by Alasdair Macleod, GoldMoney:

In the wake of the Fed’s promise of 23 March to print money without limit in order to rescue the covid-stricken US economy, China changed its policy of importing industrial materials to a more aggressive stance. In examining the rationale behind this move, this article concludes that while there are sound geopolitical reasons behind it the monetary effect will be to drive down the dollar’s purchasing power, and that this is already happening. More recently, a veiled threat has emerged that China could dump all her US Treasury and agency bonds if the relationship with America deteriorates further. This appears to be a cover for China to reduce her dollar exposure more aggressively. The consequences are a primal threat to the Fed’s policy of escalating monetary policy while maintaining the dollar’s status in the foreign exchanges.

Introduction

On 3 September, China’s state-owned Global Times, which acts as the government’s mouthpiece, ran a front-page article warning that

“China will gradually decrease its holdings of US debt to about $800billion under normal circumstances. But of course, China might sell all of its US bonds in an extreme case, like a military conflict,” Xi Junyang, a professor at the Shanghai University of Finance and Economics told the Global Times on Thursday”[i].

Do not be misled by the attribution to a seemingly independent Chinese professor: it would not have been the frontpage article unless it was sanctioned by the Chinese government. While China has already taken the top off its US Treasury holdings, the announcement (for that is what it amounts to) that China is prepared to escalate the financial war against America is very serious. The message should be clear: China is prepared to collapse the US Treasury market. In the past, apologists for the US Government have said that China has no one to buy its entire holding. The most recent suggestion is that China’s Treasury holdings will be put in trust for covid victims — a suggestion if enacted would undermine foreign trust in the dollar and could bring its reserve role to a swift conclusion.[ii] For the moment these are peacetime musings. At a time of financial war, if China put her entire holding on the market Treasury yields would be driven up dramatically, unless someone like the Fed steps in to buy the lot.

If that happened China would then have almost a trillion dollars to sell, driving the dollar down against whatever the Chinese buy. And don’t think for a moment that if China was to dump its holding of US Treasuries other foreign holders would stand idly by. This action would probably end the dollar’s role as the world’s reserve currency with serious consequences for the US and global economies.

There is another possibility: China intends to sell all her US Treasuries anyway and is making American monetary policy her cover for doing so. It is this possibility we will now explore.

China’s commodity strategy: it’s also about the dollar

Most commentators agree that China has a long-term objective of promoting the renminbi for trade settlement. While China has made progress in this objective, they also agree that the renminbi will not challenge the dollar’s status as the reserve currency in the foreseeable future. Any changes in the relationship between the dollar and renminbi is therefore believed to be evolutionary rather than sudden.

Recent developments have dramatically altered this perspective. China is now aggressively stockpiling commodities and other industrial materials, as well as food and other agricultural supplies. Simon Hunt, a highly respected copper analyst and China-watcher put it as follows:

‘’ China’s leadership started preparing further contingency plans in March/April in case relations with America deteriorated to the point that America would try shutting down key sea lanes. These plans included holding excess stocks of widgets and components within the supply chains which meant importing larger tonnages of raw materials, commodities, foods stuffs and other agricultural products. It was also an opportunity to use up some of the dollars which they have been accumulating by running down their holdings of US government paper and their enlarged trade surpluses.

Taking copper as an example, not only will they be importing enough copper to meet current consumption needs but in addition 600-800kt to meet the additional needs of their supply chains and a further 500kt for the governed owned stockpile. The result of these purchases will leave the global copper market very tight especially in the next two years.’’[iii]

Other than the spread of Covid-19 lockdowns outside China, there was no specific geopolitical development to trigger a change in policy towards commodities, though admittedly relationships with America are on a deteriorating path. Rather than indulging in state piracy on the high seas, fears that the US could blockade China’s imports would possibly be achieved by American action to prevent Western corporate commodity suppliers from supplying commodities — in the same manner as America controls with whom the global banking system transacts.

China has already agreed import targets for American soya and maize, only partially delivered, due one presumes, to waiting for this year’s harvest. She has been buying soya from other cheaper sources, such as Brazil, but it is too early to say China is holding back on American imports as part of a trade negotiation strategy. It is the timing of China’s policy to enact more aggressive purchases that is interesting: it coincided with or swiftly followed the Fed’s monetary policy change in late-March embarking on an infinitely inflationary course. Figure 1 points to this relevance.

The pecked line divides 2020 into two parts. First, we experienced the intensifying deflationary sentiment leading to the Fed’s rate cut to zero on 16 March, and then its promise of unlimited inflation in the FOMC statement which followed on 23 March. The second part is the inflationary period that commenced at that time as a consequence of those moves. The S&P 500 index then reversed its earlier fall of 33% and started its dramatic move into new high ground, and the dollar’s trade weighted index peaked, losing about 10% since then. Gold took the hint and rose 40%, while commodities turned higher as well, gaining a more moderate 20% so far. The gold/silver ratio collapsed from 125 to 72 currently, as the monetary qualities of silver resumed an importance. The S&P GCSI commodity index was initially suppressed by the WTI futures contract delivery debacle in April, but crude oil’s recovery has resumed. Both gold and commodities are clearly adjusting to a world of accelerating monetary inflation, where bad news on the economic front will accelerate it even more.

If China’s decision to increase the rate of importation for commodities and raw materials did occur at that time, it is very likely that rather than solely based on geopolitical reasons, the decision was driven by China’s reading of prospects for the dollar. When all commodity prices are rising, there can only be one answer, and that is the currency common to them all is losing purchasing power. And from its timing that is what appears to be at least partially behind China’s decision to accelerate purchases of a wide range of industrial and agricultural materials.

With a reasonable level of commodity stockpiles before 23 March, China might have taken the more relaxed view of buying additional imported commodities as and when needed. But the one stockpile she has in enormous quantities is of dollars, of which about forty per cent is invested in US Treasuries and agency debt. A short trillion or so has been loaned to trading partners, predominantly in sub-Saharan Africa and South America, as well as partners in the land and sea silk roads. The indebtedness to China of her commodity suppliers makes further protection from American interference more difficult perhaps, supporting the thesis of China dumping dollars. Furthermore, we should add it is possible that China has hedged some of her dollar exposure anyway. If so, against what is not known but important commodities such as copper would make sense.

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