Beijing swells dollar reserves through stealth

Last Updated: 3:24pm BST 26/08/2008
The Telegraph.co.UK

Rule changes for commercial banks are acting as cover for exchange rate intervention, writes Ambrose Evans-Pritchard

China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy.

A study by HSBC’s currency team in Asia has concluded that China’s central bank is in effect forcing commercial banks to build up large dollar reserves, using them as arms-length proxies in a renewed campaign of exchange rate intervention.

Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.

This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15pc to 17.5pc of total lending since March.

“China has used the pretext of reserve requirement hikes to help slow yuan appreciation. We estimate that the PBOC [central bank] intervened by about $49.6bn in June,” said Daniel Hui, the bank’s Asia strategist.

Beijing has also slashed the amount of foreign debt banks operating in China can hold. The effect is to oblige the banks to become net buyers of dollars, halting the flow of foreign “hot money”.

Given the sheer scale of China’s foreign reserves - now $1,800bn (£970bn) - any shift in its exchange policy now ripples around the globe. The covert buying may help to explain at least part of the explosive dollar rebound over recent weeks.

There is little doubt that the key driver behind the wild currency ructions this summer has been the blizzard of dire data from Britain, Europe, Japan and Australasia. The mounting danger of a full-fledged recession across the club of rich OECD nations appears to have caught the markets off guard.

The closely watched Dollar Index reached an all-time low in March. It crept up gradually in the early summer before smashing through resistance in July.

The world’s currency system is swivelling on its axis. Central banks in Asia and Europe have stopped raising rates, and some have begun to cut aggressively. The Federal Reserve is no longer nakedly exposed. Indeed, investors are already starting to look ahead to the next round of Fed tightening.

The 18pc slide in oil prices from a peak of $147 a barrel in July has added juice to the dollar rally. Russia and the Middle East petro-powers tend to recycle a high proportion of their vast earnings from oil into the eurozone, either by purchasing European bonds or expensive imports.

A Bundesbank study found 40 cents of every dollar spent by eurozone countries on oil imports comes back again one way or another. The figure for the US is just 10 cents. This trade bias has given oil a new character as a sort of anti-dollar driving the currency markets.

Even so, the China effect is a key ingredient in the dollar comeback. Beijing’s Politburo is clearly disturbed by the sudden downward turn in the economy as export markets freeze, and surging wage inflation in the country’s manufacturing hubs eats away at profit margins.

“They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view,” said Simon Derrick, exchange rate chief at the Bank of New York Mellon.

China’s PMI purchasing managers index fell below 50 for the first time in July, signalling an outright contraction in manufacturing output. Hong Kong’s economy contracted 1.4pc in the second quarter. The Politburo has rushed through special rebates for textile producers now caught in a ferocious downturn.

Much of the clothing, footwear and furniture industry has been hit, leading to mass plant closures in the Pearl River Delta.

“During the first half of this year, about 67,000 small and medium-sized companies went bankrupt throughout China, leaving more than 20m people out of work,” said the National Development and Reform Commission. “Bankruptcies of textile and spinning companies have numbered more than 10,000. Two thirds are on the brink of bankruptcy.”

Last week’s rebound on the Shanghai stock market stalled on fading hopes of a fiscal stimulus package. “It is unrealistic to expect the government to rescue the market,” said Li Ka-shing, chairman of Hutchison. “Speculators should be very cautious now. The worst is not over in the global credit crisis.”

Lehman Brothers warns of a risk that a housing slump and the 55pc equity crash since October could combine with a global downturn to set off a “vicious cycle”. House prices have already fallen 18pc in Guangzhou and 9pc in Beijing. Prices are now falling in cities that make up over half China’s population.

One thing that the world has forgotten for the most part, is that gold is money. It has been parroted around for three generations as a commodity only, with little industrial use or demand, and no value as a currency.

Humans have this interesting tendency to forget history, even though through all of time it consistently repeats itself.

The cycle I am speaking of is the one where societies and economies cycle back and forth between paper fiat money backed by nothing but a governments promise that it has value, and currency that is backed by gold and silver.

This is not new, and in my opinion will happen again, as it always has, for thousands of years.

For a while now I have been going on about how the Chinese, OPEC, and other nations that have trillions of USD in their reserves are not going to simply sit on it and watch it devalue by 16%-20% a year because of a rampant monetary inflation policy of the Federal Reserve.

