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Guest Post: Thinking Through The Implications Of A Chinese Bubble Economy; Why Gold Is The Only Answer
Submitted by Gary Jeffery
I know there is still a great debate on whether the Chinese economy is in a great bubble state. For my thinking, any time private credit is created at such as rapid rate as it was in China in 2009 something has got to give somewhere. I will leave the finer points of the debate to the China watchers, but it is clear where my thinking on this one lies.
I also think it makes perfect sense for the Chinese monetary authorities to want to engineer a bubble, given the other potential alternatives. Ultimately when any bubble pops, as we have seen in any number of emerging market blow ups, private citizens (domestic/ foreign) attempt to flee the imploding (inflation ravaged) currency – thereby ultimately by fiat or market forces a currency is devalued. However China is really big and different – and this is ultimately why the whole global monetary system is not behaving as “most” mainstream punters are predicting.
We all know that China would prefer a devalued currency (export competitiveness) so surely a massive domestic bubble popping should be a slam dunk for Chinese policy makers. Well yes and no. On the yes side, we have the mercantilist exporters and those sufficiently able to lever and secure private “hard” assets prior to the pop. On the no side we have low income earners ravaged by imported/commodity related inflation. Or to put it another way, so long as Chinese bureaucrats can appease and/or sufficiently compensate these low income earners then the bigger the bubble the better.
However, China has some special features as well as enormous size that complicates market behaviour prior to and after its inevitable bust. The main features are 1) US$2.3 trillion (approx.) of foreign reserves, and 2) limited currency convertibility; and 3) limited truly private national champions, that is most large corporations are state owned/controlled in some manner.
Why due these matter?
For the world to rebalance/ be closer to balance, China will have to at worst stabilize its Foreign Currency reserves but more likely have to actually reduce its overall balances. In a world of double entry book keeping this means running a trade deficit. Or more simply they will have to spend more foreign currency than they earn. But China is severely limited in its ability to “spend” this money without truly blowing the inflation genie’s bottle right up domestically. Ideally, China would prefer to “spend” this money in a manner which both reduces/has minimal effect on domestic inflation and acts as a store of value for the Chinese people. So this boils down to buying/securing foreign assets or other assets that are inflation hedged. However, the buying/securing of foreign assets in large chunks (remember the size of the reserves – these purchases need to be enormous) is severely restricted due to the extensive government ownership and/ or control. In effect, host governments are not keen on foreign governments having some control/ownership of key domestic resources/ assets.
Also, with only limited domestic currency convertibility Chinese private citizens and corporations also only have limited ability to spend or hoard the foreign currency, rather than redeeming it for a rapidly bubbling and likely popping domestic currency with their Central Bank. Nonetheless, they are doing their best with private stores of copper, in particular, plus other key commodities being stockpiled (i.e. foreign currency hoarded) in record volumes. Wonder why Australia didn’t have a recession?
It is the combination of all of these factors that has polarized the inflation / deflation camps.
This game can have only one ending. China is incentivised to blow an enormous bubble. This bubble will pop. Global heads of countries that matter (let’s call it Gee Whatever!) are all called to somewhere, hopefully private, to agree to some new global currency accord and capital account rebalancing.
So how does China rebalance its accounts? In effect China will want to secure as many inflation protected reserves for its account prior to and after the eventual bust as well as potentially having to allow private citizens to also secure foreign private assets. That is, a freely floating currency with limited intervention/control. This surely must be a very scary option for a centrally controlled economy – you are allowing the brightest, best connected and richest to vote with their feet. An in your face version of democracy. Just have a look at how all of the Russian Oligarchs have helped Russia’s capital account depletion/exhaustion in the transition to a floating currency.
So what happens at the Global Currency Accord? – participants agree on some “Preferred” trading bands for the major crosses, but most importantly China gets its devaluation from the current managed rate on the proviso of a managed run down in reserves and full currency liberation within x years. Also, as an initial and upfront token of everyone’s sincerity and commitment China will purchase up to US$500bn of gold from the major exiting central bank holders at the agreed price of US$xx,xxx per ounce. In effect, gold has been monetized.
Why the upfront gold transfer? The pure logic of gold is simply how illogical it its. It is so useless that it is really the only asset that can act as a store of value and wealth transferal mechanism from global lender (China) to global borrower (the West) without significant first round imported commodity price inflation. China will in effect be partially or wholly on a gold standard. Everyone’s winner, especially if you have any gold. This ultimate stimulus will hit the debt burdened but gold holding Western economies.
