II: The First Shoe Drops
October 14, 2004
of my February 2004 issue
of Financial Insights was entitled: "Will 'Buy America'
Become the World's New Mantra?"
In that essay
I discussed the various options available to foreigners, to manage
the mountain of U.S. dollar credits that rested in their coffers.
Further, I compared today's condition with that existing during
the late 1970's through late1980's. During that period alien
governments and individuals, led by the Japanese, began to dis-hoard
their vast dollar holdings. The latter part of that era was hallmarked
by the purchase of numerous prized American treasures, and the
threatened acquisition of untold others.
Under current conditions, given the enormous increase in dollars
that have since been amassed by our trading partners, the U.S.
now finds itself in a far more precarious state. When the world's
major economies finally decide to divest themselves of their
U.S. dollar hoards, rather than continue to accumulate them,
our nation's citizens will be forced to bear the brunt of the
fall-out from the trend reversal.
It was recently announced that Minmetals, a large Chinese government
controlled corporation, is in the process of acquiring Noranda,
Canada's foremost mining company. In addition to the other metals
that it mines, Noranda is the world's ninth largest copper and
the number three zinc producer. Additionally, Noranda controls
a 59% interest in Falconbridge, which is a major nickel and copper
miner in its own right. Of similar note is the concurrent announcement
that Sinopec, another massive Chinese government sanctioned company,
is attempting to purchase a large lease-holding covering an important
segment of Alberta's rich oil sands. A combination of today's
high oil price and recent advancements in technology, have thrust
these heretofore uneconomic hydrocarbon bearing sands into a
position where they can now be economically exploited.
In essence, if these acquisitions are consummated China, which
is rich in U.S. dollar credits and is commodity poor, will essentially
be able to "kill two birds with one stone". It will
find a home for some of the U.S. dollars that it has accumulated,
and it will simultaneously secure some of the resources that
they desperately require to satisfy their insatiable mineral
thirst. The price tag for Noranda is currently about $5.5 U.S.
billion, and that of the oil sands also runs into the billions
of dollars. While both acquisitions may primarily require Canadian
dollars, U.S. dollars will first be exchanged for those of our
northern neighbor, which in turn will be used to complete the
purchases. As an aside, this will benefit the already strong
Canadian Dollar and will help drive it to even greater heights
against its U.S. counterpart.
China is presently accumulating dollar credits at the mind-blowing
monthly pace of over $10 U.S. billion. This is in addition to
the reported one half trillion plus dollars that they currently
possess. This incredible cache of U.S. credits is acting as both
a boon to China and an Albatross around it's neck. On the positive
side it is utilized to fund the purchase of massive amounts of
raw materials that are direly needed by their industries. Negatively,
it forces the government to generate a substantial and undesirable
increase in their local currency, the yuan. This is fostering
inflation in their domestic price structure which is threatening
to undermine their economy's future growth and health.
When a Chinese business acquires U.S. dollars they exchanged
them for yuan through their banking system. The yuan are created
by the Chinese central bank. By significantly inflating their
money supply inflation is generated. Additionally, this greatly
expanded availability of capital is stimulating poor investment
decisions and an overexpansion of projects which may outpace
the markets that they hope to service. This too can do long-term
harm to their economy.
Further damage accrues to China as the result of the ongoing
decline of the dollar. The dollar's fall is generating currency
exchange losses for all of the United States' trading partners,
including the Chinese. This threatens China's dollar holdings
with further depreciation, and gives them an additional reason
to find avenues to rid themselves of their dollars, before they
lose even more of their value.
Most of the dollar credits that leave the United States to fund
our balance of payments deficits return, and are invested in
U.S. Treasury paper. This results because foreign states have
only a few primary fashions to utilize their amassed dollars.
They can use them to acquire other currencies, American products
or assets, or they can invest them in U.S. Treasuries where they
will bear interest.
This circumstance has worked exceptionally well for the U.S..
First, the dollars leave our domestic monetary system and therefore
are no longer counted in our money supply. Next, it allows our
government to run budget deficits, and fund them through the
issuance of Treasury paper which our trading partners largely
purchase. In effect, the dollars that leave our nation, only
soon to return, are invested in our Treasuries, thus restraining
an increase in our monetary aggregates. Had these dollars remained
within our monetary system they would have fostered inflation.
Unfortunately, recent events may be aligning to create a condition
where this situation may be in a state of change.
Foreign entities own nearly 50% of all outstanding U.S. Treasury
debt. Further, from the dollar's peak at the end of 2001, it's
international value as measured by the U.S. Dollar Index has
eroded by 33%. This places all external dollar holders in a very
difficult position. They have already lost one-third of the value
of their holdings, and are likely becoming frightened that they
will lose more. The recent action by the Chinese in their effort
to acquire Noranda and the Alberta oil sands, may be the first
obvious sign that one of the world's two largest dollar holders,
may have reached their limit.
