China Sends Foreclosure Demands To U.S.

China has sent its latest foreclosure notice to the U.S. by way of a People's Bank of China adviser:

The U.S. has to resolve its “twin deficits” in the government budget and the current account, Xia was quoted as saying. Three ways that may help the U.S. achieve that target include reducing military expenses, selling part of its gold reserves and relaxing some export limits on technology, he said.

These are are more than merely helpful suggestions.  Nothing in superpower affairs is ever so innocent.  Each of those three polite hints will serve to strengthen China's strategic position.  China is putting the U.S. on notice that a gradual transfer of its hegemony is an acceptable alternative to China's sudden exit from the U.S. Treasury market.  China wants to avoid a sudden drop in the value of its Treasuries and is seeking a typically face-saving alternative to the "nuclear option" of a bond market selloff or boycott. 

The U.S. is not likely to take the hint.  The bond market will thus have to force Uncle Sam to pay attention. 

China Prepares For U.S. Dollar Self-Destruction

Another chapter unfolds in China's "Unrestricted Warfare" strategy against the United States.  China's position as a primary customer of U.S. Treasuires gives it the ability to dictate U.S. policy.  China will not tolerate U.S. pressure to let the yuan float and the U.S. political leadership is powerless to fight back without triggering a flight from the dollar. 

The dollar's fifth stright week of decline against the currencies of the U.S.'s largest trading partners is the market's recognition that quantitative easing will destroy dollar-based assets.  China's assessment of the U.S.'s fundamental weakness is correct.  Global currency traders are anticipating that further monetary stimulus from the Fed will trash the dollar's value. 

China, despite its growth-related problems and urban real estate bubble, is in a relatively stronger position than the U.S.  Any eventual appreciation in the yuan will increase the value of Chinese companies and their earnings in dollar terms.  Chinese investors can easily use this leverage to pick up dollar-based assets on the cheap after a run on the greenback. 

U.S. Economy Faces No-Growth Stagflation

The U.S. is in no position to lead the global economy away from the brink of a double-dip recession.  The rest of the world is doing just fine without us:

Just three years since America began dragging the world into its deepest recession in seven decades, Goldman Sachs Group Inc., Credit Suisse Holdings USA Inc. and BofA Merrill Lynch Global Research are forecasting that this time will be different. Goldman Sachs predicts worldwide growth will slow 0.2 percentage point to 4.6 percent in 2011, even as expansion in the U.S. falls to 1.8 percent from 2.6 percent.

That's the Wall Street consensus, and we all know how the best and brightest often get forecasts wrong.  There's some wisdom in the general point about U.S. weakness even if you want to quibble with the specific numbers.  Nations that find themselves in weak competitive positions often resort to trade sanctions as a last resort:

Legislators from both sides of the aisle, frustrated by years of conversations with China over the deep imbalance in trade activity between the two countries, and concerned over plant closings in their districts, are beginning to take action.

Here's a point that appears to be lost on our erstwhile legislative saviors.  China buys a whole lot of Treasury bonds to allow us to fund our profligate empire.  If we launch a trade war using a specious provocation like a WTO complaint over currency manipulation, China will probably exercise their nuclear option of ceasing to buy our sovereign debt.  Say goodbye to the bond market bubble when that happens, regardless of any good economic news. 

The U.S. has no decent path out of its no-growth future as long as we keep piling on debt.  China knows this and plans accordingly.  Joe Six Pack remains sound asleep in front of the TV. 

Full disclosure:  Long FXI with covered calls.

China Uses Rare Earths As Economic Weapons

China has just escalated its diplomatic standoff with Japan over ownership of the East China Sea.  The Middle Kingdom has just decided that rare earth metals will not be available to Japan at any price:

Sharply raising the stakes in a dispute over Japan’s detention of a Chinese fishing trawler captain, the Chinese government has blocked exports to Japan of a crucial category of minerals used in products like hybrid cars, wind turbines and guided missiles.

Any high-tech manufacturers with part of their supply chain in Japan will be very concerned about this news.  Toyota's strategic plan of ensuring it can obtain sufficient rare earths for its projected Prius sales is now in doubt. 

