by Sol Palha

September 12, 2006

Sure of their qualities and demanding praise, more go to ruined fortunes than are raised.

Alexander Pope 1688-1744, British Poet, and critic

250 billion dollars of China’s reserves are in U.S. Treasuries. Now you know who the true power really is; the one that holds the strings to the purse is usually the puppet master. If they even hinted that they were going to dump these treasuries watch interest rates skyrocket and the market crash. If they actually dumped them the scenario would be utterly devastating and crippling for the majority. This means that the U.S. is only in a position to bark to try to fool the world that they have some say in China’s policy-making decisions. They lost the ability to bite China long time ago.

On a different note if China listened to the U.S. and unpegged the Yuan from the dollar the true effects of inflation would be felt everywhere. All those dollar and 99 cents stores would have to change their names to maybe a dollar plus more or 2 or 3 dollar stores. An un pegged Yuan would appreciate approximately 30% that means all these prices would have to rise and the sad part is that we would have to pay these prices as we have lost almost our entire manufacturing base. So the U.S. should be careful what it wishes for.

The wealthiest 10% of Chinas population controls 45% of the China’s wealth and the poorest 10% controls or holds only 1% of this wealth. Most Americans would be aghast by such numbers however the sad part is that the situation is much worse here in the U.S. The top 1% control 1/3 of the country’s wealth and the wealthiest 5% control over 50% of the wealth. If we go to the other end of the curve the extreme poor in this country have little or no wealth at all. So if deflation ever hit the U.S. (which it will after a hyper inflationary phase) debt holders will be shredded to pieces. Since the U.S. has a negative savings rate we can safely assume that the majority (if we were to guess we would say at least 75% of the population falls into these category) will go through a phase one could safely call “the hell on Earth phase”. When this will happen is something no one can predict but happen it will and as the inflationary forces keep rising the day of reckoning draws even closer.

China has achieved a spectacular level of growth for the last several years in a row but a lot of that is based on mal investment. Right now steel mills and aluminium foundries are producing and storing far more then they can ever hope to sell and they continue to build even bigger and larger mills. If this excess aluminium, steel, iron, copper etc were ever dumped on the open market the entire base metals market would take an extremely severe beating.

There is one more possibility. We have always stated that the Chinese are advanced chess players in the sense that they have an uncanny ability to plan for events in the future that most individuals or nations will miss.

What if china was actually building all these mills and buying up all these raw materials as form of wealth diversification. They have billions of dollars in reserve; if they started to buy just Gold, or platinum, or palladium they would drive these markets to insane levels. They also cannot just dump the dollar for the Euro for they would hurt themselves in the process. Hence one way to do this subtly would be to buy every single commodity possible.

Coke (Raw Iron) producers produced so much last year that supply exceeded demand by over 100 million tons. Steel supplies exceeded demand by over 120 million tons last year and the list goes on. In 2005 investments in this sector grew by 25% and even though supplies are far exceeding demand it appears that this sector will grow by another 20% plus this year. This will result in even larger surpluses this year. Now normally such an event would cause prices to tumble but note raw material prices continue to rise. In between yes there are corrections but the main up trend line for most basic raw materials is still intact. This means that the only logical conclusion one can draw is this excess supply is not making its way to the markets but is being tucked away for maybe a rainy day.

The fly that does not want to be swatted is safest if it sits on the fly-swat.

Georg C. Lichtenberg 1742-1799