|China Only Holds A Small Percentage Of US Debt|
The main reason China bought up so many U.S. Treasuries over the years is that it wanted its currency pegged to the dollar. Dollar-pegging adds stability to the yuan since the dollar is viewed as one of the safest currencies in the world. This has been a common practice for many countries since the 1944 Bretton Woods Conference. Still, even though China owns these U.S. Treasuries, China is running a massive U.S. dollar shortage both on a corporate and a national level. Much of the problem stems from Chinese companies having roughly $2 trillion U.S. dollar-denominated debt owed to international investors.
Loans of this type are not uncommon, especially in developing nations. Much of global debt is denominated in U.S. dollars. This means the companies owing it need to pay both the principal and the interest payments to their lenders in U.S. dollars. This results in a demand for dollars and usually a constant flow of dollars out of the country. This is a totally separate issue from individuals or companies shifting wealth out of China to avoid the pain of currency devaluation or to escape its repressive regime. An article titled; China Continues To Prop Up Its "Unpropable" Economy, delves into how China continues to prop up a financial collapse and how China suffers under crushing debt. It contends due to the huge amount of debt China's demise can only be postponed but not stopped.
|China's Debt Soared After 2008 (click to enlarge)|
Many of us are drawn to a good illusion and in some ways, it could be said that our culture has become obsessed with avoiding what is real. With this in mind, we must remember that politicians and those in power tend to go to extreme efforts to avoid taking responsibility for the problems they create and this has been done in China. History shows that one way a country can kick their gross domestic product higher is to build a false economy based on infrastructure or war. China's version of this is apparent in its "ghost cities." Unfortunately, when a country gorges at the trough of deficit spending that generates a big temporary boost in its GDP it also creates a wall of debt. One of the best examples of building an economy on such a foundation was demonstrated by Germany when it turned its economy into a war machine during the 1930s.
To understand the ramifications of the situation China now finds itself in we need only look at the finding of the 2009 bestselling book titled, "This Time Is Different." The book written in 2009 by Carmen Reinhart and Kenneth Rogoff. It chronicles eight centuries of financial follies in which financial meltdowns have typically followed real-estate bubbles, rising indebtedness, and gaping deficits. Their work adds credence to the belief that debt has consequences. The authors highlight a clear pattern of similarity between many of the defaults that have occurred throughout history and the situation developing today. Debt has been growing at an incredible rate across the globe but even more in China.
For years as they debate the true strength and sustainability of China's economy and its role as a global player has been debated by China watchers, economists, and investors. Those of us that paint a picture of future collapse and a day of reckoning are often accused of spreading "doom-porn" when we claim that the Chinese have masked over their dire situation by continually expanding credit. It is important to note that over the years each new wave of money has begun to lose its impact as the efficiency of stimulus waned and more and more of the credit was absorbed in supporting existing debt. The fact is few good investment opportunities currently exist in China and this causes much of the newly printed money to leak across the border inflating asset bubbles in other countries.
|China's Yuan Is A Small Player (click to enlarge)|
In our modern global economy, a huge percentage of our wealth is contained within the rather closed system of fiat money. The laws and rules governing this system by their nature discourage freedom of movement into tangible assets. History shows that when the nations granting a currency have proven unable to control their budgets and are crushed under the weight of debt bad things happen. This situation frequently results in inflation. A key reason inflation has remained so low since 2008 is because people have been willing to store their wealth in paper instruments. The good people of countries like Argentina, Venezuela, Iran. and Turkey that held on to their country's currency have been financially raped as the currencies have fallen in value. Today they are far less wealthy compared to people in countries that have seen their currencies remain stable.
The rubber will meet the road as more countries that export to China question the value of the Chinese currency and demand payment in dollars and refuse the yuan. While China enjoys a trade surplus with America this is used to support trade deficits with many other nations. If at some point China decides to or is forced to sell its FX reserves to get access to U.S. dollars to help prop up systemically important firms it becomes a bit of a self-defeating exercise. When a currency implodes or fails, wealth is transferred from those improperly invested to survive such an event to those positioned to benefit. The canary in the coal mine portending of such an event may be the stories we hear of central banks and countries buying gold. In the future investors would be wise to prepare for a rude awakening due to a huge shift in the values of currencies.
Footnote; A recent article by on The Sounding Line delves into the idea the Chinese stimulus is not working anymore. The link to that article can be found below.