The Great Game - China De-Links from the US Dollar - an appraisal

• From: fulco <fulco@xxxxxxxxx>
• Date: Wed, 17 Aug 2005 12:24:10 +0100

-----

China De-Links from the US Dollar

On July 21, 2005 China formally dropped the link between the yuan and
the US$, allowing it to revalue upwards by 2%. The yuan will now be
linked to a basket of currencies comprised of Chinas major trading
partners currencies, though the composition has not been divulged.

US critics of the link have pushed China into this step, saying that the
Chinese currency is undervalued by up to 40%, thus unfairly subsidizing
Chinese exports. Under threats of being classified as a currency
manipulator and having major tariffs imposed on exports, China decided
to give the US what it wants.

What are the likely consequences of this step?

As the US continues to run monthly trade deficits of $ 55-60 billion
with its trading partners, China (its largest trading partner) has been
absorbing US $ in exchange for its goods, and using these to buy US
Treasury bonds (it needed to do this rather than sell the US $ to keep
the yuan from appreciating against the US$). It is now one of the
largest foreign holders of US Government debt and US$ in the world.

Now that China is willing to let the yuan rise, China does not need to
hold as many US $ in its reserves and to use them to buy US Treasuries
(which the US issues at record levels to finance its budget deficits).
China is likely to reduce its demand for US bonds, helping raise US long
term interest rates. Rising interest rates are the most direct threat to
the US economy, as they jeapordise the US housing market boom.

The US economy is highly sensitive to consumer spending, which accounts
for 67% of GDP. The US consumer survived the 2000 recession due to the
Federal Reserve lowering interest rates to 45 year lows and massively
increasing money supply. This led to a housing boom and the creation of
debt levels that have never before been seen in the US (it also led to
the worldwide housing boom). It is the wealth effect of seeing their net
worth rise due to rising housing prices that has kept consumers spending.

Interest rate increases are the Achilles heel of the US economy, and the
yuan devalution is potentially the move that will resolve Mr.
Greenspans conundrum that, while he keeps raising short term rates,
long term bond yields have been declining.

This is also likely to weaken the US $ as China is not only likely to
sell future US $ that it acquires but also to sell existing reserves.
The pegs that GCC currencies have with the US $ are under scrutiny. As
trading links with China (now accounting for 8.5% of total GCC imports
from virtually nothing a decade ago) and Europe grow and the US dollar
weakens, economists such as National Commercial Banks senior economist
Nahed Taher are calling for a de-linking of the Saudi Riyal from the US
$ now, rather than consider it at the time of the proposed GCC monetary
union in 2010. He believes that the link is creating inflationary
pressure in the GCC.

Abdel Aziz Aluwaisheg, director of the GCC Secretariat's economic
integration department says that "We've just agreed to a formal peg ...
It is too soon after that to change." This happened in 2002, when Kuwait
finally pegged. He says that "There is a realisation that we are losing
because of pegging to the dollar but there is also a feeling that this
(reluctance to change so soon) is a big obstacle  as well as the issue
of foreign exchange risk." The exchange risk comes from oil prices being
quoted in US $.

Nothing prevents the individual and institutional investor from
de-linking to the US dollar by moving part of their assets to non-US $
assets. And one of the most important of these asset classes are
precious metals and related equities as these move in opposite
directions to the US $.

The Economist magazine in its latest issue highlights the fact that with
this revaluation, the Chinese government now effectively can control
global interest rates, bond yields, money supply, US $ exchange rates,
and economic performance.

The Great Game:

* General Zhu Chenghu warned the US on July 14 that China was
prepared to go nuclear if the US intervenes in any conflict China may
have with Taiwan.

"If the Americans are determined to interfere, then we will be
determined to respond," he said. "We Chinese will prepare ourselves for
the destruction of all the cities east of Xian. Of course the Americans
will have to be prepared that hundreds of cities will be destroyed by
the Chinese."

* The June 2005 issue of Atlantic Monthly has its cover issue
titled How we would fight China and discusses the likelihood and
possible results of future warfare between the US and China.

* The Chinese government, through its oil company CNOOC, tried to
buy the American oil company UNOCAL. The US Congress effectively killed
the deal, which should have been a normal commercial transaction, by
raising the specter of national security. This act of what amounted to
political warfare was conducted in order to prevent the foreign
ownership of strategic US oil interests, even though 67% of UNOCALs
assets are in Asia.

* Russia and China have just announced their first ever joint
military exercises to be held in August 2006.

Whats going on?

The US has been investing heavily in China since the 1980s and has
essentially outsourced a large part of its manufacturing base there due
to a 20-1 cost advantage, alongwith other developed countries. This
global investment surge has created the Chinese growth rates that are
propelling China to become the next superpower.

As China and India develop at unprecedented growth rates, there is an
enormous demand for the commodities (oil, gas, copper, nickel, zinc,
silver, etc.) that required to build the massive infrastructure needed
to absorb the millions of rural workers migrating into the cities and to
meet the material expectations of a growing middle class.

The global supply of resources cannot be increased immediately in
response to demand as it takes years for mines to be built in order to
increase production of precious and base metals.

In the case of oil, we appear to be approaching Hubberts Peak of Oil
Production. Dr. King Hubbert was a US geophysicist who correctly
predicted in 1956 that US oil production would peak in the early 1970s.
He was laughed at then but proved to be right. He predicted that the
entire fossil fuel era would be of a very short duration.

