China

With the dollar tumbling overnight, many were scratching their heads as to what caused the move in the dollar. Citi's Stephen Englander provides a useful explanation, which fits perfectly with the commentary from PBoC advisor Li's earlier that the dollar's position as a reserve currency is now "absurd": namely that more and more in the world are starting to look at the CNY as the new reserve currency. And as we pointed out earlier, its fixing surge of over 0.5% overnight caused many to blink. Is China finally pushing to aggressively force the dollar out?

Precious metals have now entered their parabolic phase. The latest catalyst for gold having traded north of $1,420 is not only the ongoing collapse of Europe via surging spreads and accelerating ECB bond monetization, which in tried and true bizarro fashion have lead to a more than 100 pip move higher in the EURUSD, but the latest speech by PBOC academic advisor Li Daokui, who said that it is "absurd" that the dollar is still the reserve currency of the world. We are confident that pretty much everyone in China agrees. The likelihood that China is about to do something big in FX land was also confirmed by the biggest move higher in the CNY which rose by 0.51%, the most since the revaluation period, and also by the high yield in the one week auction, which has led some to believe that China may be willing to hike rates once again, and further weaken the dollar peg.

With republicans back in control, it was only a matter of time before the military-industrial complex reminded the world of its existence. It took about 72 hours: republican senator Lindsay Graham, who apparently has not received the memo that all modern wars are now waged in binary, and are won by those who can push the FX bid/ask the furthest and the fastest away from equilibrium, spoke at the Halifax International Security Forum, giving a very distinct taste of what US foreign policy is about to look like: "Iran is a major threat to any conceivable world order" and that he sees an almost inevitable confrontation with Iran. As AP reports, the South Carolina Republican saw the United States going to war with
the Islamic republic "not to just neutralize their nuclear program, but
to sink their navy, destroy their air force and deliver a decisive blow
to the Revolutionary Guard, in other words neuter that regime." And the Democrats, still in shock over their recent pummelling, will likely not have the resolve to respond palliatively to such warmongering, which they likely deem as supported by the broad population: "US Democratic Senator Mark Udall, who joined Graham during a panel
discussion at the forum in Halifax, Nova Scotia, urged continued
sanctions against Iran. But he also noted that "every option is on the
table," a thinly veiled reference to possible military action." And just when the world was getting along so well, and all the international bickering appeared to be taking place over various Forex terminals...

As is all too well known by now, starting over the next few days, the Fed will commence purchasing $75 billion in Treasury securities monthly until the end of June, and will buy an additional $35 billion in Treasurys to make up for declining holdings of MBS (due to repurchases). We still believe that as a result of the imminent drop in rates (especially those around the curve belly), as we have claimed for over a month, the feedback loop that will be created will result in a far greater repurchase frequency of MBS securities over the next 8 months, and we would not be surprised if at some point in Q2 2011, the Fed is buying $150 billion in Treasurys monthly. Since nobody will believe this until it is actually confirmed by the H.4.1., we will leave this topic alone for the time being. And after all its will "only" mean a rotation of Fed holdings, a switch in duration, and an impact on the shape of curve. What is certain is that on June 30, the Fed's balance sheet will have $2.68 trillion (or more) in holdings, of which $1.77 trillion will be in Treasurys, compared to the $840 billion today. What is also certain is that the Fed will not be able to stop there. Which is why we have extended the projection period through January 2012. At that point the Fed will hold $2.6 trillion in US Treasuries, or roughly 25% of total US marketable debt at that point.  And for those who collect now completely irrelevant statistics, the Fed will surpass China's $868 billion in UST holdings before the end of November. Yes, ladies and gentlemen, shit just got real.

The subcontinent is poised to overtake China’s white hot growth rate. India will grow by 8.5% this year. Growth could exceed that in the Middle Kingdom as early as 2013. Financing and construction of huge transportation, power generation, water, and pollution control projects are underway. India is also a huge winner on the demographic front, with one of the lowest ratios of social service demanding retirees in the world. Many hedge funds believe that India will be the top growing major emerging market for the next 25 years. (INP), (FXI).

As we wrote recently, in what may become a rerun of the Rare Minerals export cut, after an abnormally long silence, China is finally starting to make noises in the gold market. As Bloomberg reported earlier, according to an article appearing on the website of the Chinese Ministry of Commerce, Meng Qingfa, researcher as the China Chamber of International Commerce said that China should buy more gold to diversify its foreign exchange reserves. "China should increase its gold holdings if the country aspires to “internationalize” its currency. China has $2.6 trillion of foreign-exchange reserves, mostly in dollar assets, Meng said. Such holdings will put China at a disadvantage when the U.S. dollar depreciates, as is inevitable amid a worsening U.S. debt problem, he said." While this is not an outright endorsement that the PBoC will begin to warehouse the precious metal, it is certainly an escalation in the war on words that the US and China have been engaging in for quite some time. The bigger problem is what may happen to the world gold market should China, which is now the world's largest producer of gold, decide to internalize its gold product output. Already the country's gold demand is surging. Should roughly 340 tons, or the amount of gold China makes each year, be withdrawn from supply, no amount of Goldman contemplation on the matter of physical ETFs will prevent a spike in the metal price.

