MAC/20: Mines and Communities

Why is China buying metals it doesn't need?

Published by MAC on 2009-06-02


Last week, this website published an article pointing to a little-known and understood dynamic in minerals and metals trading.

Although most mineral-dependent states, and to a large extent the companies operating within them, have to sustain their expenditure with local currencies, their earnings are marked up in dollars.

As these non-dollar currencies appreciate against the greenback, so real mining-related income falls. The recent dollar depreciation has wiped out many supposed "gains" during the apparent marked recovery of prices for some major minerals and metals over the past two months. See: http://www.minesandcommunities.org/article.php?a=9266

A major factor in this sudden rise in prices is what appears to be resumed buoyant demand from China, already the most important single driver of the metals bull market over the past seven years.

Does China actually really need the increased tonnages of copper, iron, nickel and coal that it's been importing since February this year - especially as the regime (just in the past few weeks) has insisted on a cut back on domestic consumption - at least of steel and coal? This looks to be even more of an anomaly when one considers that China is also the world's largest domestic producer of this fossil fuel.

In early May, as Chinese purchases of copper suddenly escalated, it was reasonable to assume that this was due to a "bottoming out" of the red metal's price. The supplies would be kept in storage, possibly not for any actual use in near future, but as a bargaining chip.

China is locking up commodities...

But now, one influential financial website goes a step further, arguing that: "[W]hile the rest of the world has been grappling with the global slowdown, China has been locking up supplies of commodities that are only going to become more scarce (and more valuable) as global demand escalates. "

Says Money Morning: "China has been quietly and shrewdly reinventing itself ... While companies in the United States, Great Britain and Europe are being forced to shed promising assets in order to compensate for massive losses or to pay down debt, cash-rich China has been able to operate as a buyer in a buyer's market."

The online magazine argues that, although the rest of the world "has interpreted this as a sign that China's interested in buying the things it needs to grow", we haven't yet understood that "China's also interested in using physical assets as a source of "currency" that offsets an increasingly eviscerated U.S. dollar."

... and currencies too

Moreover, says Money Morning, China now "fully intends to boost [the yuan] in status to the point where it becomes an internationally accepted currency." This is likely to come to fruition as the US treasury pumps trillions of dollars into its failed banks and industries, triggering "a currency crisis the likes of which few are capable of imagining" and leading to "a near-complete devaluation of the once-almighty U.S. dollar."

At the moment, because of the huge amount of US dollars held by Chinese state banks in reserve, it's going to be difficult, if not impossible, for the regime to dump the currency and thus devalue it even further. Thus, according to Money Money, China must "elevate the credibility of its own currency in the international financial markets and effectively remove the exchange rate risks associated with its own partially blocked yuan."

However, the regime is also "hedging its bets" by "seek[ing] out other stores of value, such as natural resources, which are highly liquid and reasonably ‘deep' in global markets". As recent experience has dramatically shown, however, these are "very volatile from a pricing standpoint."

So China needs to pursue both strategies at the same time. This is amply witnessed by its aggressive forays into oil-rich states (such as Sudan) and its massive purchases of gold since 2003. But even more aggressive efforts have been made to locate and extract the yellow stuff within China's own borders - and Tibet. (A fortnight ago, we reported a confrontation between Tibetan villagers and Chinese armed forces backing the opening of a new mine in the Chamdo prefecture. See: http://www.minesandcommunities.org/article.php?a=9268)

The new global capital?

While adopting a more sanguine view on the fate of the dollar, Forbes magazine will tell us next weekend that: "Beijing is threatening to halt its Treasury buying if the dollar slides and has suggested that IMF Special Drawing Rights (SDR) replace the greenback as the world's premier reserve currency."

But this may well be an intermediate, "softening-up" strategy by the Chinese regime. As Forbes acknowledges, SDRs are "not a tangible medium of exchange or a claim on one. [They are] simply an accounting metric the IMF uses to balance its books [with] no real commercial application." Therefore, "just in case it doesn't happen, China is buying gold."

