resolution just because global demand for Treasuries might remain
> high in coming months. That would only signal that the Treasuries bubble
> is growing more massive, and that the distortions in the global financial
> order are only becoming more profound and dangerous, threatening to bring
> in a second wave of destruction, and that the bubble is therefore much
> nearer to bursting. This constitutes a potential perfect storm against the
> dollar and against the present global financial order that no one wants,
> but no one is seeking to prevent either.
> W Joseph Stroupe is a strategic forecasting expert and editor of Global
> Events Magazine online at www.globaleventsmagazine.com

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