“Dollar crisis looms, says Nobel laureate Mundell
Reuters June 3, 2008 at 8:36 AM EDT

VALENCIA, Spain — A major dollar crisis could come within five years and China is discussing reforms to the global monetary system to protect its $1.6-trillion (U.S.) reserves pile, says Nobel Prize-winning economist Robert Mundell.

Mr. Mundell, who has regular contacts with Beijing officials, said they are considering proposing ways to fix major currencies including the dollar and the euro, in a system similar to the one which operated under the Bretton Woods agreement from the end of World War Two until the 1970s.”

If you were China and seeing this happen to your National Treasury, would you sit there and do nothing or look for a solution?

The answer is obvious.

“China is worried about its pile of about $1.6-trillion in foreign reserves, built up during years of U.S. trade deficits, which loses value as the greenback depreciates. “

The excerpts from the above Reuters article shows that China seems to be interested in a gold backed system. If this were to occur, we need to take a serious look at what it means for the price and demand of gold.

I will give you one simple equation, which you can then apply to any nation, or the economy at large. If the USA were to go to a gold backed standard, that means each dollar in circulation would then have to be redeemable in gold. The current measure of USD in circulation based on private firm analysis is above $14 Trillion USD. The US Treasury claims it has 261,498,899.316 ounces of gold according to its website http://www.fms.treas.gov/GOLD/current.html . If we were to divide the number of USD in circulation by the amount of gold claimed to be on hand in the US Treasury, it would make the price of gold $53,537.00 per ounce.

You can perform this calculation on any nations currency, if you know the amount of currency in circulation and the country’s claimed national reserves in gold.

The bottom line is, if the world heads to any form of gold backed currency system, or any world government chooses to make its own currency backed in gold, then two things would happen:

1. That country will be the best runner up for the next world reserve currency

2. The valuation on gold will skyrocket beyond the angels

“Without reform, the global monetary system is headed for a dollar crisis within years, Mr. Mundell believes. “

I sure hope you own some gold before that happens.

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Alex’s Notes: Unexpected inflation?? You have got to be kidding me.

It does not cease to amaze me how often main stream media financial analysts are either completely ignorant of how the economy works, or are deliberately creating spin to keep consumers fat dumb and happy.

The bottom line is we have added over 14 TRILLION dollars to the money supply and currently the rate of adding money is only increasing. We are about to hit 19% in terms added change to money supply.

How anyone can expect that we will not see price increases under such conditions and call themself a financial analyst is beyond my comprehension.

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India’s Inflation Unexpectedly Accelerates on Food
By Cherian Thomas

May 16 (Bloomberg) — India’s inflation rate unexpectedly rose to the highest in 3 1/2 years, adding pressure on the central bank to raise borrowing costs further to tame prices.

Wholesale prices rose 7.83 percent in the week ended May 3 from a year earlier, after gaining 7.61 percent in the previous week, the government said in a statement in New Delhi. Economists surveyed had expected a 7.55 percent increase.

Increasing borrowing costs will check the flow of money to speculators in the commodities market and rein in food prices, former central bank Governor Bimal Jalan said in parliament last month. The government, to augment monetary policy action, has persuaded steel and cement makers in the past week to cut prices and help slow inflation.

“More monetary tightening cannot be ruled out,” said Rajeev Malik, senior economist at JPMorgan Chase & Co. in Singapore. “More measures are likely as inflation is expected to remain above the central bank’s target of 5.5 percent.”

The index for fruits, vegetables and other food items rose 0.5 percent, while that for manufactured products gained 0.3 percent, today’s statement showed.

The rupee declined to 42.73 against the dollar from 42.65 before the data was announced. The yield on the benchmark 10- year bond was little changed at 7.88 percent, holding near this week’s high.

China Inflation

India and China, the world’s fastest growing major economies, are battling rising prices stoked by consumer demand and high food costs. Wholesale prices in China rose 10.3 percent in April from a year earlier, the fastest since at least 1999.

India’s central bank twice asked lenders to set aside more funds last month, raising the so-called cash reserve ratio to 8.25 percent, the highest since March 2001, from 7.5 percent. The Reserve Bank of India may raise the ratio for a third time this year to control inflation, according to six of nine economists surveyed by Bloomberg News on April 30.

India’s cement makers joined steel producers on May 14 in pledging to cut prices after Finance Minister Palaniappan Chidambaram said the government will take “administrative action” against them for behaving like cartels.

