|
Mr. Hu Jintao, the Chinese President, is scheduled
to visit Washington later this month while the United States
continues to put pressure on China to let its currency appreciate
against the dollar. It seems China is going to comply:
In December Mr. Yu Yongding, who is a member
of the monetary policy advisory committee to the People's
Bank of China, said that China should weaken the link between
the yuan (renminbi) and the US dollar, to make the exchange
rate more flexible and improve the (Chinese) government's
ability to manage the economy. Mr. Yu suggested that the
weighting of the US dollar in the basket of currencies against
which the renminbi is set should be reduced; thereby reducing
the impact that changes in the US dollar would have on the
value of the renminbi. Mr. Yu also said that Chinese firms
should get ready for a strengthening of the yuan in the
next one to two years. The "fuller the preparations,
the better," he said.
In January China said that it would allow
interbank spot trading (i.e. not futures trading) of its
currency - a major step towards a less restricted foreign
exchange regime in China.
Another significant announcement came from
China’s State Administration of Foreign Exchange (SAFE)
that said China should diversify its massive foreign exchange
holdings, which are predominantly held in US dollars. SAFE
gave no specifics and no hint as to any kind of timetable,
but this is not the first time that we have heard such rhetoric
from Asia.
The BBC reported this week that Chinese Parliamentary
vice-chairman Cheng Siwei suggested China might reduce the
amount of US bonds it holds as part of its foreign exchange
reserves. China’s Central Bank was quick to point
out that Mr. Cheng was speaking in his private capacity;
however, with President Hu Jintao’s imminent visit
to Washington I find it hard to believe that Mr. Cheng’s
opinion is an aberrant opinion. His remarks led to a decline
in the US dollar and a concomitant increase in the gold
price this week. Gold is within spitting distance of $600
an ounce.
Perhaps less widely publicized, but potentially
far more important, is the increase in long-term US interest
rates. The benchmark 10-year Treasury fell this week causing
the 10-year interest rate to rise to 4.971% - a four year
high.
Why are US bonds falling, causing interest
rates to rise? Because if the Chinese allow their currency
to appreciate against the dollar it implies reduced purchases
of US Treasuries by China. Japan has already curtailed its
purchases of US Treasuries and, in fact, Japans holding
of US Treasuries is busy declining.
The mechanism by which China and Japan have
been supporting the US dollar is to buy US Treasuries instead
of selling US dollars into foreign exchange markets. If
they are forced by Washington to let the dollar fall, it
means they will have to buy less US Treasuries; hence, a
falling US dollar will go hand-in-hand with rising US interest
rates, exactly what has been happening recently - and as
predicted in these pages.
Note, however, that it is not short-term interest
rates, over which the Federal Reserve has considerable control
that we are looking at; it is longer term interest rates,
which are set by the market, that will tell us what is going
on.
An aspect of the current situation that is
being ignored is that US government debt is about to explode.
Rising interest rates mean the interest burden on US debt
is rising. But, higher interest rates will put a drag on
the economy and I do not, for a minute, believe that the
current jobless economic expansion is going to last. I am
afraid that a more realistic expectation is a slowdown in
economic activity, which will lead to reduced tax receipts
by the US government. In addition, there is no reason, whatsoever,
to think that the US government is about to curtail its
spending; rather, if the economy does slow down, there is
some reason to believe the government will try to stimulate
it by increasing its deficit spending. Thus we are looking
at reduced income for the US Treasury in the future and
an increase in government expenditures and a higher interest
burden on the burgeoning outstanding Treasury debt.
Many people pooh-pooh the US debt situation.
Let me try to put it in context for you. The US Treasury
has a hair under $8.4 trillion in outstanding debt. Did
you know that if you deposited one million dollars into
a bank account every day, starting 2006 years ago, that
you would still not even have ONE trillion dollars in that
account. If you deposit one million dollars into a bank
account every day it would take 23,000 years to accumulate
$8.4 trillion dollars.
Maybe you don’t like to think that far
into the future. Perhaps a trillion is just too big a number
to comprehend, so let’s think about billions. During
the past six months, since the beginning of the current
fiscal year, the US government’s debt has increased
by $456 billion. On an annualized basis that is $912 billion.
The US government’s debt increases at the rate of
$2.5 billion per day, including weekends. How much is a
billion? A billion seconds ago it was 1974 and one billion
minutes ago Jesus may still have been alive. Next time someone
tosses the word “billion” or “trillion”
around casually you should ask if they actually know how
much it is.
It might be true that the US economy is very
large, and many people believe the US economy is large enough
to carry the humungous amount of US debt. Personally I believe
that US economic growth is overstated but, even if we assume
the official numbers are correct, then US economic growth
is only about 2% to 3% per year. The US government’s
debt is currently growing at an annualized rate of 11.5%
and, as I explained earlier, that growth rate is about increase.
The amount, and the growth rate of US government
debt, coupled with the possibility that China will have
to reduce its purchases of US Treasuries to comply with
the wishes of Washington, means that US interest rates could
soar. Again, we are not talking about short-term rates here,
but longer-term rates: The five-year rate on which auto
financings are based, and the twenty and thirty-year rates
on which mortgage rates are based. This is bound to hurt
US consumers, corporations and the US economy and it will
occur in conjunction with a weakening US dollar, which means
higher gasoline prices.
A weaker dollar also means higher gold
prices.
Paul van Eeden
P.S. If you enjoy reading these commentaries
I suggest you go to my website at http://www.paulvaneeden.com/commentary.php
and register to get them by email. Rest assured that I do
not sell or rent any of my subscribers' email addresses.
Paul van Eeden works primarily to find
investments for his own portfolio and shares his investment
ideas with subscribers to his weekly investment publication.
For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
******
This letter/article is not intended to meet your specific
individual investment needs and it is not tailored to your
personal financial situation. Nothing contained herein constitutes,
is intended, or deemed to be -- either implied or otherwise
-- investment advice. This letter/article reflects the personal
views and opinions of Paul van Eeden and that is all it purports
to be. While the information herein is believed to be accurate
and reliable it is not guaranteed or implied to be so. The
information herein may not be complete or correct; it is provided
in good faith but without any legal responsibility or obligation
to provide future updates. Neither Paul van Eeden, nor anyone
else, accepts any responsibility, or assumes any liability,
whatsoever, for any direct, indirect or consequential loss
arising from the use of the information in this letter/article.
The information contained herein is subject to change without
notice, may become outdated and will not be updated. Paul
van Eeden, entities that he controls, family, friends, employees,
associates, and others may have positions in securities mentioned,
or discussed, in this letter/article. While every attempt
is made to avoid conflicts of interest, such conflicts do
arise from time to time. Whenever a conflict of interest arises,
every attempt is made to resolve such conflict in the best
possible interest of all parties, but you should not assume
that your interest would be placed ahead of anyone else’s
interest in the event of a conflict of interest. No part of
this letter/article may be reproduced, copied, emailed, faxed,
or distributed (in any form) without the express written permission
of Paul van Eeden. Everything contained herein is subject
to international copyright protection.
|
