What’s Going on Inside China? — Reality of China’s Power and Politics

What’s Going on Inside China? — Reality of China’s Power and Politics

Dear Reader,

That’s the focus of today’s edition of The Daily Reckoning Australia.

The Middle Kingdom may be flexing its muscle on the international stage, but internally things look very different. In fact, as Jim Rickards explains below, China is more vulnerable than you might think — particularly as political infighting continues to intensify.

But what does it all mean for investors?

Read on to find out…

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia

China Is More Vulnerable Than the Facts Indicate

There has been an enormous amount of speculation in recent years about some secret plan by China to displace the US dollar as the world’s leading reserve currency with the Chinese yuan. Some even suggest that China has been stockpiling gold in order to launch a ‘gold-backed yuan’ that would definitively sink the dollar once and for all. That speculation is mostly nonsense.

Reserve currencies gain their status not because of the currency itself, but because of a large liquid pool of investible assets. Most central banks and sovereign wealth funds are extremely conservative when it comes to investment policies and portfolio allocations. They like the dollar because they can invest in US Treasuries, which make up the largest, most liquid asset market in the world.

China does not have a yuan-denominated bond market to speak of. China lacks the rule of law, a network of bond dealers, bonds in all maturities, repo markets, futures markets, when-issued markets, settled auction procedures, and reliable digital ledgers. In short, China has none of the needed channels or institutions to support a reserve currency and is unlikely to have them in less than 10 years, if ever.

The Chinese financial house of cards could collapse

China’s gold reserves are growing but are still only 2% of total reserves (versus 74% for the US). China is even more vulnerable than those facts indicate, as reported in this article.

China receives dollars for its exports and needs dollars to buy imported oil and other commodity inputs. Dollar payments move either through the Fedwire or the Clearing House Interbank Payments System (CHIPS), both of which are controlled by the US or major banks regulated by the US.

The only other global payment channel for China is SWIFT, based in Belgium, and controlled by a consortium of members but heavily dominated by the US. If the US were to cut off China’s access to dollar payments, it would collapse the Chinese financial house of cards.

The article describes how China is moving to a back-up plan using its own Cross-Border Interbank Payment System, or CIPS. The problem is that CIPS is limited to yuan payments for now and no one really wants yuan. Far from dominating the world of reserve currencies, China is totally at the mercy of the US.

If confidence in the US dollar collapses, it won’t be because of anything China has done. It will be because the US has abused its own privileged position. In that case, the fallback won’t be the euro or the yuan. It will be gold.

What’s going on inside China? Is there a coup d’état in the works?

The country of China is entirely subordinate to the Chinese Communist Party. You can study the Chinese government all you like, but you won’t learn anything about how China works unless you study the role of the party.

The Communist Party and its survival come first. Everything else in China is devoted to that end. The problem is that the Communist Party itself is opaque and difficult to understand. Written rules mean nothing. What counts are personal loyalties and control over organs of state power through party cadres.

The most powerful individual in history

For the time being, Communist Party Chairman Xi seems to be in a dominant position. He has the firmest grip on power of any leader since Mao Zedong, who died in 1976.

Considering China is much richer and more powerful militarily today than in the days of Mao, Chairman Xi is arguably the most powerful individual in history, with firm control over the lives of 1.4 billion Chinese and many more in surrounding countries.

But, is all well in China? It’s difficult to know, but, according to this article, Chairman Xi may be walking on shaky ground. The article was written by Bill Gertz, who has excellent connections inside the US intelligence community and who has a long track record of accurate geopolitical predictions far in advance of events.

China is on red alert

Gertz reports that China is going on red alert. It is putting up signs telling citizens how to get to bomb shelters. Military factories are being moved away from factories that produce civilian products. Ham radio operators report rumours of an attack on some remote islands technically controlled by Taiwan.

More importantly, rumours persist of an internal power struggle between Chairman Xi and what is known as the Shanghai political faction led by Zeng Qinghong.

It’s difficult to sort fact from fiction in China, but investors should be braced for some kind of geopolitical shock emerging from China in the next few months. This will be good for Treasuries, gold, and cash, and bad for investors in Chinese stocks and emerging markets.

The rumours may amount to nothing, but they may presage a major shock. Bill Gertz has a great track record for accurate forecasting. Investors should prepare accordingly.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia

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