China is now the premier gold producer and among the leading sellers of the yellow metal. It continues to be the most important importer of other key metals. The government doesn't require these stockpiles for its own citizens' short, or even medium-term, benefit. And China's game plan now seems seriously focussed on minimising wasteful use of minerals; closing down hazardous and polluting mines and plants; and absolutely reducing its emissions of global greenhouse gases.

Surely, the most compelling reason for China's hectic buying of these commodities is to bulwark its global economic and geo-political standing?

The prospect of the world's most populous nation soon becoming, not only its most powerful deployer of capital, but also the prime moderator of its currency and commodities-backed trades, may be closer than we think.

Maybe that's just historical - if not very poetic - "justice".

[Comment by Nostromo Research, 31 May 2009]


CHINA SEEKS TO DETHRONE THE DOLLAR, TRANSFORMING THE YAUN INTO THE DOMINANT GLOBAL CURRENCY

By Keith Fitz-Gerald, Investment Director, Money Morning/The Money Map Report

27th May 2009

China has taken yet another step to transform the yuan into the dominant global currency, a long-term initiative that could ultimately dethrone the dollar as the world's top unit of exchange.

In the last four months alone, China has signed currency swap agreements worth more than $95 billion (650 yuan) with an array of nations - including: Argentina, Brazil, South Korea, Indonesia, Malaysia, Belarus and Hong Kong - that are only too glad to move away from the increasingly shaky U.S. dollar.

For Westerners who are struggling to come to terms with the notion of a disarrayed dollar, the thought of oil, gold or other commodities being priced in yuan instead of dollars has to seem about as likely as having another country put a man on the moon.

But the Chinese yuan is already well on its way to becoming that globally accepted standard unit of exchange and the proverbial genie, as they say, is out of the bottle. In fact, I'd even go so far as to say the dollar's days of dominance are numbered and with each new round of bailout chicanery, the clock is winding down ever faster.

Asia's Long-Term View

In such Asian markets as Japan, Hong Kong and Mainland China, the long-term planning that's an anathema to Corporate America is actually standard fare. During the height of Japan's dominance in the 1980s, the Western business press - with a touch of derision - wrote about how some Japanese companies routinely formulated business plans with durations of 100 years or more (while working in Asia early in my career, I actually even contributed to several such plans ... but that's another story for another time).
That's neither here nor there to most people who note smugly that Japan is getting its comeuppance. But what they don't understand is that Japan is not alone. In fact, many people I talk with are shocked to learn that at a time when the West is still busy handing out Band-Aids in an attempt to deal with the greatest financial crisis on record, China has been quietly and shrewdly reinventing itself with the same kind of long-term vision.

Take commodities, for example. While companies in the United States, Great Britain and Europe are being forced to shed promising assets in order to compensate for massive losses or to pay down debt, cash-rich China has been able to operate as a buyer in a buyer's market. While the rest of the world has interpreted this as a sign that China's interested in buying the things it needs to grow, what they have not understood is that China's also interested in using physical assets as a source of "currency" that offsets an increasingly eviscerated U.S. dollar.
This is actually a double-whammy of sorts, for while the rest of the world has been grappling with the global slowdown, China has been locking up supplies of commodities that are only going to become more scarce (and more valuable) as global demand escalates.

In fact, as I've suggested for months, now, China isn't just going to consume those assets; it's going to use them as part of the same long-term vision it's been staking out with regard to its own currency, the yuan, which it fully intends to boost in status to the point where it becomes an internationally accepted currency.

The Once-Dominant Dollar

That's quite a turn of events.

Even now, despite the travails of the U.S. economy, the dollar remains the world's most widely held reserve currency and, as such, is the standard unit of exchange in most international transactions. In fact, many non-U.S. firms (such as Airbus SAS) actually price their manufactured products in dollars. And the dollar is the de facto unit of pricing for such commodities as oil (hence the term "petrodollar"). Several countries even use it as their "official" currency.

But the global financial crisis is threatening that dominance.