The ongoing China-Japan spat is about more than just China's assertion of historical hegemony in Asia.  The China Development Research Foundation, a Chinese government think tank, published a report concluding that the urbanization of 400 million migrant workers over two decades will cost $300B per year.  This commitment to development is absolutely essential if China is to maintain its internal stability.  China has a short window in which to decide how it will pay for the infrastructure improvements it needs to meet the rising expectations of its people.  Its options include offshore resource development in places like the East China Sea.  Alternatives to that option include curtailing the amount of money China spends buying U.S. Treasury bonds. 

This development gives renewed urgency to U.S. efforts to develop alternative sources of rare earths from Mountain Pass, California and elsewhere.

Friday's Fun Miscellany

Let's take a look at a big jumble of newsworthy stuff on an options expiration Friday.


Goldman Sachs' wrist-slap SEC fine is being spun as a victory for Lloyd Blankfein's skill in negotiation and strategy.  Maybe so, but I think influence peddling among Goldman alums (now lobbyists) and SEC staffers' i-banking aspirations played a strong role too. 

BP caps the Deepwater Horizon well.  I think it's going to hold.  They didn't even have to hire SpongeBob SquarePants to get the job done on the ocean floor.  Maybe a short-expiration covered call strategy on BP is a special situation worth playing.  I have all weekend to think that one over. 

Greece continues to take its austerity medicine by raising retirement ages for government workers.  Great!  Now let's do the same thing here and stick it to government employee unions, who BTW are now the majority of unionized employees nationwide. 

The Creature from Jekyll Island grows more tentacles.  The Fed is now the fourth branch of government, a development that puts it outside the Constitution's system of checks and balances.  A central bank owned by private interests that has veto authority over a broad swath of economic activity is something the Founding Fathers never envisioned.  The U.S. has entered unchartered territory with its population completely unaware of the new reality.  What did Ben Franklin say we had?  "A republic, if you can keep it." 

An overhaul of housing finance is coming three years too late.  The time to break up Phonie and Fraudie and unwind their obligations has passed.  China threatened Uncle Sam with the nuclear option of dumping Treasuries back in summer 2008 and Uncle Sam caved in.  Now Uncle Sam is stuck with the bill for supporting 95% of all new mortgages.  "Overhaul" now means just another way of disguising wealth transfer from American taxpayers to Chinese agency debt owners. 

Full disclosure:  Anthony J. Alfidi has plans for the weekend.

China Has Had Enough Of U.S. Debt

The tipping point in Uncle Sam's debt binge is finally here. It came in bits and pieces but the overall outline is no longer in doubt:

China reduced its holdings of US government debt by the largest margin in nearly nine years in June, according to data from the US Treasury.

China holds more US government debt than any other country and cut its holdings of US securities by more that 3% in June, said the BBC's Chris Hogg.

The handwriting is on the wall but many Americans are illiterate. One by one, the U.S.'s foreign creditors will decline to buy our Treasury bonds. One by one, they will choose to stimulate their own economies and not ours. One by one, they will pursue autarkic programs and leave the U.S. to its fate. There is no need for another Smoot-Hawley tariff this time around to drive global trade through the floorboards. The eventual collapse of the dollar will accomplish that all by itself.

Nota bene: Anthony J. Alfidi is long FXI with a short straddle.

China Closes Down, Spooks U.S.

It used to be that when U.S. markets sneezed, Asian markets caught a cold. Now it's the other way around:

World stocks sank Wednesday, with European indexes spooked by a 5 percent drop in China that strengthened fears stocks have become overpriced after this year's powerful rally.
(snip)

China's benchmark index has lost nearly 20 percent since Aug. 4 on worries about corporate profits, the strength of China's recovery and possible changes in Beijing's easy credit policy that has helped to fuel the bull run in Chinese stocks this year.

Dow and S&P 500 futures were down too; I expect Aug. 19 to be a down day for U.S. markets. This is the kind of news that illustrates how the world is changing, with China supplanting the U.S. as the nation to which the rest of the world turns for leadership. I look past the fact that China's stocks are down from their peak. That's why I'm holding FXI for a very long time.

