China Sees the Writing on the Wall
December 16, 2005
The US trade deficit increased to $68.9 billion in
October with China's net exports to the US at $20.5 billion for
the month. This year's annualized deficit with China is now the
largest ever recorded in the history of the US. It is almost twice
as large as the deficit with Europe and almost three times as large
as the deficit with Japan.
Earlier this year, before I started harping on the
impact a downturn in the real estate market would have on the US
economy, I said that the dollar would weaken when either China or
Japan decided to stop supporting it by keeping their trade dollar
reserves off the foreign exchange market. I also discussed how China
and Japan could use their foreign reserves to stimulate their own
economies once the marginal benefit of supporting the US dollar
has diminished. Well, there was an interesting article in a Chinese
newspaper, called The Standard, on Tuesday. The newspaper quoted
Mr. Yu Yongding, who is a member of the monetary policy advisory
committee to the People's Bank of China, as saying that China should
weaken the link between the yuan (renminbi) and the US dollar, to
make the exchange rate more flexible and improve the government's
ability to manage the economy. Yu suggested that the weighting of
the US dollar in the basket of currencies against which the renminbi
is set should be reduced, reducing the impact that changes in the
US dollar would have on the value of the renminbi. The market read
this as a prelude to China allowing the dollar to weaken and its
own currency to strengthen.
On Wednesday Mr. Yu Yongding was quoted by the same
newspaper as saying that Chinese firms should get ready for a strengthening
of the yuan (renminbi) in the next one to two years. The "fuller
the preparations, the better," he said. He went on to say that China's
current account surplus and America's current account deficit are
reflections of savings and investment imbalances in the two countries.
He also said that the dollar would probably weaken unless the United
States tackles its current account deficit.
The same article mentions a research paper obtained
by Reuters, wherein Mr. Yu Yongding suggested China could reduce
the growth in its foreign reserves by running expansionary fiscal
policies and invest in infrastructure and research and development.
The gold price has been volatile this past week, and
I suspect that much of that volatility can be attributed to Yu's
comments. The rise in the gold price was in anticipation of dollar
weakness, and the subsequent decline was due to a comment on the
14th by the Chinese Central Bank chief, Zhou Xiaochuan, that he
does not see the need for the yuan to appreciate next year if the
country's trade surplus shrinks. Damage control.
The very witty Bill Bonner and Addison Wiggin have
written a new book, called "Empire of Debt". Bill Bonner has phenomenal
insight, and while many authors have belabored the debt-ridden state
we find ourselves in, perhaps it is Bill's assigned role to make
us more aware of how absurd today's common sense really is.
Here is a short quote from the book:
"I read in the Figaro that the American economy has
become completely dependent on China," said a friend at a dinner
party recently. "But I guess the Chinese have no choice. They need
Americans to continue buying their products."
We are alarmed. Even chemists and shoe clerks have
taken up macroeconomics. Everyone thinks he understands how the
world economy works.
"Well, it is a little like that," we began to explain.
"The Chinese do sell to the U.S. and they do lend money back to
the U.S. But there's no law that says this has to continue."
"Imagine a shopkeeper whose biggest customer was having
a hard time paying his bills. He extends credit . . . hoping the
man will get his finances in order. But the more credit he gives
him, the worse the man's finances are. It would be very nice if
that could work out. But it rarely does. Instead, it eventually
blows up. The customer has to stop buying and the shopkeeper has
to stop lending. There's going to be hell to pay, in other words."
"What should an investor do to protect himself?" our
friend asked.
"Buy gold."
Happy Holidays,
Paul van Eeden
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