The United States has already "injected" into the world economy trillions of dollars that are collectively worth more than 60% of this country's entire gross domestic product (GDP). And the prospect of still more injections for California, GMAC LLC and other "national" interests is extremely worrisome - and not just to millions of Americans, either. If Washington stays on this path, the result will be a currency crisis the likes of which few are capable of imagining and a near-complete devaluation of the once-almighty U.S. dollar.

Ironically, both events will only further embolden China, speeding up its efforts to boost the yuan's international acceptance.

The "New" Yuan

While some experts may question Beijing's motives, it's hard to question China's long-term strategic vision, since the country is actually being forced to take these steps that ensure its own survival. Unfortunately, our leaders in Washington don't seem to understand this, so they're only making matters worse - when they instead could be actively working with China and the world community on this instead of summarily ignoring the fact that the yuan may well be the world's next reserve currency.

At the very least, China's currency is likely to be granted a global status on par with the current major currency trading pairs for purposes of settling international transactions, whether the West wants that to happen or not.

I've outlined this scenario many times in recent years and, quite frankly, too often received blank stares in return. Most folks here in the West just aren't prepared to deal with the idea that the U.S. dollar could be finished and that another currency could replace it after more than 60 years of global dominance. But they better get used to the idea - and in a hurry.

China is acutely aware that not having international currency convertibility hampers both its development and - thanks to the ongoing financial crisis - its potential survival. Not only has China been forced to accept huge reserves built upon previous trade growth (its $2 trillion in reserves is an all-time record), but its own policies have contributed to its relative inability to flex its capital-market muscles. That's especially true in transactions involving U.S. dollar/yuan exchange rates.

What for us sounds quite theoretical in nature represents a very real problem for businessmen such as Dong Xianbin, the chairman of the Guangxi Sanhuan Enterprise Group Holding Co. Ltd. He estimates that he's lost more than 150 million yuan (about $22 million at current exchange rates) on international trade in the past three years alone because of exchange rate changes between the dollar and the yuan. So he's keen to see yuan-based transactions that will reduce exchange-rate risks, or eliminate them entirely. And he's not alone. Thousands of Chinese companies are chomping at the bit for the same reasons.

As a nation, not having a universally accepted currency is a huge issue. China's record reserves are now at risk thanks to the U.S. government's bailout boondoggle, because each new greenback printed debases the value of every other dollar out there, including the ones China holds.

Historically, Beijing sought to mitigate that risk by diversifying its holdings into other currencies most notably the European euro and the Swiss franc, for instance. But now China's facing the kinds of problems that massive mutual funds closer to home must deal with when they hold a disproportionately large amount of money: China's reserve fund is so massive that there's literally no other single currency that can absorb all that liquidity. So even if China wanted to diversify more aggressively, it's going to be hard pressed to do so.

Incidentally, this is precisely why China's so-called "nuclear option" will never become more than a theory bandied about by conspiracy buffs. Under such a scenario, China will either "dump" its dollars, and/or stop buying them, causing the value of the greenback to plummet. China might start selling, but there literally is not another currency on the planet that could absorb a wholesale liquidation.

Therefore, the reality is that China needs to have the U.S. boost the value of the dollar - even as the United States needs to have China do all it can to maintain the dollar's value.
Shopping for Commodities

At this point in time, China essentially has two alternatives:

• It can seek out other stores of value, such as natural resources, which are highly liquid and reasonably "deep" in global markets, but which can also be very volatile from a pricing standpoint.

• Or it can elevate the credibility of its own currency in the international financial markets and effectively remove the exchange rate risks associated with its own partially blocked yuan.

Never one to leave anything to chance, China is pursuing both strategies. For instance, China's been buying gold like there's no tomorrow - and is looking to add to its holdings. Since 2003, China has boosted its holdings of gold by 73% to an estimated 1,054 metric tons, with an approximate value of $31.3 billion. This makes China the fifth-largest holder of gold on the planet, followed by the United States, Greater Europe, and Switzerland.