So in essence the pay off diagram of the accord is China agreeing to buy a totally useless asset from the West at a highly inflated price in exchange for being allowed to devalue and given time to make the transition from Mercantilist to a Consumerist economy.
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China buying US stock market ahead of their own bubble bursting. When it does, chickens come back to US markets to roost, enabling China to offload at a huge profit into a rapidly rising market, helping to contain their own bubble damage.
is it Jim Rogers that says there's no bubble in China?
yeah, and if you have a problem with that, you too probably "couldn't even spell china 10 years ago"
*places another order @ bullion dealer*
fantastic piece.
Assuming they are willing and capable of making
the transition from a mercantilist economy. Many
of us don't think they can. This forces another
outcome. Good article otherwise.
Travel outside the "official" circles in China and you will find the results of the old Soviet Command Economy. Empty homes, empty factories, empty office towers.
China's GDP numbers are perverted by the Government and by methodology.
Remember our own disigenuous Greenspan who infamously pronounced "irrational exuberance" then later backtracked, stating he could not contain "bubbles" ? That is China today, but on steroids.
When the Central Buyers in China stop buying Commodities, it is going to be one hell of a ride to the bottom.
P.S. I installed 4 MADE IN CHINA light fixtures on the weekend, since retailers do not stock U.S. made fixtutes.
Of the 12 Made in China light bulbs, 7 have burned out in the last few days. Savings, my ass, exactly what is being saved with this crap ????
gold, whelping dogs
Couldn't they also avoid inflation by getting institutions to hold Yuan as reserves? Put extra yaun into intrenational reserves instead of new lending.
Absolutely, I think that will be the second leg of the accord some currency exchange as well. There will still be too much excess cash for too long though given the devaluation - so money will still flow to gold.
I am a believer there's a bubble in China and that the growth figures are partly fabricated (how does electricity and gasoline useage go down when GDP growth is 8%?)
Looking at the effects of the rise of China may give an indication of what any halt in that rise may do. Over the last 20 years the rise of China has allowed Western economies to keep down CPI. This has allowed enormous monetary growth that would have been stamped on much earlier if cheap Chinese imports weren't keeping the carefully selected headline inflation rate down. This extra money then expressed itself in rapid rises in other prices such as education, health care, housing and stock prices.
A Chinese crash would lead to a slow down in the growth of Chinese manufacturing, a slow down in the price cuts on manufactured good, which would lead to a reduction in the suppression of the CPI ending the ability of the central monetary authorities to pump out money without it being obvious in the inflation numbers.
So a crash in China would paradoxically be inflationary on the CPI side for the West and lead to monetary tightening which would cause deflation in certain classes of prices and assets. Basically a mirror image of what's been happening over the last 20 years. Houses, stocks, education and health care down, electronics and plastic crap up.
We had the best of all worlds for 20 years due the emergence of China holding down the CPI. We'll have the worst of all worlds as that emergence screeches to a halt and CPI no longer has that holding it down requiring tighter monetary policy.
Everyone knows the effect of tighter monetary policy on stock, housing and gold prices.
The only alternative is for the government to say they're abandoning they're inflation targets, and the consequences of that are also quite predictable.
Which of those "best" worlds was melamine, lead, cadmium, and sulfur dioxide part of?
HWC - thats my feeling. I basically look at China's huge foreign reserves as an inflation store. They have suppressed inflation directly as a result of their currency intevention. That model is now broken, but we will limp on. Ultimately any fix requires some form of release from the foreign reserves. Sooner or later China will also want to release the reserves. Hence releasing that stored inflation.
I think the unemployment situation will preclude any tighter policy - the onset of an inflationary hit (which I think will be sometime this quarter) will scare markets. We will see QE 2.0 sooner as well.
Regards
Gary Jeffery
Excellent, excellent piece.
I don't think $xx,xxx is a realistic price for gold. All the gold ever mined still exists in some form (mostly Jewelry). Less than 20% of total gold is held by central banks and Governments. At those prices the shadow reserve of gold (over 80%) held by individuals would flood the market and be melted down. I think $5,000 is a more realistic estimate of gold's value when used as a monetary unit, but even this price is subject to crashes due to dumping.
Observation,and I guess a question.
When Gold get's to any price over, where it is even NOW, what's the Upside to it?.
