Friday, July 29, 2005

Is China Sick of Holding U.S. IOUs?

According to this article at Forbes, China is basically sick of its ever growing pile of U.S. IOUs and is putting its money into more tangible things like gold bullion and other hard assets. Kiss the currently low long-term interest rates goodbye.

Some choice quotes:
"Put yourself in China’s shoes. Your economy is heavily dependent for its economic growth and well being on exports to the United States, long its least-favorite country. It has to accept payment for its exports in U.S. dollars,a currency over which it has no control other than to cause it to depreciate by trading out of the dollars it holds and into another currency. (Note: This is something the U.S. is trying to get China to do to itself by revaluing the yuan.) To add insult to injury, it has accumulated a staggering $700 billion of such dollar reserves and sees no other investment option besides the U.S. Treasury market."

"Hence, they not only supply cheap goods to this least-favored country, they then lend it back the proceeds of their labor—lending which makes them vulnerable to a freezing of these reserves by the U.S. should serious enough policy differences arise, à la Iran. Welcome, China, to the World Trade Organization, or should I say, "Welcome to the Hotel California.""

"Fairly recent history offers... examples of countries who have dealt with this problem with mixed success. In the 1970s, when OPEC managed to take control of the oil market and more than double prices, their foreign reserves quickly built up as they had not yet figured out how to spend these vast sums. Their solution was to invest in CDs with large international banks, thereby providing the funds necessary for oil-importing countries to fund their higher oil import bills. This dubious arrangement lead to an international banking crisis, as the debtor nations defaulted nearly causing some major international banks to fail."

"The recent purchase attempt of Unocal (nyse: UCL - news - people) by CNOOC (nyse: CEO - news - people ), the state-controlled China oil company, exemplifies an attempt to pursue yet a different route for diversifying out of dollars. China appears to be trying to spend its foreign reserves to buy entire U.S. companies. From a Chinese strategic point of view, this is definitely the right policy: Buy the means of producing the raw materials you need or alternatively, buy the companies that have the technology and distribution channels for the products you produce or want to produce."

"For the United States, however, this strategy is a serious threat that goes beyond trade rivalry. Let no one kid himself. International trade and capitalism is a form of warfare where domination is the objective."

"Such dominance by a country that is fundamentally hostile to U.S. interests will not be tolerated by the U.S. government."

"How then can China reduce its subordination to U.S. interests and use its dollar reserves to strengthen its role in world affairs?"

"I believe China will eventually find gold as a partial solution to its foreign-exchange problem."

"Dominating the gold market would offer a number of benefits to China. It offers a viable alternative to buying more U.S. Treasury debt."

"The ultimate attraction of such a policy for China is that it allows them to reduce their vulnerability to the United States. Even more so, it allows them to play a dominant role in international affairs, clearly a high priority with current Chinese leadership."


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