Chidambaram yesterday said there is significant scope for further reduction in cement prices. Steel Authority of India Ltd. and other Indian steelmakers on May 7 agreed to lower prices for a second time since April.

Indian Elections

The Associated Chambers of Commerce and Industry, an Indian trade organization, says it expects the combination of steps taken by the government, central bank and companies to slow inflation to 6 percent in the next four to six weeks.

Prime Minister Manmohan Singh’s government has been stepping up measures to cool prices in Asia’s third-largest economy to improve his re-election chances in a vote that must be held before May 2009.

The government wants to bring inflation down to 4 percent, to protect consumers in a nation where the World Bank estimates half the 1.1 billion population live on less than $2 a day.

Over the past two months, the government scrapped import duties on edible oils, steel products and banned the export of cement, pulses, rice, wheat and edible oil to contain prices.

Last week, under pressure from its communist allies, the government also banned futures trading in soybean oil, rubber, chick peas and potatoes to reduce speculation. It halted wheat and rice contracts last year and lentils in 2006.

Today’s inflation rate may be revised in two months when India’s government reviews the figures after receiving additional price data. The Commerce Ministry today increased the inflation rate for the week ended March 8 to 7.78 percent from 5.92 percent.

                       Week Ended    Week Ended     Percentage
                         May 3         April 26        Change

Primary articles         239.3         238.6           0.3
Fuel, power              345.4         342.5           0.8
Manufactured products    198.9         198.3           0.3
Food products            204.3         202.8           0.7
Edible oils              186.6         187.9          -0.7
Cement                   220.8         221.6          -0.4
Iron & steel             354.6         360.6          -1.7
Pulses                   241.8         243.9          -0.9
Fruits & vegetables      253.2         247.1           2.5
Total                    228.6         227.7           0.4

http://www.bloomberg.com/apps/news?pid=20601068&sid=aN4UwM8U3oQA&refer=economy

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Alex’s Notes: This quick note was fired to me from Simon Heapes, Director and Treasury Officer of The Anglo Far East Bullion Company. This was his comment and response to my post on the possibility of China holding the next world reserve currency:

2,000 yrs ago As Rome debased its currency and expanded via inflationary methods, the question must be asked who was buying the tangible productive assets?

It was the Byzantine Empire! When the Byzantines finally did over run Rome, they did not collapse it, they merely replaced Rome’s leadership with their own leadership, and effectively ran Rome as a defacto Empire keeping all the same systems in place for another 200yrs.

Finally, the Byzantium leadership broke apart from a Moral decay into the nations we call Europe today!

So the Question now, is China & the East going to do the same thing and keep the current system running further expanding globally and running inflation even further sending the cost of tangibles higher for many yrs to come? It certainly looks that way!

- Simon Heapes, The Anglo Far East Bullion Company

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Alex’s Notes: The long trend here for food, energy, commodities, metals is up. Why? Because China, Brazil, India, are all coming online with hundreds of millions of new consumers who all have disposable income to spend.

When 950 million new consumers enter a market, and they all want a car, a nice watch, a tv, a dvd player, a computer, a new refridgerator, washer/dryer, etc etc etc, it has more than a tiny impact on global demand for raw materials.

Another factor is when people who have had to mind their food budgets for generations have the ability to eat more, and eat well, they do.

Some feel we have seen the top of commodities, I have to disagree. Yes we will see normal corrections and consolidation, but the overall trend will be up for a good many years to come.

By STEVENSON JACOBS

NEW YORK (AP) — Wheat futures vaulted above $12 a bushel for the first time Tuesday as investors bet that a shortage of high-quality milling wheat will keep prices high for the grain used in bread, pasta and other foods.

Other commodities traded mostly higher, with crude oil surpassing $100 a barrel and silver hitting its highest level since 1980.

Wheat prices have surged 34 percent since the start of year, pushed higher by growing world demand, tight supplies and bad weather that has pummeled crops in Canada, Argentina and India. U.S. exporters are selling wheat a record pace to meet demand, rapidly depleting stockpiles. The Department of Agriculture expects U.S. wheat inventories will total 272 million bushels by the end of May — the lowest level in more than five decades.

“Everybody is coming to the realization that the shortage of wheat is not going away,” said Elaine Kub, a commodities market analyst at DTN. “There’s no relief coming from anywhere in the world until June,” when the U.S. wheat harvest begins.

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