Importantly, this may be the first indication that the Chinese
have struck upon a method where they can solve two problems.
They can acquire needed mineral and hydrocarbon resources, while
simultaneously ridding themselves of some of their unwanted dollars.
As I stated in the precursor to this essay, "If you will
recall, during the latter half of the 1980's, a wave of foreign
purchases occurred of American real estate and businesses as
well as irreplaceable works of art and other items ....This 'buying
of America' was led by the Japanese, and at times a certain amount
of U.S. outrage occurred as asset after asset was being gobbled
up by our foreign trading partners. During this era, landmarks
such as Rockefeller Center, Pebble Beach as well as Universal
Pictures were acquired by the Japanese."
It remains to be seen if we are experiencing the first in a series
of similar Chinese acquisitions. However, I believe that this
is only one of numerous ideas that China is considering to divest
themselves of their mountain of U.S. dollar credits. China's
government is likely already directing their efforts to make
purchases in other areas, and in different asset classes, using
their dollars. In any event, it is my contention that we are
witnessing the early stage of a flight from the U.S. dollar,
as visibly depicted by the recent actions of the Chinese. When
a widespread movement out of the dollar occurs with a vengeance,
this time it will be different, and it will likely be far worse
than our 1970's experience.
DOLLARS COME HOME TO ROOST
A major problem
will result when foreigners begin to dis-hoard their dollar stockpiles.
It has the potential to generate a U.S. inflationary episode
that will make the one that occurred during the latter part of
the1970's pale by comparison. To my mind, it is not a question
of if, but of when! At some point foreigners will become terrified
of holding our currency. They will become fed up with watching
our hemorrhaging balance of payments deficits, and the dollar's
seemingly endless deterioration in value.
When that time arrives we will likely be subjected to a flood
of dollars entering our monetary system and markets. As I have
described, the dollar credits that were exported to "pay"
for our balance of payment deficits, actually temporarily mitigated
any inflationary impact on our economy. However, a very different
set of circumstances will occur when these earlier expatriated
dollars return to U.S. shores and enter our money supply.
Heretofore, U.S. budget deficits were largely funded by foreigners
in their effort to at least achieve some benefit from holding
dollars; they bought and received interest on U.S. Treasuries.
These hundreds of billions of U.S. dollars circumvented entering
our domestic money supply. The dollar credits were instead acquired
by the Federal Reserve and exchanged for Treasury bills, notes
and bonds. This greatly benefitted all Americans and allowed
our citizenry to increase our standard of living while simultaneously
reducing the inflationary effects. Unfortunately, the reverse
will result when foreigners ultimately jettison a substantial
amount of their U.S. Treasury holdings.
When foreigners sell their U.S. Treasuries some will take the
received U.S. currency and purchase other currencies. This will
further weaken the dollar's value on the international market,
and will trigger a further liquidation of foreign held dollars.
Others will use their dollar proceeds to acquire U.S. dollar
denominated goods and assets.
This is where the problem arises! A flood of dollars that are
issued when foreigners sell their Treasuries will enter the U.S.
monetary system and dramatically inflate it. The resultant exploding
money supply will have the potential to foster a serious inflationary
A balance occurs in a country between the size of its money supply
and the value of the goods and services offered on their markets.
When this is in a state of equilibrium, prices are stable. Throughout
history whenever a nation fostered an increase in their money
stock, without a similar rise in the quantity of their offered
goods and services, prices rose. In effect, a condition results,
called inflation, where too many monetary units are chasing the
same number of goods. An extreme case would be the German hyperinflation
of the early 1920's, of which we have all heard. In that event,
their government was creating so many deutschemarks that in the
end, before the currency and the country collapsed, it required
a wheel barrel full of currency to purchase a loaf of bread.
I sincerely hope that this is not the state of affairs that awaits
our future. True, gold will benefit and may trade at monstrous
heights. However, we and our family and friends will have to
live in our great country. No amount of gold profits can compensate
for the misery that the ultimate return of our expatriated dollars
can and likely will produce.
October 14. 2004
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I expect to
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possible, to offer stocks that I believe will allow my subscribers
to participate without unduly affecting the stock price. It is
my desire for my subscribers to purchase their stock as cheaply
as possible. I would also suggest to beginning purchasers of
these stocks, the following: always place limit orders when making
purchases. If you don't, you run the risk of paying too much
because you may inadvertently and unnecessarily raise the price.
It may take a little patience, but in the long run you will save
yourself a significant sum of money. In order to have a chance
for success in this market, you must spread your risk among several
companies. To that end, you should divide your available risk
money into equal increments. These are all specula-tions!
Never invest any money in these stocks that you could not afford
to lose all of.
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is written and published by Dr. Richard Appel and is made available
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