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
"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
Paul van Eeden
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