China's Scare Tactics & Longer Term Vision

Over the last few months China has been more vocal in asserting its voice in the economic wilderness. Beijing has openly blamed the excesses by the Americans as being hugely responsible in bringing about the current global financial calamity. Next Beijing further warned the US not to assume that China will always buy US Treasuries. As if that wasn't enough, Beijing went further to suggest that the US dollar has to be replaced as the reserve currency of choice. They cited the IMF's Special Drawing Rights as an option. Are these genuine concerns?

To me, its a lot like a mother nagging his son to get married. Its not like the mum is going to disown the son if he fails to get married. Its mainly nagging voices from Beijing. Why? The IMF Special Drawing Rights is a pie in the sky idea (please read my previous posting on the subject). Next, China will never be able to stop buying US Treasuries completely - the two nations are too interdependent on each other's economy to risk obliterating that relationship. If Beijing stops altogether, US interest rates will balloon, can you imagine what will happen if US interest rates rises from 3% to say 12% - US rates will rise sharply to continue to attract other funds to buy US Treasuries. That will stop borrowing and lending dead in the tracks, that will cause the stock markets to hit new lows because how are you going to find stocks that can better the risk free rate of say 12%. The move will cause other central banks to be filled with fear and start dumping US Treasuries before the currency collapses further. So, the USD may fall to 60 yen to the dollar and imagine the 1 USD buying only 2.4 ringgit. Which might not be a bad idea at all because that will make US exports a lot more competitive and thus helping to address its trade deficit.

But all that is hype and snarls... what is really happening is that Beijing has shifted the bulk of their holdings and new purchases to just the short term Treasuries. They are staying away from the long term Treasuries because they probably forsee a sustained long term weakness of the USD judging from the quite massive printing of new money by the Americans.

Beijing knows it cannot stop buying Treasuries, so it is thinking outside the box by reducing the risk strategically by other means. There is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money. Hence the first priority is to GUARD AGAINST THE inflationary consequences of the US printing press - buy real assets, preferably denominated in a currency other than USD.

Chinese companies thirst for Rio Tinto, Fortescue Metals, ... is just the beginning ... they will buy and keep buying any and every kind of commodity producers.

The second strategy is to be nicer to countries other than the US so that they will be more open to Chinese companies expansion and acquisition strategy. Its more pragmatic but will strengthen China's economic hand at being able to dictate global economic direction, rather than being dictated now by the G-7. The one big issue which many have not brought up has to be the "currency swap lines". China has been very open and friendly to arranging these swap lines with many countries trying to defend their currencies during this financial crisis.
China has just signed its sixth bilateral currency swap arrangement with Argentina for CNY70bn ($10bn) . This follows five other earlier bilateral currency swap deals with:
Korea (CNY180bn last December)
HK (CNY200bn in January)
Malaysia (CNY80bn in February)
Belarus (CNY20bn in March)
Indonesia (CNY100bn March).

The CNY vs. local currency swaps, which total CNY650bn (US$95bn), will be valid for three years. More agreements with other emerging market countries are expected in the pipeline. The bilateral swaps with China do not require an IMF program to access more than 20% of the swaps. In the short term, China’s bilateral swaps promote bilateral trade and investment (especially trade finance), helping Chinese slumping exports by making access to finance easier. In the longer term, it is China’s strategic economic and political interest to promote internationalisation of CNY. But that will require full convertibility of the CNY.

The most recent deal with Argentina has swamped the media in Latam. More importantly is what this could mean for other Latin American countries should China extend this further across the region. Bilateral trade with the region adds up to USD112bn for which the top three are Brazil, Mexico and Chile. These swaps can help internationalise the Chinese yuan, if there is to be a new reserve currency in 30 years, why can't it be the Chinese yuan, or so Beijing seems to be thinking. The swaps will increase trade financing and engineer a closer economic relationship between the said countries.

Looking at it from a geopolitical point of view, Beijing has been quick to help Asian countries to stabilise their currencies. Like it or not, Beijing knows that for China to lead the rest of Asia into the next 50 years to be The Decade Of Asia Rising, China will not be able to it alone, and will need all the Asian tigers and lions to prosper and be economic successes as well. Hence Beijing would be more than happy to extend economic help to the rest of Asia if it can.

p/s photo: Jojo Stryus

Asia's Nervousness

For much of Asia, the last few months have been a bit nerve wrecking. While the dominos have been tumbling in US and Europe, Asians have been sitting nervously. The consensus was that this was the biggest global contagion since the 1929 Depression.

For almost everyone in Asia 30 years and above, we are sitting tight. Though the economic conditions in Asia are still relatively vibrant, at the back of our minds we cannot shake off the memories of 1997-2002 Asian financial implosion. No one dared to come out and say that Asia is different this time around.

Surely any substantive weakness in US and Europe will have its effects on most Asian economies. We have felt the tremors, but are still wary of a potential sledgehammer in the near future. Will it be coming down soon?

At the back of our minds, the balance sheet of most Asian economies have improved significantly since the 97 crisis. Is that sufficiently strong enough to weather the storm? Many Asian countries have the US as a major trading partner, surely that counts for something.

There are a few things which have evolved over the last 5 years. One, China's emergence as an economic power. Two, Asia's intra-trade have also grown substantially. Three, the US weakness is actually impacting less on the broader US economy and larely contained in property and financials.

The third point is very important. Many American companies are still seeing OK fundamentals because of globalisation (outsourcing) that has been taking place over the last 10 years, in particular over the last 5 years which has been at breakneck speed. Globalisation involves an increasing dependence on foreign markets. The outsourcing movement has also move a substantive part of manufacturing operations and processes in emerging countries.

There are many who incorrectly criticise China's stupendous trade surpluses. However, some 60%-70% of all China exports are actually manufactured by foreign companies and joint ventures operating in China back to other markets. They are not primarily China's own real exports that are home grown. China as a growing country have parlayed the buzzing economic activity to building infrastructure, thus its voracious appetite for commodities. China is at a stage where it can still ramp up infrastructure to sustain the economic growth.

Thus the ill effects on the broader American economy is not as bad as it appears. Most emerging markets, though affected, are not that dependent on America funding. Emerging markets' banks are relatively unscathed. While some weakness will be evident, it should not be paralysingly so.

Asians are scared to even dare mention that they are OK as they know how things were just a few years back. While its prudent to be cautious, we need not scare ourselves silly.

p/s photo: Dhini Amirnati Maulana