I mean, if it is money ( and it is), other than directly affixing a tradeable value for other assets ( Tangibles/Goods).
WHY would anyone exchange it for paper vehicles of any kind. Right now no one want's Paper,if they can get PM's on the dips...............
Unless there was a complete stabilization of the Global Economies,( Trust returned) who in their right mind would part with it, unless it was a barter deal?.
If/ When this pumpkin implodes, I see no way out of NOT going back to a Gold/Slvr/Pm's based currency................otherwise, WHO would trust it?.
Not me.
Gold held by central banks and gold held in the form of jewlery in an abstract sense are being held for the same reason. Those who don't have vaults store it on their wives.
I think 5k (2009 dollars) is a good long term target. If gold breaks out quicker than expected I think it'll hit 10k+; in the long run peak oil is going to be an unsatable devourer of planetary wealth.
Good article, but calling gold "useless" is pretty shabby reasoning. The only reason it's "useless" is because it's so fucking expensive (to get, whether you go out to your local dealer to pick up refined .999 fine coins, or to a mountain to extract some ore), and people have found other metals that will perform where they would normally use gold but for far cheaper a price.
Gold has many uses, electronics being the most obvious. Anyone who says gold is "useless" should throw away their computer and cellphone, since niether would work very well without gold.
We don't use it because it's money. The same reason you don't use dollars to wipe your nose or ass. At least not yet. And talk about useless. Even if gold suddenly dropped to zero value, you could still do stuff with it (and get pussy with it bling bling bitches). When the dollar becomes worthless, it truly will be worthless. You can't even do anything with the paper because it has shitty ink all over it.
I am Chumbawamba.
Also, if gold were useless, it wouldn't require around 1,140 (at present) standard FRN units to get one standard gold unit.
Someone somewhere (i.e. nearly everyone) finds it useful enough to set such a high price in FRN equivalents.
I am Chumbawamba.
I think many who point out gold's relative uselessness are actually making an argument for why it has been historically very useful as a currency (medium of exchange). Again, historically speaking, if gold was useful, it would be used for its usefulness rather than made into adornments and bartered for as an item of exchange. For most of history, gold's use has been AS MONEY and it's value is the unique characteristics it has:
1. It's not easily obtained, even by the government (unlike FRN's).
2. Once obtained it is almost indestructable.
3. It's rare, but not too rare, coupled with the fact that it is universally desired (but not too useful).
The question is, will gold's historic usefullness ever be valued again. If so, it will be worth much more than $1140.
No. Quite the opposite.
Something gets to become money because it is relatively more marketable than any other good. That is why even cigarettes became money in WW2 prison camps.
Money is function, just as good is a function. When one commodity starts gaining money function, it starts losing the good function but for some good to gain money function it has to have a good function first.
Nothing initially useless can become money and no authority can make something money. Money arises at the market, and then governments pounce on it and start manipulating it.
I recommend Mises on money. Although he doesn't define money as a function, he clearly explains how anything becomes money.
Agree with all of the above. Plus gold and the platinum group may play a key role as emmission cleansers as we are forced to burn increasingly dirty fuels in an increasingly dirty world. If this use became more important (increasing the value even higher than the monetary value) than the wealth reserve function gold has now, maybe silver would take golds place.
The only ways I see to lose on gold are extreme long shots: Global enslavement, 50% global population die off, finding an energy source > oil.
Gold question - if buying in 1-20 ounce increments and leaving aside the issue of possibly wanting smaller denominations for barter when the world ends, what is the better forms of gold to buy??
American Eagles (which are only 92% gold but seem to be priced like 100% gold)??
Credit Suisse "bars" (which are 99.9% pure)??
Or what?
Thanks.
The $50 face value American Gold Eagle is priced like a one ounce Credit Suisse bar or Canadian Gold Maple Leaf, for example, because it's guaranteed to contain one ounce of pure gold just like they do. But an American Gold Eagle weighs more than an ounce because of the addition of other metal alloy, which makes it more resilient (i.e., less susceptible to wear) than the more pure coins and bars.
If you actually want to use them for currency, fractional Eagles are the best because they are harder and more wear resistant than 100% gold coins. Also, eagles are only 92% gold but they weigh more than a troy ounce. You are actually buying a full troy ounce of gold.
"fractional Eagles are the best because they are harder and more wear resistant than 100% gold coins".
So are Mapes......................but, you have the Premium issue's to contend with.............