After taking heat from the White House for nearly a year for its currency peg, a fact that in itself will never get China to loosen its regime as it would be perceived as yielding to pressure from D.C., China has once again gone on the offensive, this time via its commerce minister who earlier today said that dollar issuance in the U.S. is "out of control" which in turn is leading to an inflation assault on China. Of course, one simple way to deal with said assault would be to revalue the currency, but why do so if the world's biggest export economy benefits from the stupidity of the Federal Reserve. After all, the Fed's China monetary policy allows the US to continue to export inflation and to provide cheap Chinese goods to America's great unwashed masses of Wal Mart shoppers who enjoy cheap (but increasingly more expensive) products. Plus it is not as if China is not printing trillion in money of its own, however in the form of what the US used to do in the past, and do so in the form of cheap, NINJA credit. All in all, this is just another instance of a pot calling a kettle black, even as nothing ever changes.Well, one thing may change: imminent bubbles in ever more rare earth minerals, and soon, rice and rubber, will soon add to pressure in all other already inflating commodities. How companies will be able to pass through these costs to consumers, nobody seems to have either any idea, or care. Certainly not the Fed, which is very myopically welcoming this price change.

SITUATION: Defense planning efforts in East Asia have been markedly influenced by China's bellicose response to the detention of a Chinese fisherman for ramming a Japanese naval boat in disputed waters.
 
ANALYSIS: The detention generated vituperative reactions from Beijing, out of character from its traditional policy of quiet insistence on territorial claims while building naval capacity. This episode, in conjunction with China's continuing claim of primacy in the South China Sea as a 'core interest', is encouraging increased discussion among its regional neighbors regarding naval collaboration.

In view of the blistering Q3 9.6% GDP growth rate, it’s time to increase positions in the Middle Kingdom. Look for cash to rotate out of virile, young emerging markets back into the established BRIC’s. We have blasted through the 200 day moving average, suggesting that this move may have the legs of Secretariat. Rumors of its imminent demise are premature by at least a decade. Jim Chanos, please get out of New York and widen your circle of contacts. (FXI), ($SSEC), (EWZ), (RSX), (PIN).

Geithner’s strong dollar comments, China's surprise rate hike, and worries about the U.S. mortgage market led a flight by investors into U.S. Treasuries. Some analysts believe that there may be a currency accord right before the G20 meeting. However, from all indications, China and Geithner appear to be acting under totally separate agendas however “coordinated” they might seem.

Today's very remarkable analysis from Albert Edwards presents a stunning spin on the China-US Nash Equilibrium, concluding that wholesale tariffs with China are now inevitable: "If another round of credit-fueled investment is about to be unleashed onto a global economy, already on the verge of deflation " it will simply not be tolerated. Watch the trade data closely. Watch the US unemployment rate closely. The US public is on the verge of revolt which is increasing likely to end in across-the-board tariffs." Why has the SocGen strategist come to this conclusion? Simple - he now believes that "China is becoming a malevolent influence (my words) on the global economy and strong action is necessary." As to who gets to buy US bonds should China start a boycott or outright dumping? Who else: "Why, Mr Bernanke is just waiting for his chance."

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The latest escalation in the binary version of modern warfare (i.e., that fought with a Bloomberg instead a stealth fighter), comes from China, which the NYT reports has just halted shipment of rare minerals to the US: "China, which has been blocking shipments of crucial minerals to Japan for the last month, has now quietly halted shipments of some of those same materials to the United States and Europe, three industry officials said on Tuesday." As we disclosed a few weeks ago, prepare for an explosion in various rare metal prices...

China has raised its key interest rate by 25 bps, marking only the first time it has done so since announcing it has recovered from the global crisis. Undoubtedly, this is its response to not being labeled a currency manipulator. However, as the US will most likely never raise rates again, and with the Yuan still pegged to the dollar, unlike in a typical recovery, where this would signal the elimination of excess liquidity in an attempt to prevent inflation, this time it is a largely symbolic move. Nonetheless, this will put some serious pressure on Chinese stock markets, on the US futures, and will be very "positive" for the dollar, which ironically defeats the whole point of the exercise.

Today's most important piece of news for holders of precious metals comes from the far East, where Kim Choong-soo, governor of South Korea’s central bank, told a parliamentary committee on Monday, that the country: "needs to give careful consideration to the matter of increasing gold volumes in the foreign reserves.” In other words, as the FT summarizes, "South Korea, holder of the world’s fifth-biggest foreign exchange reserves, is considering expanding its small holdings of gold to diversify its dollar-heavy portfolio." Last week, a mere unsubstantiated whisper that China was doing the same sent gold $10 higher. So with the regional game theory framework changing, as more countries rush into the yellow metal, will China finally be forced to come out of its shell of gold shyness and officially start accumulating, sending gold soaring?