Posts tagged ‘China’

Why China will dump treasuries?


(This article was written in response to a comment from author Venkatesan Vembu’s comments in http://www.firstpost.com -> “Here’s the real reason why gold prices are soaring”.http://www.firstpost.com/economy/here%E2%80%99s-the-real-reason-why-gold-prices-are-soaring-65530.html

I strongly believe that China has no options but to dump treasuries and the delay they do in realising it, the more money they will loose.

There are only 3 ways to pay debt.
a) produce : export (with interest) to get dollars back into economy.
b) default : declare bankruptcy
c) inflate : print money and devalue currency

Having a glance at the total debt + unfunded liabilities US has, producing its way out of debt is out of question. If it is option b) which is default, it means extreme levels of austerity, much much more severe then we are seeing in Greece. Expecting this level of honesty from US, to bear extreme pain, to repay debt, is simply insane. The whole nation will erupt in violent revolution and no govt has the guts to accept it. Infact that situation has to happen eventually until the crisis is pushed to a point beyond which it can not be pushed any further. How the crisis is pushed further, we will see it in 3rd point.

The 3rd and the most convenient way is inflation, which means devalue your currency and print more money to get out of debt. This suits the borrower if it is the issuer of the currency in which debt is taken. But the creditor is going to suffer because he will get the money back with REDUCED PURCHASING POWER.

Let me quote what our own RBI says about Rupee denominated debt, in “India’s External Debt, A Status Report 2009-10”, (page 11) … “Unlike foreign currency denominated debt, where the currency risk is borne by the borrower, the characteristic feature of domestic currency denominated debt is that the exchange risk is borne by the creditor. The contractual liability, however, is settled in terms of the designated foreign currency (through exports in case of Rupee debt owed to Russia).This implies that the borrower gains (and the creditor loses) when the local currency depreciates since less has to be repaid in foreign currency terms and vice versa.”.

So we clearly see that central banks knows fully well that if they are the issuer of the currency in which debt exists, they can devalue and pay less. And that is what we have been seeing federal reserve doing all these decades, while at the same time accumulating more debt. The reason was that US was having the unique advantage of being the issuer of world’s reserve currency and they were exploiting this position. Therefore I believe that US will continue to inflate to get out of debt. Falling dollar means, China as a creditor in dollar denominated debt looses the value of its money anyway even if it does not do anything.

Understanding this risk of loosing value of its dollar investments, China offlate has been aggressively trying to diversify. But thats where it gets trapped in the web, because to ensure that its dollar investments do not loose value China has to continue to invest in US treasuries so that US doesn’t have to do quantitative easing and devalue its dollar. Since US is the biggest market for China, later has to continue to work and provide more goods to US to get  dollars to be invested in US treasuries. So effectively goods provided by China is filling up the supply gap  caused due to massive dollar printing by US. Now the trap here is that if China does not invest in US treasuries, quantitative easing will be required resulting in more dollar devaluation  thereby loss of Chinese investments. Since the US deficits are growing exponentially, China will have to do greater investment in US treasuries, to save dollar value. To do this greater investment, China will need to supply more goods to US (so that it gets more money to invest). So basically to get back its money from US, China has to lend them more. The pace with which China reduces the investment in treasuries, dollar devaluation will increase (because of quantitative easing). On the other hand, if China increases the investment in US treasuries to save dollar value, inflation in China will increase causing civil unrest, thereby destabilising the government. The situation as it stands today is that, thanks to trillions of dollars worth deficit US has, despite of Chinese investments the debt requirements are growing exponentially, requiring massive quantitative easing and thereby causing dollar devaluation. To help dollar retain its value, China so far has been devaluing its currency almost at the same pace but it can not do so without threatening its internal political stability as the inflation is breaking all records and causing civil unrest. China will have to quit dollar when the cost of saving dollar (inflation) will start to threaten the national stability itself. Infact China will also see that despite of their sufferings of inflation, US deficits are growing exponentially causing greater dollar devaluation and therefore making their efforts futile, to save their dollar investments’ value.

Some people argues that in the absence of other currency alternative dollar will not crash. They say that Euro, GBP and almost all major currencies are falling. Yuan and Yen both are deliberately devalued to maintain the exchange rate with dollar. So there is no alternative to dollar and therefore it will not crash. The point these people miss in their assessment is that what is the purpose of currency? Why does one holds the currency? Only to buy commodities. If the currency is fast loosing value, people will instead of holding currency will start holding the commodity. So investors will start diversifying its investments from currency to commodity because currency is loosing its function “store of value”.

