What if China plays the nuclear option?

Investors in gold are curious. And no one delights more wondering “what if” than gold investors.

It is not difficult to understand why. We are a shady bunch, uncomfortable with the status quo, unwilling to follow the media-fed herd. We got into gold, in part, because, we might well admit, we don’t have all the faith in the world in traditional stocks, bonds, and dollars. Many of us suspect that one of these days, gold will revert to its historically recurring role as a currency of last resort.

The fact is, if China has anything to say about it, that day may not be as far off as some of us think.

What happens if China stops buying Treasuries?

China has $ 1.4 trillion in foreign exchange reserves. That number alone is staggering enough, especially if you’ve ever heard how big a trillion is. One researcher thought that a trillion grains of salt could easily fill a classroom.

No matter how you look at it, it is quite a large number. And China has more than a trillion of our dollars.

However, don’t worry. As long as the Chinese are willing to absorb our excesses and buy US Treasuries (they already have about $ 400 billion) at the rate they have been, this Rube Goldberg gimmick that we call the economy can, I suppose, continue.

But what if Beijing has other ideas?

For example, a Chinese official, Cheng Siwei, vice president of the National People’s Congress, shook the world when he declared that his nation should take advantage of the appreciation of hard currencies by diversifying its 1.43 trillion in weak dollars. . This is the supposed nuclear option. Wall Street noticed instantly: the Dow sank 350 points.

That was preceded by surprising news from China’s Finance Minister Renqing that China will soon create one of the world’s largest investment funds, a fund that could make the United States adapt to the way we raise that. ” solution “of 2.100 million dollars that we each need. and every day to fund our record budget deficits.

“We can get more profit from other investments,” Renqing told a news conference, insisting on the obvious.

Treasury securities, you see, yield just under 3 percent on China’s $ 1.4 trillion … even as other governments in the region are doing much better. Temasek Holdings, the investment arm of the Singapore government, for example, claims it is averaging a whopping 18 percent annual return. Needless to say, boasts like that are making the powerful Chinese anxious.

But whether China succeeds in reaping greater rewards or not, its change in investment strategy could well leave the United States facing a monstrous deficit dilemma: If China does not finance our debt, Then who?

Unintended consequences

Of course, the Chinese nuclear option is not as simple a matter as the media sometimes portrays it.

China obviously has to be very careful that its currency stays low against the dollar so that we continue to buy Chinese products. You don’t want to end up being just another “expensive foreign import” and slit your own economic throat.

Furthermore, a Chinese “direct sale” of US Treasuries could have the opposite effect: ditching Treasuries would make them cheaper, the cheaper they are, the higher their effective yield …and the most attractive T bonds could turn out to be.

The mere possibility that the Chinese could face serious losses by disposing of their American assets should make the nuclear option unlikely. What is more likely is something said by Benjamin Reitzes of BMO Financial Group: “If China began a liquidation sale of its US dollar assets, it would face prohibitive losses. A more likely scenario would be for China. to stop accumulating US dollars, not a direct sale. “

Which would not be good news for the United States, either. Without a doubt, there could be serious consequences.

For example, would China’s action accelerate similar actions by other nations? As it stands, several potential dollar defectors are lining up, including Saudi Arabia (the kingpin of $ 3.5 trillion holders in the Middle East), Iran, Venezuela, South Korea, Sudan and Russia.

Gold “Out of Circulation”

None other than Sir John Templeton, founder of the Templeton Fund, believes that the dollar is in grave danger.
The Templeton setting looks something like this …

When and if China and Japan sell the dollar, the Fed will have no choice but to raise interest rates to attract $ 2.1 billion in new capital that we need to feed our monstrous deficit. However, those continued rate hikes will lower corporate profit margins and send an ominous signal to the stock market. Rising rates will further decimate the nation’s real estate industry. This will put a free hand over any recovery. Then stagflation could set in, a combination of economic stagnation and inflation. American consumers, seeing their living standards decline, will hold back spending and that will send another shock wave to the economy.

On a stage like that, with a sunken dollar and inflation out of control, gold could emerge as the only medium of exchange worth exchanging. That is if it is even available. Analyst Nick Guarino wrote about harsh conditions that could essentially take gold “out of circulation.”

The good news is, lastly, check at least that you could get as much precious metal as you want. As Bill Bonner once rightly put it: “While the dollar could never say ‘no’, gold says nothing more: no to debt. No to new spending schemes. No to a better world. No to re-election of the scoundrels. No to bubbles. No to foreign wars. No to trade deficits. No, no, no, no, no. “

To that I could add one no more: gold also says no to you who suffer should China, or anyone else, play with the nuclear option.