BarroMetrics Views: China Reserves
On Thursday last week, I read an interesting article in the Singapore Strait Times by Yu Yongding, President of the China Society of World Economics.
I found it interesting because on the one hand, the author did a fabulous job of analysing the problems facing China’s reserves: it is holding US Treasuries and US $ as its reserves; on the other, the author seemed to move from an analysis of reality to his own fantasy world when it came to providing solutions to the problem.
Let’s first look at his analysis.
The bulk of China’s foreign reserves are in US$ - about US$2.3 trillion is held as savings. Of that amount about US$900M is held in Treasury Bills.
Yu says (and I agree) that these reserves are facing a triple whammy:
- A possible mega US$ decline
- An increase in US interest yields (fall in prices)
- Inflation in the US and a consequent real value in US$ value.
Decline in US$
Yu argues that US$ must go South in the long term. The move started in 2002 and is likely to continue because unless US trade balances improve-but to improve , US$ must fall. So the US$ is caught in a vicious loop.
If the US$ loses value against other countries, this means that the value of China’s foreign reserves must depreciate.
Interest Rates
Yu says that because of the huge US Budget deficit, the US government must greatly increase offerings of interest securities. But here’s the rub: there is no guarantee that demand among foreign investors will be enough to accept the offerings. Consequently, as risk appetite returns, yields will rise and bond prices fall. As a result, the Chinese held US securities will suffer losses.
Inflation
Even if we accept US Government figures, it’s clear that the FED is targeting a 4% inflation. On this measure alone alone China reserves will lose value by 4%. And, there is a strong probability that inflation in the US will be greater than 4%.
All good stuff. Now all aboard for Fantasy Island’s solutions.
Because of the problems facing Chinese reserves, Yu suggests that the US adopt one of three measures:
- Replace Bills with TIP (Treasury Inflated Securities) and/or
- Convert US$ to IMF SDRs (special drawing rights) and/or
- If value cannot be safeguarded by other means, compensate,, China in some way.
Let’s see what this implies: If investors decide to hold US$ and US securities, and because of the investment, they lose money, the US Government should compensate them? And if the investments make money, the Chinese government should keep the gains?
Does Yu really think that the US government will come at this? Hey, what a great way to trade: if I lose, you take the losses; if I win I keep the gains. Please tell me where this game can be found!
This is a denial of reality, pure and simple - much like traders who enter a trade seeing only the upside. As a result, they fail to hold loss-cutting exit strategies and eventually blow their accounts.
Refer this blog post to a friend or colleague…