Here we are talking about China particularly and same principle applies to them. When they will realise that to hold dollars they are actually investing more (providing debt to US) and in turn getting negative returns (loosing money to dollar devaluation), they will definitely aggressively offload dollars which will create a panic in the currency market and global economy. This will  result in inflation which actually means prices of commodity in terms of currency will go very high.

WHEN THE BETTER SENSE PREVAILS UPON CHINA, the unthinkable will happen and IT WILL DUMP THE TREASURIES. Gold will be the real money as nobody will trust currencies. China and US both will blame each other and the likes of Marc Faber are not wrong in saying that there may be War. I see a serious US vs China war / conflict whatever you want to say, as a strong possibility. And I strongly believe that Arab’s will support China because they also have huge investments in dollars. The clock is ticking for the OPEC / China to pull the trigger…

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The reason why gold prices are soaring?


In response to the article published in http://www.Firstpost.com -> “Here’s the real reason why gold prices are soaring”
http://www.firstpost.com/economy/here%E2%80%99s-the-real-reason-why-gold-prices-are-soaring-65530.html

The author does not give any evidence / explanation against the arguments put forth by the likes of Marc Faber, Jim Rogers etc. In this article I will try to explain the other side of why gold prices are soaring and at the same time counter some of the evidences author has given in support of his argument.

The author says, “But in fact, the US today, although in rotten economic shape, is struggling with deflation, not inflation…”. Deflation can be temporarily caused by flooding the market with goods bought on debt at a time when people do not have enough credit. But when debt becomes difficult what remains is scarcity of goods along with massive unemployment or no goods and no money. Why does US TRADE DEFICIT is high if there is surplus production causing deflation? Why does US not exporting its surplus and getting back its dollars to meet its welfare expenditure to create jobs, rather than increasing external debt and printing more money? The answer is simple that US is not producing but simply consuming on debt.

Today Japan, China etc are not only supplying goods to US markets but also investing their earnings into US treasuries. Exponentially growing US debt requirements has lead to inflation in emerging economies like China who are exporting to US. Because… 
a) the good which otherwise would have been available to their own people are being exported to US consumers. 
b) they have to print more money in line with falling dollar to make their exports competitive.

So more money and less goods is causing their inflation.

Now as the better sense is prevailing upon, China is slowly increasing its diversification out of US dollar. At the same time, debt requirements, to generate employment and to stimulate the economy, is increasing in US. This widening gap due to higher debt requirement and reducing Chinese (and other’s) investment requires more money printing or quantitative easing. We have seen 2 rounds already apart from TARP. And now I am sure we will see a 3rd round soon which is being called as QE3. I expect that to happen quite soon, timings may always be debatable.

US had clearly outsourced its production to countries like China and Services to India and have adopted an easy way to finance its expenditure, i.e., to print money. More dollars coming into world economy is making dollar cheap w.r.t gold and commodities. The INFLATION in US CAN BE PREVENTED TILL SUCH TIME WHEN THE LENDERS LIKE CHINA and JAPAN CONTINUES TO DEVALUE THEIR CURRENCY AND SUPPORT DOLLAR indirectly. The investors are already attempting to get rid of dollar. In the absence of any currency alternative, they are moving to commodities specially to Gold which has historically been the money for international trade. THEY ARE DOING IT TO PRESERVE THE PURCHASING POWER WHICH IS STORED IN THE FORM OF CURRENCY. BY CURRENCY DEVALUATION, IT IS THE PURCHASING POWER THAT IS STOLEN e.g., the currency becomes weak and your Rs or $ 100 can buy less goods than what it was previously able to do so. 

The trigger of the real currency crisis could be anything such as OPEC stops accepting the dollar because of its constantly falling value. The Sheikhs of Arab eventually sees the loss of purchasing power of their dollar investments due to falling dollar. China realizes the reason of its rising inflation and start asking for something in return for the goods it is lending to US, that is not being devalued or loosing its purchasing power. When it happens heck of the crisis will come. GOLD MAY SKY ROCKET as not only investors but sovereigns will attempt to get hold of it to enable international trade. And Marc Faber is not wrong when he says we can even see war in future. Because Sovereigns nations interests will clash, specially arab’s, china (creditor nations) on one side and US, west (debtor nations) on other side. I am still leaving some dots to connect, hope you will be able to see that.

If we have the right understanding of economics it is not difficult to see the trends. Timings of events can be debatable but trends can be forecasted based on changing situations. GOLD IS GOING UP BECAUSE MONEY IS LOOSING ONE OF ITS KEY FUNCTION “STORE OF VALUE” which is much required in these days of growing uncertainties.

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