Posts Tagged ‘US Treasury’

How does China ‘save?’ Story of the circuitous journey of a US$

Sunday, July 19th, 2009

One of the most common expressions that we hear today is that “China has a very high savings rate.” It is said that China saves 50% of its income. But as investors, we have to be very clear what this high savings rate mean. Does it mean that Chinese families and individuals, on aggregate, save 50% of their income? Certainly, the personal savings rate in China, on aggregate, is higher than the West. On the other hand, the Chinese, especially the younger generation, are emulating the profligate and spendthrift of their Western counterparts (see Chinese increasingly overdue on credit cards)- their rising credit card debt arrears and skyrocketing mortgage debt in the major cities shows that they are learning the bad habits of the West fast.

It is fair to say that the personal savings record of the Chinese does not fully account for the 50% savings rate. So, what does this high savings rate mean?

In reality, China’s high savings rate is the result of forced savings by the government. The Chinese government ‘forced’ savings on the Chinese people by accumulating massive US$2 trillion reserves (as foreign assets, notable US Treasury bonds) on behalf of their people through the currency peg. To understand how it all works, consider how the US dollars spent by American consumers typically ends up as US Treasury bonds in the US (China recently announced changes to the rules, which will affect the steps below):

  1.  An American consumer pays US$30 for an Oral-B electric toothbrush at Wal-Mart.
  2. Most of the US$30, say US$27,  stays in America to pay for the worker’s wages, distributions costs, transport cots, Wal-Mart’s profit, Oral-B’s profits and so on. This US$27 is part of the 70% consumer spending portion of the US economy. That US$27 helps to ‘stimulate’ the US economy.
  3. The remaining US$3 ends up in a factory in southern China. The deal between Oral-B and the Chinese manufacturer is denominated in US$ (i.e. the Chinese manufacturer is paid in US$). But US$ cannot be used in China because the RMB is the currency of China. So, what happens next?
  4. The Chinese manufacturer will present the US$ to a local Chinese bank (say, the Shenzhen Development Bank). He has to show the receipts to the Shenzhen Development Bank (SDB) to prove that the US$ is earned by trade and not through speculation.
  5. The Shenzhen Development Bank (SDB) will take the US$3 in exchange for RMB.
  6. This is where China is different from the West. In Western countries, a bank in SDB’s situation can do whatever it likes with the US$- e.g. trade them for euros or yen on the foreign-exchange market, invest them directly in America, issue dollar loans and whatever they think will bring the highest return. In China, the SDB has to surrender all of its US$ to the PBOC for RMB at whatever the official exchange rate (the RMB is ultimately created from thin air by the People’s Bank of China (PBOC)- see Why is China printing so much money?).
  7. Everyday, there are thousands of transactions between the local Chinese banks and the PBOC. The pile of US$ that keep piling up in the PBOC like crazy. Please note that trade with America is not the only thing that result in US$ streaming into China. Trade between China and other countries are also settled in US$, which means even more US$ are piled up in the PBOC.
  8. The PBOC transfers the US$ to the State Administration for Foreign Investment (SAFE). SAFE must figure out what to do with the rising pile of US$ (which is currently over the US$2 trillion). Some will be parked in US stocks, bonds, euros and so on. But the great majority ends up as boring US Treasury bonds.
  9. And so, the US$ makes a round trip back to America, hopefully to be used on Chinese goods again.

From this, you can see one thing: as long as US$ keeps streaming towards China, SAFE has to keep on investing them. Most of these US$ investments will end up as US Treasury bonds because it is the only market that is big and liquid (and politically sensitive) enough to absorb those never-ending stream of US$. Therefore, no matter how much China dislikes holding its forced savings as US$ assets, it has no choice.

But lately, China had announced some changes in rules that will hopefully alter the status quo (which they detest). Keep in tune!

If you save, government will wage economic war on you

Tuesday, February 17th, 2009

In this economic climate of uncertainty, governments all over the world have to be seen to be doing something. The problem is, by doing ‘something,’ they are actually making the problem worse (see Are government interventions the first steps towards corruption & inefficiencies? and Supplying never-ending drugs till stagflation). In particular, they fear debt deflation because it is the more immediate threat. It is this fear that led Helicopter Ben (i.e. Ben Bernanke) to subscribe to the Zimbabwean school of economic thought (see Bernankeism and hyper-inflation) in the Keynesian belief that forcing people to spend and consume is the way to go. If printing money are the answers to the Global Financial Crisis (GFC), then Zimbabwe will be the richest and most prosperous nation in the world. Indeed, judging by the number of billionaires, in that country, it must be so! When you see Zimbabwe’s central banker praising the central banks of US and UK (see Zimbabwe?s central banker in praise of Fed), you know something is very wrong with the monetary policy of the Federal Reserve.

As we said before in “Government?s contradictory messages,”

Without the liquidation of mal-investments and restoration of the structural imbalances that is brought about by deflation, applying bigger and bigger stimulus packages will only function in similar ways to drugs- more and more for less and less effect. The reason why Keynesian reflationary pump-priming worked during the Great Depression was that it was applied after the cleansing effects of the deflation had done its work. But today, in reaction to the financial crisis, governments all over the world are doing so before the purge of fire. As a result, the much-needed economic correction that the economy had to have will not happen.

Thus, whether you are currently in debt or not, if you intend to save money, the government will be very keen to discourage you from doing so by undermining and debasing the currency in which your savings are based on. As we said in “When real interest rates is below zero, why save money in bank?

 … if we disregard the doctored statistics of the official figures, real interest rates are negative!

That is why governments all over the world are sending so many mixed messages to the effect that an average person do not know whether he/she is meant to spend or to save (see Government?s contradictory messages). A very simple way to resolve this paradox (sarcastically) is to think of it this way: save while everyone else is committing financial suicide by spending willy nilly.

What if you are a saver who simply does not wish to spend, invest, borrow or speculate? If you believe that the government will fight this war against debt deflation by marching our credit-based economy towards a Zimbabwean-style economy (see Recipe for hyperinflation), you will be forced to make very difficult choices. For such a saver, the best case scenario for your savings will be severe price deflation in an environment of zero-interest rates in a properly functioning banking system (while still employed/business earning positive cash-flow). But if you are pessimistic about this best-case scenario happening, then you will be forced to ‘speculate.’

As the government and RBA try to erode your savings by taxing them and pushing down interest rates to below price inflation (even perhaps to zero), what can you do? Good question.

Let’s take a look at the US. Currently, short-term US Treasury bonds are yielding almost nothing. At one point, their yield even became negative! In that case, what will be the difference between a nothing-yielding government bond and gold? As we said before in “Is gold an investment?“, gold is

a boring, inert metal that does not have much pragmatic use and does not pay dividends, income or interests, it is completely unfit for ?investment.?

That probably explains why we are seeing, at least for now, US Treasury bonds and gold moving upwards together. Traditionally, they move in opposite directions. Today, this inverse relationship seems to have decoupled.

Therefore, the risk/reward profile has come to the point that savers who have spare cash may want to consider transforming part of their savings from cash to gold.

P.S. Use the government’s free stimulus cash to buy gold. 😉