China Went For The Gold . . . And Got It

Looks like Olympic medals weren't the only kind of gold China's been pursuing in recent years:

China revealed on Friday that it had secretly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tonnes - or a pot worth about US$30.9-billion - and confirming years of speculation it had been buying.

This confirms what I've suspected for a while. China has been "shaping the battlespace" in its undeclared economic contest with the Anglo-West by stockpiling an alternative store of value that competes with the U.S. dollar.

The article also reveals something that took me by surprise:

China is the world's largest gold producer and does not permit exports of gold ingots, only jewellery, leaving plentiful supplies for the domestic market.

I had always thought South Africa was the world's top gold producer. Not anymore! Now Asian producers have more pricing power at the start of the supply stream. This knocks another pillar out from under the Anglo-West's ability to dominate the world.

The article concludes with Hou Huimin, vice general secretary of the China Gold Association, forecasting the end of U.S. dollar hegemony:

"The financial crisis means the U.S. dollar value is changing fast, and it may retreat from being the international reserve currency. If that happens, whoever holds gold will be at an advantage."

I couldn't have said it better myself. :-)

Nota bene: Anthony J. Alfidi is long FXI (with covered calls), IAU (with short puts), and GDX (with short puts).

Chinese Banks Grow Assets While U.S. Banks Dilute Equity

In a sign of relative strength, Chinese banks are able to grow their loan portfolios de novo, i.e., without artificial capital infusions:

President Hu Jintao said April 1 that China’s 4 trillion yuan stimulus plan was taking effect, after urban fixed-asset investment surged 26.5 percent in the first two months. China’s lending boom contrasts with the struggle in the U.S. to rid banks of illiquid assets and efforts by central banks from Switzerland to Japan to unfreeze credit.

The excerpt above hints at my next point. U.S. banks are unable to make capital available for asset growth without severely diluting their owners:

Goldman Sachs Group Inc., by selling stock to help it repay $10 billion to the U.S. Treasury, may pressure competitors to follow suit or appear dependent on government support, analysts said.

Now do you guys see why I'm staying long China and short the U.S.? We're going to see this story play out in many different ways over the next few years.

Nota bene: Anthony J. Alfidi is long FXI (with covered calls) and short uncovered calls on SPY and IWM.

China's Warning Shot Across U.S.'s Bow

China is warning the U.S. not to destroy its bond portfolio:

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China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.

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You may recall from my post yesterday that the Fed is going through public motions about finding ways to ward off inflation while quietly preparing to inflate the dollar away with massive purchases of U.S. Treasuries. China is signalling that it will have none of this gamesmanship. That big red dragon wants some kind of iron-clad guarantee that the U.S. will not inflate away its debt obligations. China's "nuclear option" is a financial WMD.

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China is demonstrating its aptitude at applying the concepts outlined in Unrestricted Warfare, a book that should be read by anyone who really wants to understand the delicacy of U.S. relations with China. China's ownership of U.S. debt gives it a powerful bargaining chip when negotiating with the U.S. over solutions to Great Depression 2.0. Expect concessions from the U.S. on trade in exchange for continued Chinese purchases of Treasuries. China's master plan to supplant the U.S. as the world's dominant power is coming along just fine.

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Nota bene: Anthony J. Alfidi is long FXI (with covered calls).

US's Subprime Credit Rating Will Trigger Sovereignty Crunch

The United States government, long one of the most creditworthy institutions on the planet, is in serious danger of becoming insolvent in the near term:

The United States may be on course to lose its 'AAA' rating due to the large amount of debt it has accumulated, according to Martin Hennecke, senior manager of private clients at Tyche.

John Whitehead, former chairman of Goldman Sachs, has gone public with a similar negative assessment of U.S. solvency:

"Before I go to sleep at night, I wonder if tomorrow is the day Moody's and S&P will announce a downgrade of U.S. government bonds," he said. "Eventually U.S. government bonds would no longer be the triple-A credit that they've always been."

