Saturday, November 15, 2008

China's Golden Opportunity

China is looking to buy some gold:

Beijing is considering changing its asset allocations during the financial tsunami in order to build up gold reserves "in a big way," the source said.

China's fears about the long-term viability of parking most of its reserves in US government bonds were triggered by Treasury Secretary Henry Paulson's US$700 billion (HK$5.46 trillion) bailout plan, which may make the US budget deficit balloon to well over US$1 trillion this fiscal year.

China's desire to reduce its exposure to U.S. Treasuries, combined with its recently announced fiscal stimulus plan, spell trouble for Uncle Sam's plan to fund the TARP with new debt. Who will buy that debt if China doesn't belly up to the bar? Not me, unless they pay a whopping yield (15% or more).

Unfortunately, the deflation-fixated Anglo-West continues to misread the global impact of conditions in China:

After a recent visit to China, Nobuyuki Saji, chief economist and equity strategist for Japanese investment bank Mitsubishi UFJ Securities, issued a report warning that China could be on the verge of pushing the world into a deflationary spiral. The problem? Swelling industrial overcapacity, which threatens to undermine prices both for China's exported goods and its imports of raw materials.

Industrial overcapacity is IMHO more of a problem for the West, where labor unions and their political retainers fight tooth and nail for bailouts to stave off retooling. China's political system suffers from no such obstacle. China's fiscal stimulus will, at a minimum, flood consumers' pockets with money in the short term and provide price support for retail goods. Deflation in China is now a much less likely outcome.

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