Unpegging China
David Chuhran
A couple of weeks ago one of the topics at the G7 + China meeting was the unpegging of China's currency, the Yuan (Renminbi). Although no agreement was announced and China appeared to balk, there have been several reports of high level discussions (including the President) since that meeting interpreted by some as "a signal that something may happen after all."
There could be some serious consequences of the unpegging process, especially if it happens quickly. USDollar denominated debt instruments that are held by the Chinese are actually dollars that have been removed from our money supply. They were created from debt, as all of our money's origin is debt, and then they were removed by the Chinese using existing dollars from their trade surplus. Tough concept, but trust me it's money supply neutral.
We've had astounding trade imbalances causing us to print more and more money that's never reflected in the domestic money supply. That money still exists, but it's dormant and stands as an unsatisfied claim against the United States. It was accepted by the Chinese as payment for goods and then recycled into USTreasuries resulting in a weakening of the Yuan relative to the USDollar. That's one of the mechanisms used by the Chinese central bank to maintain the Yuan's peg. That increased demand for our bonds has also facilitated low interest rates as the bond prices rise causing their yields to fall. This relationship has allowed us to live-beyond-our-means by exporting the inflationary effects of an increasing "real" money supply while not suffering the consequences of domestic price inflation.
China gets to build new factories and sell us stuff; we get to buy cheap stuff with printed dollars.
That relationship may be changing. China's overheated growth has fueled a voracious appetite for raw materials and we're readily seeing that in the price of Oil. Recently, China Minmetals has made a $5.5 billion bid for Canada's Noranda which is one of the world's biggest nickel and zinc producers.
And even more recently:
"China eyeing investment in Alberta oil sands"
"CALGARY -- Sinopec Corp., the giant Chinese energy company, is eyeing a major investment in Alberta's oil sands -- perhaps even its own project -- as it pushes to secure supplies for its booming home market.
"That push comes even as the United States increasingly looks to the oil sands as a secure source of supply for its own uses, with terrorism and other geopolitical upheaval threatening conventional oil production overseas."
So, what happens when all those dollars come out of hibernation?
This may be a sign of the initial stages of the unpegging. If China stops funding a portion of our nearly $3 billion/day twin deficit needs, through their purchase of USTreauries, we'll see bond demand fall and yields rise. Sure, the Fed could step in and "monetize," but that's inflationary as it creates new dollars that didn't previously exist.
Also, if they take the proceeds of their $10+ billion/month trade surplus and begin to buy up large North American base metal and oil deposits, then those uncounted, dormant dollars will come washing back ashore causing domestic price inflation. Not only that, but the Chinese will now control huge strategic deposits of North American resources. Finally, without the Yuan currency exchange demand for USDollars on the Forex, the Yuan will "unpeg" and begin to rise relative to the USDollar causing Chinese goods to become more expensive resulting in even more price inflation.
Bottom line: This could spell higher inflation and higher interest rates.
Much higher!
David Chuhran
goldwings@bellsouth.net
Copyright © 2004 David Chuhran. All Rights Reserved
October 15, 2004
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