Sunday, April 24, 2011

Storm Clouds from The East

In the last twenty five years, the Gov't of China has been stashing US Dollars as a reserve.. and as their economy has grown, these reserves have become massive.. a little over three trillion, some of which are US Gov't Bonds as well as cash. This demand for US Dollars has held up the value of the USD for years now, especially of late since Bernanke has been printing USD like mad. It's been a cozy arrangement for both nations; it has allowed China to sell their goods to us and have the currency in which they sell it hold some value. China has, especially since the 2008 Lehman meltdown, warned us to stop printing money like madmen as it devalues the value of the trillions of USD they hold. Over the last year, and especially the last six months, China had experienced serious inflation.. especially for food and gasoline, which last week led to a huge protest by truck drivers at Shanghai's largest port. They have of late tried to raise the reserve requirements of their banks {which has the effect of curbing lending by Chinese banks} but this has had little effect so far. Much of the money in China is arriving via investments from abroad.. much of it in newly printed US Dollars thanks to The Fed's policies. Many have loudly accused Bernanke of "exporting inflation", and China seems to be one of the main recipients of this policy. For China this is a serious matter-- food and fuel expenses are a large part of a common Chinese family's budget, and if these continue to rise precipitously it might {as China's leaders have openly expressed} lead to unrest, as witnessed by the dock protests this week. This last week, the Head of the People's Bank of China {PBoC}, one Zhou Xiaochuan, had this to say: "Foreign exchange reserves have exceeded the reasonable levels we actually need. The rapid increase in reserves has led to excessive liquidity and has exerted significant sterilization pressure. If the government does'nt strike the right balance with it's policies, the buildup could cause big risks". This was his way of saying that China needs to reduce it's three trillion in excess reserves. Today came an even bigger warning from one Xia Bin, a member of the Monetary Policy Committee of the PBoC: "One trillion dollars would be sufficient. China needs to invest it's cash reserves more strategically by using them to acquire resources and technology needed for the real economy"  This could mean that China "diversifies" the other two trillion US Dollars. If this were to become China's policy.. and it looks increasingly like it will instead of simply revaluing their currency, it would mean essentially that China is going to unleash a flood of US Dollars to begin purchases of natural resources and technology. In short, it seems that China wants to spend them now before they become worth even less. To me, if they indeed take action, this would be a strong vote of no confidence by the PBoC. This would mean that the USD would lose value even faster than it already is. If you thought gas and food prices are high now, just wait until they begin this process in earnest. Over the last few days, the price of nearly all commodities.. silver especially.. has gone up sharply, and I'm thinking this action from China is a large part of the reason why. $5.00 gas anyone ? China has a habit of making loud warnings but doing very little when push comes to shove. But they have to do something to curb inflation in their own nation, and as yet seem quite reluctant to revalue the Yuan.

Meanwhile in Japan, it seems that their demographics are catching up with them in the wake of Fukushima. You see, Japan is the world's oldest nation.. and the number of citizens who are elderly is rocketing upwards.. and the cost of their social security and medical needs are also skyrocketing. The Japanese Government will have to borrow yet more money to keep up. Then came Fukushima, and the need to borrow hundreds of billions of Yen to rebuild the area. So far, the Japanese government has been extremely lucky in that their government can borrow from it's own citizens, who are willing to loan their government money at extremely low interest rates. When the people don't step up to loan the Gov't money, the buyer of last resort has been the Japanese Government Pension Investment Fund.. indeed about 2/3rds of the GPIF's money is in government bonds.

But this week, the GPIF.. thanks to an increasing number of pensioners and the ridiculously low interest rates they get back from their Japanese Gov't Bonds {JGB's}, announced that they had a shortfall in revenue of about $78 billion. From Reuters: "Japan's GPIF is planning to withdraw 6.4 trillion yen {$78 billion USD) from it's assets in the current fiscal year to cover a shortfall in pension payouts. The GPIF is likely to raise cash by selling JGB's and other assets in it's portfolio as pension contributions and tax income continue to fall short of payouts, which are growing because of Japan's rapidly aging population" 

Think about it.. at a time when Japan's government needs to borrow more and more money.. it's biggest cash cow is not only not loaning them more money, they're actually selling bonds.. and the JGB's that the GPIF throws onto the market will compete with the JGB's that the Japanese government will need to fund itself. In short, it means that Japan will likely have to raise the interest rates it offers on JGB's to keep itself solvent. The problem here is that Japan's government has the world's highest Debt-GDP ratio in the world. It owes so much money that even a small hike in interest rates {which would mean that Japan's government has to pay more of it's revenues to interest payments on its debts, and thus less to other things like Social Security and Medicare} might have big consequences. In short, Japan is a nation that is getting very old very fast and is enormously in debt. On the good side.. Japan has a lot of assets abroad.. including about a trillion dollars in US Bonds. One thing the GPIF could do is to dump the US Bonds instead of the JGB's onto the market, thus raising the interest rates our own government has to pay on it's own debt. While this $78 billion is not a huge amount in the grand scheme of things, it marks a serious turning point for Japan.. in the wrong direction.


  1. Enjoy your occasional posts. Keep em coming.

  2. Me too , I pick up nuggets of explanations that continually clarify the big picture on a global scheme, keep them coming Walt. Thank You

  3. Excellent post!