Archive for September, 2010

Pay attention to China-US currency tension

Monday, September 27th, 2010

Last week, in What can you do to protect yourself from increasing currency volatility?, we wrote about the rising currency/trade tension between the US and China is flaring up again. While such tensions are hardly common occurrence in the love-hate mutual co-dependency relationship between the two giants, this current one has reached a a new high point.

Last week, US politicians have agreed to vote on a bill to retaliate against perceived Chinese currency ?manipulation? with trade sanctions (see US Congress committee approves China sanctions bill). For this bill to become law, the two Houses of Congress (House of Representatives and Senate) have to approve of the bill. This coming week, the House of Representatives is going to vote for it. But it is unclear whether the Senate will support this bill before the November mid-term elections.

If this bill comes into law, and if the Obama Administration decide to slap China with draconian trade sanctions against China, then outcome will be a trade war between the world?s two largest economies. The Chinese will definitely retaliate, sparking another round of retaliation from the United States. The outcome will be mutually assured economic destruction.

Some prominent American economists (e.g. Paul Krugman) in the United States that a trade war will hurt China more than it will hurt the US. This is because they subscribe to the theory that a trade war will disrupt vast swathes of the Chinese export-oriented economy, which in turn will result in social and political instability that will threaten the legitimacy of the government. Hence, these economists are very keen and aggressive with the idea of imposing trade sanctions on China. But as we wrote in Will China fall under popular revolt?,

? this school of thought do not understand the cultural and political reality of modern China.

However, there is a subtlety that you have to understand- Yes, the immediate impact of a trade war will probably be more painful for China initially. The idea is that, as we wrote in Can China really ?de-couple? from a US recession?,

This will translate into a disproportionate contraction in the higher stages of production, which is China?s job. This in turn will result in yet another disproportionate contraction in yet another higher stage of production.

But we do not subscribe to the theory that this will result in political upheaval in China. Instead, we believe a trade war will fan the flame of nationalism in China and strengthen the position of the Chinese regime.

Regardless of who wins in a US-China trade war, countries like Australia and the rest of Asia will suffer as collateral damage. As the saying goes, when two elephants fight, the grass below will suffer.

Has gold reached its zenith?

Wednesday, September 22nd, 2010

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What can you do to protect yourself from increasing currency volatility?

Sunday, September 19th, 2010

Six months ago, we wrote about America’s consideration to label China as a “currency manipulator” in Watch April 15 2010: simmering tensions between US and China. Just before the deadline, China appeared to make a little concession about their RMB, thus avoiding the “currency manipulation” label.

Today, currency tension between the US and China is rising again. The little concession that the Chinese government made was simply not enough. American lawmakers are getting impatient and are itching to enact laws to slap China with trade sanctions. Should that happen, it will be the beginning of a damaging trade war between the world’s largest economies. Their charge is that China’s artificially low currency is responsible for (or at least contributed to) America’s economic woes. But as we wrote in Watch April 15 2010: simmering tensions between US and China,

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China?s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America?s unemployment rate. By implication, it is perceived that with China?s official unemployment rate much lower, China is ?prospering? at America?s expense.

Currency tensions between China and the US are nothing new. As we wrote in that article, it’s been around for the past 3 to 4 years. Many times, the rhetoric about America labelling China a “currency manipulator” came and went away without eventuating into reality. However, that does not mean that it will never happen. As America’s economic woes worsen, the pressure to find a scapegoat will increase. As a result, the probability of a trade war will increase.

The Chinese, on the other hand, are not standing idle, waiting for a trade war to happen. For starters, they are establishing trade and investment links with Asia, Middle-East and Africa. Secondly, it is no secret that they have been diversifying their colossal hoard of reserves away from the US dollar. Given the well-known intention of the Federal Reserve to print more money, diversification has become increasingly urgent. But that in itself is not easy because given the colossal size of the money involved, any whispers and hints about any particular Chinese diversification strategy will move the markets quickly in a big way. For example, the recent rumours that China was buying up Japanese government bonds probably helped to contribute to the surging yen. As a result, the Japanese government became very unhappy because a very strong yen will negatively impact on their export-oriented economy. In response, the Japanese government may take concrete actions (beyond just talking about it and taking token measures) to weaken the yen, in which the end result is more Japanese purchase of US government debt.

In such an environment of competitive currency devaluation and price volatility, what should investors and savers do?

To us, it is clear that having all your savings and investments confined to a single country or currency is an increasingly risky proposition. Currency exchange rates will become more volatile, with implications on asset values, price inflation and economic growth (see Real economy suffers while financial markets stuff around with prices). For example, in Japan, real businesses are suffering as a result of the rising yen. The Germans, on the other hand, are secretly gloating whenever the euro weakens. In Australia, should the banking system fall into a crisis as a result of the bursting of the property bubble, the consequence of a resulting collapsing Australian dollar will be price inflation (see Can price inflation occur in the midst of debt deflation?).

If currency volatility goes to the extreme, investors will even have to question the idea of national currency as a store of value. So, what can investors and savers practically do to mitigate against this?

Quite some time ago, we talked to the guys at and learnt of how a lot of their clients (presumably the “rich”) use them. In case you do not know, (a regulated company operating in the financial services industry) enables

… you to hold gold, silver & platinum that is fully insured and stored securely in specialised bullion vaults in London, Zurich and Hong Kong. All metal is owned directly by you with no counterparty risk.

