You could argue that America’s economy is hitched to the Chinese wagon. But it’s only true in the sense that Uncle Sam, the debtor, is trotting behind the Chinese bandwagon. Up to now, it’s been a leisurely trot, with a steady stream of cheap textiles and electronics coming off the back of the wagon. But yesterday, things changed. That is, the Chinese chose to remind the US that a debtor ought to be careful what he says to a creditor.
“China has accumulated a large sum of US dollars,” said He Fan, an official at China’s Academy for Social Sciences. He wasn’t exactly speaking for the government. But he was clearly articulating what’s on everyone’s mind. “Such a big sum,” he continued, “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.” But…?
“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.”
Well then, there you have it. US Treasury Secretary Henry Paulson has pushed China to allow the yuan to appreciate, driven by nationalist and protectionist sentiments in the US Senate. China knows the US Congress is keen to act, and blame the foreigner in an election year for American economic woes. Its well-timed reminder of the leverage it has over the dollar is a warning to the Americans to be careful what they ask for.
And just what would a stronger yuan mean anyway? For one, it would mean marginally higher prices for Chinese imports in America. But would American textiles and manufactured goods suddenly become more cost competitive on global markets through a yuan revaluation? Maybe. Does America even make toaster ovens anymore?
For the rest of the world, Mr. Fan’s comments are a sign that a big transition lies ahead in the global economy. Imagine yourself as a member of the Chinese politburo. At what point does it make sense for you to allow your own currency to appreciate? Well, the whole point of having an artificially weak currency is to boost exports by keeping them cheap. China’s economic growth has thus far been export driven.
But today, China’s savers are pouring their money into a booming share market, risking both a stock market crash and the social instability it would create. Why not increase the purchasing power of those savings by allowing the currency to appreciate? This has the added benefit of containing local inflation, along with increased reserve requirements at banks and higher interest rates.
What’s more, increasing the purchasing power of the local currency means China’s economic growth becomes driven more by domestic demand instead of by exports to the American consumer. And after all, the American consumer is looking pretty bedraggled these days. His savings rates are low. His chief financial asset, his house, is at the centre of uncertainty. And his lines of credit are all but tapped out.
Yes, it sure looks like China has announced to America what it has known all along. Its investment in US Treasuries, and the support that offers both to the American dollar and the American consumer, were always driven by what was best for China. And what’s best for China now? Well, we don’t know for sure. But buying the US dollar doesn’t seem look a good idea for anyone right now. Selling it, on the other hand, or trading it for tangible assets…that seems like a much better idea.
On an entirely different note, what do you do when a stock goes up over 200% from your entry price? Well, normally you’d take your profits and count your lucky stars. It’s a good kind of “problem” to have. And it’s one we have with one of our alternative energy stocks at the Australian Small Cap Investigator. The little solar stock we like has consistently met its benchmarks and attracted some deep-pocketed investors. What’s next? More on that tomorrow…
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Joe on 10 August 2007:
This whole concept of China dollar sale threat is idiotic. If China sells US currency, then China's will plunge also as its linked, trashing its own currency. If China's currency is delinked, its a revaluation up to the dollar, what US wanted all along. I don't see how China could win by selling US assets.
Comment by Joe cont on 10 August 2007:
Truth be told, a financial storm may result, but most of it will eventually be soaked up by central banks of Japan, Korea, India, Russia, and Brazil to protect their currencies, buying dollars. The long term effect is just a transfer of forex assets to these countries from China. Only a concerted selling by these nations could smash the US currency.
Comment by Jeoff on 10 August 2007:
Indeed, there is too much hype about china's bond holdings. A massive sell off would hurt china and other asian nations in general in terms of taking a hit on reserve values. Then they would get a second longer term hit from reduced export volume.
Comment by NewTV.com on 11 August 2007:
I think you guys (people commenting on the article) are underestimating what can happen in a global credit and currency crisis.
China can average out of the dollar at a rate of a 10 - 20 billion a week, buying silver, gold, Euros, pounds and so on. In a year they have dropped their $ holdings to 500 to a trillion billion before we start to notice how bad things are.
Towards the end of the year it would hit the market just how many dollars have entered the market, and the dollar would being on its way to its all time low.
My point is that you seem to think they are going to dump the trillion + over the course of a week. The will not. They will average out of it as quietly as possible.
Comment by Jeoff on 11 August 2007:
4 - People are commenting on a "mass selloff precisely because that is the content of this article as stated by the chinese officials. Don't mistake this to mean we believe this will happen. On the contrary it is quite clearly stated above by commentors that a mass selloff would harm china and other nations such as Japan. As far as them averaging out, this has been going on for a couple of years and has been openly stated by chinese officials. I don't see a problem with that, and it needs to happen to change the exchange ratio.
Comment by phosforos on 12 August 2007:
I saw on the news that yesterday the U. S. Federal Reserve bought $38 billion of mortgage backed securities in open market operations. Can somebody please tell me what is going on here. Alice Rivlin said it doesn't really matter whether they purchase mortgage backed securities or treasuries. It's really just symbolic.
So, are these the same mortgage backed securities that nobody else wants because they probably don't have any value? If the Federal Reserve is going to print $38 billion couldn't they use it to fund bonds to give people educational opportunities?
If we go into recession and housing prices drop like a rock these securities will be absolutely worthless. Then we can chew them up and turn them into spitballs and throw them at the Sunnis and Shiites. That would represent a $38 billion symbol for our times.
Comment by Tony on 17 January 2010:
After reading the article, I knew it had to be written by a chinese - what has happened to some-what unbiased reporting????????
Pingback by Let’s Get One Thing Clear – Paradife Loft on 25 April 2010:
[...] reason, but reason with unfortunate significance nonetheless. Recently, and somewhat less recently (here and here,) people have been speculating the consequences of China selling off US Treasury Bonds. [...]