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The World's Biggest Cash Pile

April 16th, 2009 7:23 AM by Lehel Szucs

The World's Biggest Cash Pile
Make no mistake: it's a much bigger problem for China than it is for us.
When you're sitting on the biggest mountain of surplus cash in the world, what do you do with it? This is the roughly $2 trillion dollar question that Chinese central bank officials have to wrestle with.
And the problem just keeps getting bigger. For the first three quarters of 2008, China's foreign exchange reserves increased by a whopping $377 billion. That's $10 billion more than the same period in 2007.
Why does it continue to buy them? The simple reason is that is has to, because of its exchange rate policy. In order to keep the value of the Chinese yuan from appreciating versus the dollar, China's central bank must buy U.S. dollars in massive quantities. And rather than just sitting on the physical currency - which pays zero interest - it buys foreign securities.
What percentage of China's foreign reserves is held in U.S. Treasuries?
No one knows for sure, but analysts generally believe the figure could be as high as 70%. That would put China's U.S. debt paper pile at around $1.4 trillion.
So what are China's options if it wants to "diversify" its holdings?
The short answer is: not many... not many at all.
China's Investment Options
All the gold in the world...
What about gold? That one's easy: it's estimated that all the physical gold in the world that's ever been produced amounts to roughly 140,000 tons (worth about $4.5 trillion dollars using $1,000 an ounce). About 75% of that is either in coins or jewelry... not available to China, or to any other government.
The new gold available each year is miniscule: about 2,600 tons (almost $83 billion dollars worth) of new gold is being mined and refined annually, increasing the total supply by 2% per year.
You can see that China's problem - if it wants to invest in gold as a diversification strategy - is that there isn't enough available for sale. 30,000 tons are held in various government central bank vaults. Privately held bullion amount to about 20,000 tons.
Any major purchase of gold on the open market - which is where China would have to buy it - would drive up its price. To put this in perspective: China buys enough U.S. treasuries in one month to pay for all the gold mined in a year everywhere in the world.
So we can throw gold onto the "won't pile"...
Other foreign currencies...
As of the end of 2008, the value of all Eurodollars in circulation exceeded the value of U.S. dollars. Since then, the Euro has fallen 8% against the dollar. Other world currencies have suffered similar fates.
Assuming China sold their dollars and bought a basket of currencies, it would clearly have lost money on its investment. The reason is that the global economic crisis deepened, other countries have flocked to the dollar as the only safe haven investment... driving it up in value against all other comers. This will likely continue to be the case. Another one for the "won't pile"...
Private Sector Bonds...
Way too risky. Most companies have been severely affected by the global economic slowdown. Their balance sheets have decimated credit ratings across the board, reducing much of the available corporate debt to well below investment grade.
Back to Square One
In summary...
1. Will China continue to buy U.S. Treasuries? Yes.
If fact, purchases of U.S. debt by China will likely continue to increase for the foreseeable future, as it continues its policy of propping up the Yuan. By fixing its currency to the dollar and by buying them, it keeps both strong, thereby protecting its investment.
2. What will happen when it stops and starts buying something else? Forget it.
There IS nothing else that's as good of an investment as the U.S. dollar.
3. Would it start dumping U.S. Treasuries? Not a Chance.
China central bankers might as well all strap on six-shooters and begin firing them at their feet. It would reduce the value of the Yuan, something China can't afford.
For better or worse, China and the U.S. are inextricably linked in an incestuous financial relationship. We need China to buy our debt to finance our annual federal budget deficit, and China needs to buy dollars to prop up its currency.
And it's in both countries' best interest to see that things stay that way for a long time.
Posted in:General
Posted by Lehel Szucs on April 16th, 2009 7:23 AM

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