China's also gone global in its hunt for oil - which, of course, is the only other global "currency" truly in international demand.

While there's a real benefit to having locked up supplies of commodities, they aren't an ideal store of value. And that suggests that what China really needs to do is elevate the global prominence of its own currency at the same time, whether U.S. leaders aid the process or not.
History shows that strong economies tend to have strong currencies. And the actions that I've reported on recently from China - the cross-Straits agreements reached between China and Taiwan, the Hong Kong yuan-trade agreements and the "yuan carry trade," to name a few - only reinforce the effort China is putting forth to achieve this goal.
Speaking of goals ... there are obviously plenty of Doubting Thomases on this issue - but they were around years ago before China announced that it wants to put a man on the moon by 2020.


When Currencies Falter

Steve H. Hanke

Forbes Magazine

8th June 2009

The financiers in Beijing are getting a little leery of dollars and are accumulating gold just in case. You should do likewise.

Want to know where the real action will be over the coming months? Forget stocks, think foreign exchange. There are tectonic moves afoot in the currency markets these days. During the past year the Polish zloty has fallen by 23% against the euro and 11% against the Hungarian forint. Now both countries are talking about replacing their currencies with the euro. The International Monetary Fund likes this idea and wants other European countries to "euroize" as fast as possible.

The Chinese are wringing their hands over the U.S. Federal Reserve's ballooning balance sheet. Beijing is threatening to halt its Treasury buying if the dollar slides and has suggested that IMF Special Drawing Rights (SDR) replace the greenback as the world's premier reserve currency. A United Nations panel has seconded China's motion, but just in case it doesn't happen, China is buying gold.

Currently, dollar-denominated assets account for 64% of the world's official foreign reserves, and the euro accounts for 27% of the total. The British pound and yen account for only 4.1% and 3.3%, respectively. In terms of the international reach of paper money, the dollar dominates, with 60% to 70% of all folding currency held overseas. The comparable figure for the second-place euro is only 10% to 15%. When it comes to foreign exchange trading, the dollar is involved in 88% of all trades.

Will the euro ever challenge the dollar's supremacy? Not likely. Poland and Hungary want to go euro, but the European Commission and the European Central Bank are dragging their feet. So it's not surprising that the European Union (of which Poland and Hungary are members) is openly hostile toward non-EU countries trying to adopt the euro. It is exactly this pathological insularity that I think will keep the euro from posing a threat to dollar dominance anytime soon.

One caveat relates to the experience of Montenegro, a non-EU country that is currently euroized. In late 1999 former president and current Prime Minister Milo Djukanovic (whom I was advising at the time) dumped the Yugoslav dinar and replaced it with the German mark. The mark morphed into the euro, and now Montenegrins use the euro. Indeed, this currency shift was a linchpin in Montenegro's drive for independence in June 2006, an event followed in April of this year by the approval of Montenegro's candidacy for EU membership.

It's a lesson for other countries wanting to euroize. The key is to limit the role of indigenous currencies while facilitating euro use. Panama has successfully followed this strategy for a century. Most people doing business and banking in Panama think the U.S. dollar is Panama's national currency. But it's not. Panama's currency is the balboa. One balboa is equal to one dollar. And while Panama issues balboa-denominated coins, it does not issue paper money. Thus Panamanians break out balboas only for small transactions requiring coins. The greenback is used for everything else.

The SDR as a dollar contender has its backers. Zhou Xiaochuan, governor of the People's Bank of China, recently announced that Beijing wanted a new international reserve currency that would be "disconnected from economic conditions and sovereign interests of any single country." Translation: We want a viable U.S. dollar alternative, possibly the SDR (which consists of 0.6 U.S. dollars, 0.4 euros, 18.4 yen and 0.09 British pounds). Its value fluctuates with exchange rates, and today one SDR is equal to 1.5 U.S. dollars.

But the SDR is not a tangible medium of exchange or a claim on one. It's simply an accounting metric the IMF uses to balance its books. It has no real commercial application. So don't look for it to displace the dollar soon.

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