You can “easily buy gold, silver & platinum and take delivery of physical bars of gold.”

What their clients did was to use their account as a conduit to link their bank accounts all over the world. This strategy makes sense as it gives investors and savers the flexibility to shift their savings all over the world, using gold, silver and platinum as an anchor for the store of value. In an environment of currency volatility, this flexibility is a valuable aid in helping to protect your hard-earned savings from hare-brained government interventions.

However, for those who are ultra-pessimistic and distrust any assets that have any hints of paper, the only way to go is to take possession of physical gold and silver (see How to buy and invest in physical gold and silver bullion).

Is Chinese iron ore demand going to crash (thereby crashing the Australian economy)?

Sunday, September 12th, 2010

Last Thursday, an article in the Sydney Morning Herald screamed, Slump likely in iron ore demand,

Chinese demand for iron ore seems set to slump after Beijing’s extraordinary move to turn off the power supply to its industrial heartlands.

There seemed to be fears in the industry that the Chinese government is slamming on the brakes on their economy. As the article continued,

Radical power cuts across the country reflect the promise of the Premier, Wen Jiabao, to use an "iron fist" to achieve tough, five-year energy intensity targets that expire this year.

There seemed to be an air of incredulity floating around. Is the Chinese government really hell-bent in crashing their own economy? As one of Macquarie Bank?s commodities analyst said,

You can’t just turn steel production off and expect the economy to function – it’s insane.

If the Chinese government are really that insane, then it doesn?t take a genius to figure out that iron ore prices will slump significantly going forward. Share prices of companies like BHP will follow as well.

But are they really that insane?

To answer this question, we recalled a comment by one of our readers (Paul in Beijing) in Concerns about China?s slowdown,

Put this in your diary. The restrictions will last until November. By December this year, production of key items such as steel and cement will be returning to full pelt.

As Paul said in Do you think China will crash soon?, we are now at the final months of China?s 11th five-year plans.

The first is that the 11th 5-year plan is now just a few months away from concluding. As in all political situations, it is of paramount importance for the current leadership to return an unblemished report card at the next Plenary meeting of the Communist Party. Hence the attacks on inflation, energy intensity and other issues.

What we think has happened is that on the issue of emission targets, the Chinese government realised that they were not going to reach it at that rate it was going. They had a set of numbers for the targets to reach by the end of this year and they realised that they weren?t going achieve that based on the status quo. Hence, the urgency to slam on the brakes so that at least where the aggregate numbers were concerned, they had done their job.

Why is it so important to reach the targeted numbers? Some say it?s a matter of saving face. That is, not reaching the targeted numbers is humiliating for the government. Others say it is a matter of having a perfect report card for the Hu-Wen team. That is, reaching the targeted numbers is another tick in their report card.

But assuming that by December, the restrictions are relaxed, the Australian economy is still not out of the hook yet. As Paul said,

The second point is that the 12th 5-year plan has not yet been promulgated. Already there are rumblings as to what it might include. The China Nonferrous Industry Association, for instance, has drafted a plan that would limit the capacity of alumina, aluminium and copper over the next 5 years. If such a plan were to be introduced, it would have massive repercussions for the world (buy UC Rusal shares for a start!).

In hand with this is the fact that the current leadership has only 18 months left in their tenure. The next generation of leaders has apparently been tapped and is being groomed. But unlike the present pair, the next generation come from opposite factions within the CPC. their ability to lead harmoniously may well be sorely tested! (Should they fall out, it would leave the Howard-Costello schism, or the Gillard-Rudd antagonism, for dead.

This is what we have to watch out for!

Divergent view of Australian economy between domestic and foreign investors

Sunday, September 5th, 2010

Back in If the Australian economy ?booms? further, how is it setting the stage for a bigger bust later?, we wrote that

? as Australian-based investors, we are looking into increasing our allocations to investments that have greater exposure overseas

Increasingly, foreign investors seem to be concurring with our outlook. For example, as we wrote in What do overseas property investors see that Australian property investors don?t? foreign investors are getting more nervous about Australia?s housing market.

As this article in The Australian reported,

The Weekend Australian spoke to senior traders in New York, London and Hong Kong to gauge the appetite for investing in Australia. The overwhelming response was that global institutional investors are wary, despite the economy having emerged as one of the best performing in the world and avoiding a recession.

In fact, the debt market is predicting a small chance of interest rates cut next year. Currently, financial markets is pricing in a 40% of a rate cut of 0.25% by the first half of 2011. You can be sure that if the RBA ever cut rates, it will be in the context of bad news in the economy. As we wrote in What will happen if RBA cuts to zero?,

If Australia?s interest rates ever reach zero, it will happen in the context of a hard landing or even a depression.

Yet, on the other hand, forecasters in Australia are expecting that rates will continue to rise in 2011. For those of us residing in Australia, it is very clear from observing the mainstream media reports that the mood is pretty optimistic.

Since foreign investors have less of a stake in Australia than domestic investors, they will have the attitude of shooting first and asking questions later when they see trouble. That will translate to volatility in the AUD and stock market. That in itself can become a self-fulfilling prophecy.

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Wednesday, September 1st, 2010

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