As The Trade War Rages – China Won’t Be Held Hostage By The U.S. Dollar

Adem Tumerkan September 28, 2018
Category: Research

This is a repost of the recent Palisade Weekly Letter –

 

In last week’s Palisade Weekly Letter, I wrote about how the Chinese are now selling their U.S. debt. And since this was an important write-up, I also published it as an article – so if you missed it, click here.

I mentioned that although China’s now a net-seller of U.S. debt – they’re slowing doing so.

I reckon they’re doing just enough to let the Treasury and Trump know that they can send yields soaring and can’t afford it if China unloads the whole $1+ trillion amount.  

That’s why we at Palisade Research have called this China’s ‘nuclear‘ option – it’s no doubt a financial weapon of mass-destruction (FWMD).

If China suddenly dumped their $1+ trillion of U.S. debt, it would cause markets worldwide to implode.

But that also means China would suffer. . .

Now, China isn’t stupid. They’ve worked decades to grow their massive dollar surplus and reserves. They won’t recklessly lose it all for nothing.

But still, this put’s China in a corner. Because although they won’t risk blowing themselves up to hurt the U.S. – what if the U.S. must cheapen the dollar to boost trade? Or get out of a recession? Or monetize the Treasury’s never-ending spending and huge fiscal deficits?

The depreciation of the U.S. dollar for any reason is a huge threat to China currently.

Today China holds roughly 3 trillion of dollar reserves. That’s down 25% from the 4 trillion they had in beginning of 2015 (the strong dollar really hurt them).
 

 
And putting things into context – if the U.S. dollar devalues by just 10%, that’s more than 300 billion of purchasing power lost from China’s dollar reserves. . .

Gone – just like that. And completely out of China’s control. 

Imagine if someone else held the power to devalue the money in your own bank account. That puts you at their mercy – in a very fragile place – right?

Well, China is aware of this. . .

They know that they are at the mercy of the U.S. Federal Reserve.

Normally if the Fed tightens, the dollar usually appreciates. And if they ease, the dollar depreciates.

The Fed just hiked rates again this week. That’s the eighth time they’ve done so in this tightening cycle that began in December 2015. They’ve also sold off more than $400 billion in bonds through Quantitative Tightening.

Eventually – the Fed will have to ease. It can’t tighten forever. And thanks to the Fed’s Paradox’ – the more they hike, the greater chance of a financial crisis occurring. 

History tells us (and so does logic) that when the Fed tightens, the economy slows down, and debt burdens becomes harder to service. Sooner than later, something collapses – usually a debt-fueled bubble sector can’t sustain itself without the easy money and low rates (like housing in 2007, or dotcom stocks in 2000).


 
And contrary to what the mainstream talks about – China is fully aware of this.

As I’ve written about months ago – China adopted a financial warfare strategy in the mid-to-late 1990’s (read here). They knew that they could never beat America militarily – so they decided to build up financial weapons.

An example of this is China buying more U.S. debt than what’s necessary. They now own enough that if they dump it all, it will cripple the U.S.

And another move – which is the most important – is that their hoarding gold. . .

They saw the price of gold soar after the 2008 crisis. They realized that the Fed’s easing devalued the dollar – thus boosting gold’s value. Not to mention it’s historically the best universal money. 

Don’t forget that gold acts as a barometer for the dollar’s value.

When the price of gold rises – it’s not that the gold’s worth more, but rather the paper money’s worth less (i.e. it takes more cheaper dollars to buy the same gold ounce).

The countries that held huge amounts if gold saw their asset base surge as gold went from $700 to nearly $2,000 between 2007 and 2011.

And the countries that sold their gold in the 1990’s (I show this in the article I published earlier this week – read here), they missed out on this huge gain. And looked like serious fools for selling.

Therefore, China’s hedging their huge dollar reserves and U.S. debt holdings with gold.

So when the Fed eventually must ease and print money to cover the Treasuries massive liabilities – or to simply boost economic growth – China is hedged and protected from the devaluation. 

And even though China’s hoarding gold – they aren’t exactly rushing to publish how much they have.

Who would put all their cards on the table? Especially if you’re buying so much of something?

Imagine there’s a sale at Target for special goods. Would you go tell everyone else about it – or buy as much as you can before the sale ends or the crowd catches on?

Here’s the recent ‘official’ gold reserves held by China’s government. . .
 

 
Take their ‘official’ numbers with a grain of salt – but as you can see – the trend is that every few years they announce how much they’ve bought. Look at those big ‘stair-steps’ upwards. 

I expect the next time they announce the their gold reserves – it will be near 3,000 tons. And that will still underestimate how much they truly have.

But if you look at the research that actually tracks China’s annual gold mining output, private gold ownership, net-inflows, and official reserves – it’s nearing 20,000 tons.

That’s over 10-times more than what the ‘official’ reserves claim. . .

The point I’m getting at here is that China’s hedging against the dollar and the Fed’s eventual easing. They don’t want to be brought down by the U.S.’s inevitable debt and funding crises (especially when China has their own deep debt problems – but I’ll go in to that another time).

Just look at how badly Emerging Markets have suffered this year because of the Fed’s tightening and dollar rally  – China doesn’t want to end up like them.

China’s financial warfare tactics are complex and economists like Jim Rickards – author of Currency Wars – have tried to get the U.S. Pentagon and Treasury to be aware of such threats. And why gold’s so critical and will play an important role going forward. 

Hopefully they’re catching on – for all our sake.

I truly think the market will be surprised once China unveils how much gold they really have. Remember, big world changing events happen suddenly and randomly – don’t expect it to be calm and projected accurately. That’s how you lose your shirt.

The crowd always think they know something, then once the truth comes out – they scramble to re-position themselves. 

Putting it simply – expect the unexpected. 

Before I let you go – remember this: throughout history – the county with the most gold is the world power.  

Food for thought. . .

Did You Like What You Read? Get Our Free Exclusive Content
Enter your email below and you'll receive our 'Weekly Palisade Newsletter' covering Contrarian Ideas and Macro-Situations that the mainstream financial media ignores. You'll also get our Top Investment Ideas and Asymmetric Trading Opportunities right when we find them...
Don't worry - we respect your privacy

Get our Research for FREE