The cost of Mfg of the smaller coins, is substantial, and WE pay a hefty premium for that.
Like 2- 1/2oz. Eagles cost you say, $600.00ea., $1200.00oz............
A 1oz. Eagle, cost your $1,182.00............
Too bad that's the case, but it is.
I see no way to go back on the TRUE Gold/Slvr Std...................the world is just too huge, and there is not enough Gold/Slvr on the planet to go around, to use it as a unit of monetary measure against paper notes.........
What would the cost per oz. be, if ALL the currencies in use were backed by Gold/Slvr?..............astrofriggin nomical.
Mapes are .9999 pure, so they are soft. But Krugs are alloy like Eagles, but IMO they are ugly and poorly minted.
Yes, fractionals are silly from a cost perspective. Buy one ounce coins. I'm a manufacturer and I know first hand that coins should not cost what they do. Much of their premium over gold price is profit for dealers and a kind of secondary market price for physical over paper promises that fluctuates.
Personally, I think gold can fill the role of currency again. I'm insured against that possibility. Zerohedge community is cutting edge as far as having an understanding of the house of cards nature of our financial system. When distrust reaches a high enough level in the non-zerohedge community, black market and barter could reappear, even in the US. Gold would be an obvious barter choice.
When? who knows. On a long enough timeline...
Remember, the US Mint used to be open. Meaning you could bring gold to them, they would assay it and make you US coins out of it and only charge about one percent. Why couldn't that work again? It could. It would. When "backed by the full faith and credit of the United States of America" doesn't have quite the ring it used to.
Gold is money and nothing else.
Heavy duty, man. Nice job. You agree with Chanos that China is in a bubble that is designed to burst. I would say the most telling evidence that they anticipate the bubble bursting in a 12-18 month time frame is the fact that the oligarchs finally caved and just gave big investors the right to trade on margin and to utilize alternative strategies, such as shorting. They are going to bet against themselves to hedge the crash and concentrate wealth for the aftermath.
I've lived in China for years, there isn't anyone in this place who knows what's going on or knows what the government is doing, least of all the government. One high ranking official said recently that when he wanted to get some idea of the domestic situation, he had to leave the country to find out. Every bureaucracy is islolated from the next, as are the vertical levels within agencies. To understand China is to understand undirected, perpetual chaos that that is held together through illusion, but for how long?
What's this talking point going around now about "balancing or re-balancing" the global economy?
The global economy has never been "balanced." If it had been or was, there would be no money being made anywhere.
Wealth is created because of imbalances - demands vs. supplies.
This article deserves a read, if nothing else it provokes some thinking about the impact China and the world has on each other. When it comes to China, this phrase is always useful: "It is less than what you hope, but more than what you expect." No one actually has the full picture, and most are "guesstimating" if at all. The proverbial blind men describing the elephant comes to mind.
The article paints China in a stage of homogeneous development, hence if the bust occurred - which is likely - the whole of China is deeply impacted like the developed nations (aka the West and Japan). However, as shown in the US, the current financial crisis is impacting different regions differently. Similarly, it will also be the same for China. After all, the developed eastern provinces has about 400 million people as compared to about 900 million inland, so an impact on them (who are more vocal) would reduce them to the level of their inland compatriots. The Chinese would either adapt or for those with means, emigrate abroad. This brings another consideration that those who wish doom for China rarely consider, imagine one-tenth of the 400 million coming over to the developed world.
The best thing to happen is for China to slowly cool down their heating economy, incrementally adjust their FX and consumption patterns. Sudden dislocations, as proven in history, tend to make people do irrational things and the last thing that the world needs is for the hardliner faction to take power.
As for the assertion that gold is useless, reading this makes one's head spin. Gold, as a metal, can be fashioned into anything that other metals perform. In fact, it would be superior in its malleablity, corrosion-resistance and conductivity to almost all metals. However, due to its rarity, our predecessors naturally kept it apart from everyday use. Hence, it was elevated to use as jewelry. It always amuses and saddens me that people nowadays confuse between the aim (precious metal gold) and the use (jewelry), thinking that it is because gold is useless that is why it is used as jewelry.
Perhaps this thinking is emblematic of today's times with the 3 witches in Shakespeare's Macbeth saying it best: "When fair is foul, and foul is fair."
Hat tip to one of Doug Casey's newsletters
http://www.youtube.com/watch?v=0h7V3Twb-Qk