In plain terms, China has ALL the trump cards when it comes to global monetary/ economic issues.
Phoenix Capital Research 23 November 2010
Ben Bernanke has made a very dangerous bet.
The Fedís Quantitative Easing 2 announcement of $600 billion in additional Treasury purchases is literally a ďbet the farmĒ move. True, the Fed had already engaged in an unbelievable amount of bailouts both known and unknown. However, the Fedís previous moves were all made when 1) the world financial system was teetering on the brink of collapse and 2) other countries were engaging in similar practices.
In contrast, the Fedís new QE 2 announcement comes at a time when the consensus is that the US economy is recovering (I donít buy it, but most analysts/ commentators do) and other central banks have publicly declared they wonít be engaging in additional easing (the ECB and UK) or are outright tightening credit and raising interest rates (China and Australia).
So this time, the Fed is going at it alone. Indeed, the only other major economy that is determined to engage in more intervention is Japan, which has thrown trillions of yen down the toilet for decades with nothing to show for it. And itís not like Japan is pleased about the Fedís move as it devalues the Dollar and cuts into Japanese export margins.
Consequently, even the country engaging in more QE is NOT a fan of Bernankeís QE 2 plan. However, this is just ONE of the myriad of problems QE 2 faces. The three biggest problems with QE 2 are:
1) The potential for a US Dollar break-down
2) Treasuries falling and pushing interest rates UP
3) China retaliating.
Of these, #3 is the most worrisome for the global financial markets. Letís be clear here, China is extremely adept at making investing/ financial decisions. And while we do need to take its decision to cut Treasury exposure seriously, I cannot believe China would actually telegraph that it was dumping Treasuries when the dumping really starts.
Moreover, China has shown that when it comes to real issues, it doesnít mess around. Consider the September 7th news story in which a Chinese fishing boat crashed into two Japanese coast guard ships. Japan arrested the captain and his crew. China responded by cutting rare earth exports to Japan.
Rare earths are used in a multitude of electronics (hybrid cars, LCD screens, magnets, batteries, TVs, etc). China controls 93% of the world production of these elements. And Japanís economy, which is focused on electronics manufacturing, is heavily dependent on these items for growth.
Consider this sequence of events.
1) A Chinese boat crashes into a Japanese coast guard ship.
2) Japan arrests the crew.
3) China CUTS its exports of critical resources that Japan NEEDS.
The message here is clear. China does NOT mess around and is more than happy to play hardball when it comes to issues it deems important. Moreover, when China holds a trump card, itís not afraid to use it.
These are some of the trump cards China currently holds:
1) Rare earths production
2) US Treasuries ownership (a decision by the #1 holder to dump would start a global rush from the US Dollar)
3) Derivatives: China could simply tell its banks and firms to renege on all derivatives deals, not just the commodity ones (commodity derivatives only comprise 2% of global derivatives, interest rate-based derivatives, in contrast, comprise 80% or so of the $600 TRILLION derivative market.
4) Interest rates hikes.
In plain terms, China has ALL the trump cards when it comes to global monetary/ economic issues. For that reason, its decision to simply ban exports of rare earth elements to Japan during the fishing boat tussle should be seen as a MAJOR warning of how China will conduct its affairs as it continues its quest to become a global super power.
Which is why Bernankeís decision to blame China for everything is NOT a good idea.
Our illustrious Fed Chairman recently told Congress that China is the BIG problem and that the Fed is blameless. Nevermind, that the speech was one of the biggest loads of self-serving nonsense in history, this is literally Bernanke loading insult on top of injury (heís personally seen to it that China loses BIG $$$ on its US Dollar investments).
How China will respond to this remains to be seen. But if the Japan/ China fishing tussle is any guide, Bernankeís going about EVERYTHING the wrong way here. No one knows how China will respond to this, but one thing is clear: the Global monetary showdown just got one BIG step closer to its end.
And whatever the end is, it WONíT be pretty.