There are at least ten "trillion dollar problems," facing the United States, he said, including social security, expanding health insurance, rebuilding infrastructure and increased spending on green energy. At the same time, the public does not want to pay for it.

I bolded that last sentence in his quote. Why has it come to this? Instead of leading the way in preparing the American people for austerity measures and financial realism, our ruling elite and their enablers in the professional caste engage in magical thinking typical of children. The most well-educated and privileged people in our governing class - lobbyists - are engaged in a final desparate grab for largesse:

Of the initial $350 billion that Congress freed up, out of the $700 billion in bailout money contained in the law that passed last month, the Treasury Department has committed all but $60 billion. The shrinking pie — and the growing uncertainty over who qualifies — has thrown Washington's legal and lobbying establishment into a mad scramble.

The Treasury Department is under siege by an army of hired guns for banks, savings and loan associations and insurers — as well as for improbable candidates like a Hispanic business group representing plumbing and home-heating specialists. That last group wants the Treasury to hire its members as contractors to take care of houses that the government may end up owning through buying distressed mortgages.

A sovereign debt default will probably spur the U.S.'s main foreign creditors - China, Russia, and sovereign wealth funds in Asia and the Middle East - to demand enormous financial concessions from the U.S. government. These entities may be willing to renegotiate payment terms if Uncle Sam accedes to putting their interests first, ahead of the American people. That could mean a number of things . . .

• Cuts in federal discretionary spending to ensure debt payments will be made without delay. Imagine: no space program, no school lunches, no farm subsidies, no state disaster aid, no SBA loans, and basically no more goodies for all kinds of constituencies.
• Cuts in military commitments that encroach upon on our creditors' regional spheres of influence.
• Cuts in middle class entitlements (ouch, the most painful one). Bye-bye Social Security and Medicare for the Baby Boom generation, starting in 2009.

Think I'm being alarmist? We'll find out soon enough (probably by the end of 2009) whether the U.S. addiction to debt will result in the "nuclear option" of the destruction of our superpower status via a Sovereignty Crunch. The only possible silver lining is that forced austerity will trim the fat from America's welfare state and force our people to become as self-reliant and hardy as our ancestors on the frontier. One can only hope.

Chinese Fire Drill

China once again demonstrates the speed of its OODA loop:

China announced a 4 trillion yuan ($586 billion) stimulus plan to spur expansion in the world's fourth-largest economy, helping sustain global growth as the U.S., Europe and Japan teeter on the brink of recession.

I've argued before how China's neofeudalist economic structure (Communist in name only) enables their elites to make effective decisions faster than U.S. elites. The bad news for the U.S. is that all of the reserve money China is spending on infrastructure will not be available to buy new issues of U.S. government debt. I'm so glad to be a long-term investor in China.

Nota bene: Anthony J. Alfidi is long FXI (with covered calls) at the time this commentary was published.

A Long Way To China

I've had mostly short positions this year, but I've finally decided to take a long position in addition to my gold holdings. I have opened a long position in FXI because I am bullish on the long-term prospects of the Chinese economy.

In simple terms, FXI is on sale. Today's closing price of 39.43 is almost half of what the ETF was worth a year ago. Bottoms are hard to call, but I'm not going to call one. Too many investors are fearful of further declines, so it's time for yours truly to get greedy.

The macroeconomic rationale is even stronger than the opportunity posed by FXI's price haircut. China is in a position of strength relative to the United States. Beijing's enormous holdings of U.S. Treasuries gives the Chinese political leverage over Washington, and I believe they have been quietly using it. Treasury Secretary Henry Paulson knows this, which is why he is so keen to stay on the Middle Kingdom's good side. A long position on the Chinese stock market is a kind of carry trade against the dollar given the interest payments the U.S. must make on China's Treasuries.

Most importantly, China's internal market and trade relations with its neighbors have matured to the point where it can afford an export slowdown without worrying too much about whether its economy will suffer. The combination of China's newfound strength and the historic drop in the FTSE/Xinhua China 25 index is too attractive for me to ignore.

Nota Bene: Anthony J. Alfidi is long FXI and is writing out-of-the-money covered calls against this position for additional yield.