Hubberts Peak is the theory that represents that point in time when 50%
of the entire oil available on earth has been extracted. There is a
general consensus that the Hubberts Peak theory is valid and debate is
limited to the time when Peak Oil will be reached. Theories range from
1995 to 2010. Consensus also has it that total oil production will not
last for more than another 100 years.

This has major global implications, for maintenance of living standards,
security and competition for access to vitally needed resources.

And Africa has suddenly become a major focus of international attention,
focused on poverty alleviation, health crises and democratisation. Is
the fact that Africa sits on tremendous mineral wealth a potential
factor in this concern by the international community?

The Great New Game: Blood and Oil in Central Asia is a book written by
Lutz Kleveman, which postulates that the next great global battle for
resources will be in Central Asia. This will pit the US, Russia, China
and Iran as the major protagonists for the rich mineral resources in
that area. It seems that the rhetoric has already begun.

Central Asia is home to the newly liberated countries that were part of
the Soviet Union. Central Asia sits atop some of the largest pools of
petroleum and natural gas in the world. The massive Tenghiz oil fields
of Kazakhstan lie just to the north of Uzbekistan. Huge gas reserves lie
just to the south in Turkmenistan. To the west, across the Caspian Sea,
is the Azerbaijan offshore oil industry.
	
Oil and gas and other commodities are going to be in major demand in the
coming decades. This coming battle will resemble the Cold War between
the US and the Soviet Union, as alliances are built by the major powers
with these countries.

Thus, the US has military bases in Uzbekistan and Kyrgyzstan (and is
looking to open bases in Tajikistan), to help in the war in Afghanistan.
These forces also provide security for the newly built pipeline between
Baku in Azerbaijan and Ceyhan in Turkey, which provides oil for the West.

Russia has bases in Krygyzstan, Tajikistan, Georgia and Moldova while
the Chinese have tremendous influence over the region as it lies close
to its borders. India also has a base in Tajikistan as well, its only
foreign military base.

In July 2005, China, Russia and four former Soviet republics (which make
up the Shanghai Cooperation Organization {SCO}) called for the United
States to set a date for withdrawing from military bases in Central
Asia. That call is the closest that an increasingly powerful security
grouping has come to taking a clear anti-American stance, said Dr.
Kirill Nourzhanov, a specialist in Central Asia at the Australian
National University.

The declaration by the Shanghai Cooperation Organization is a boost for
Moscow and Beijing, both of whom have bristled at the growing influence
of the U.S. in the region, according to Dr. Nourzhanov.

Another step in that direction was seen when the meeting approved SCO
observer status for India, Pakistan and Iran, prompting summit host and
Kazakh president Nursultan Nazarbayev to observe that delegates around
the table represented countries comprising "half of humanity."

So what does this mean for the investor? The rising demand for
commodities has led to record prices for most base metals. US $
weakness, the global uncertainty related to the war on terror and the
global economy has taken the price of gold from $ 250 to over $ 460
since 2001.

There is likely to be a sustained rise in prices for base and previous
metals, based on increasing global demand, which will take years for
supply to catch up to. Mining companies shares will benefit from this.

However, in the event of sustained US $ weakness, or an economic
recession in the US that spills over into the global economy or an
escalation in the war on terror or other international tensions, then
gold and silver will be the natural beneficiaries of such an uncertain
environment and investors should position themselves accordingly.

                      ***

Disclaimer

The ACAMAR Journal is an independent publication intended to provide
factual and timely research on general economic trends, opinions about
trends in specific industry sectors, references to other publications
and reports that may be of interest to investors, information about
specific companies, and information on general trading strategies.
Acamar Asia Consultants Inc. (Acamar Asia) is not a registered
investment dealer or adviser, and is a subsidiary of Acamar Advisors Inc.

Although the statements of facts in this report have been obtained from
and are based upon sources Acamar Asia believes to be reliable, we do
not guarantee their accuracy, and any such information may be incomplete
or condensed. All opinions and estimates included in this report
constitute Acamar Asias judgment as of the date of this report and are
subject to change without notice. Acamar Asia makes no warranties,
express or implied, as to results to be obtained from use of information
in this report, and makes no express or implied warranties of
merchantability or fitness for a particular purpose or use.

This report is for informational purposes only and is not intended to be
advice, or an offer or a solicitation with respect to the purchase or
sale of any security. This report does not take into account the
investment objectives, financial situation or particular needs of any
particular person. Investors are advised that investing in securities
entails certain risks, and they should obtain individual financial
advice and undertake extensive due diligence based on their own
particular circumstances before making any investment decisions.

Acamar Asia may from time to time perform corporate communications or
other services for companies mentioned in this report. In addition,
Acamar Asia or any individuals preparing this report may at any time
have a position in any securities or options of issuers mentioned in
this report. Director, shareholders or employees of Acamar Asia may be a
director or officer of a company mentioned in this report.

.

• Prev by Date: Judge rules in favor of holding public hearings on detainee abuse, despite GOVT INTRANSIGENCE
• Next by Date: Re: Ayaan Hirsi Ali's blog
• Previous by thread: Judge rules in favor of holding public hearings on detainee abuse, despite GOVT INTRANSIGENCE
• Next by thread: Sir Ian Blair tried to cover up de Menezes killing
• Index(es):
  • Date
  • Thread

• Security
• UNIX
• Linux
• Coding
• Usenet

• Archive
• About
• Privacy
• Search
• Imprint