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China ignores Western morality

Beijing's strategy will bring out the worst in minor world leaders...

Gold Forecaster, Global Watch 19th February 2007
Below is a snippet from the latest weekly issue from GoldForecaster.com

A YEAR AGO the Chinese began making plans to push a good percentage of their foreign reserves overseas. They are now at last taking action to implement a new policy of diversifying the country's over US$1 trillion foreign exchange reserves.

   The Ministry of Finance (MOF) is planning to issue Yuan-denominated bonds to raise funds that will be used to "buy out" as much as $200 billion from the country's foreign reserve pool.

   To take funds out of the foreign exchange reserves the government must pay the equivalent amount in Yuan to balance the books. At the current exchange rate, the total amount of Yuan bonds to be issued by the MOF will be more than 1.5 trillion Yuan. The ministry will sell the bonds to commercial banks. The scale of the Ministry of Finance’s planned bond issuance is so huge that it will have to be done phase-by-phase.

Easing the liquidity pressures in China

   In so doing, pressure on market liquidity can be alleviated. Although the market is awash in liquidity, the issue needs to be in line with monetary policy. Nowadays, liquidity inside the banking system is more than sufficient. If the government bonds are issued phase by phase, the due bank notes issued by the People's Bank of China and the new base money from the purchase of the foreign exchange will allow the market to absorb the pressure. If the 1.5 trillion Yuan is drawn from the banking system in three years, the market could bear the impact on liquidity, it is believed.

   The $200 billion "bought out" from the foreign exchange reserves will then be injected into a new company to be set up this year to handle overseas investment with foreign reserves. The State Council, China’s cabinet, will control the new company, tentatively named National Foreign Exchange Investment Co. It will spend funds from the foreign reserves on mergers and acquisitions of overseas businesses, including foreign financial institutions. It will also target overseas energy assets and will likely acquire equities in the domestic markets, or even lend money to help finance domestic research and development projects. Very neat!

   Why? Because the way this is being handled takes excess liquidity out of the Chinese monetary system and keeps the reserves offshore. This way the upward pressure on the Yuan can be eased as well. Simply put the foreign exchange reserves are being separated from the internal economy despite their being export revenues. The control of the money supply through the draining of liquidity from the internal system after exporters have received Yuan payments is the only way to do it.

   But this permits the effective overseas investment of the surpluses. Some suggest that the government adopt a Japanese practice: the Ministry of Finance issues home-currency denominated bonds to buy foreign exchange flowing into the country. The purpose of the policy is to separate the burgeoning money supply from the increasing foreign exchange reserves.

   This contrasts with the US system where such issues are used to accommodate foreign investments inside the USA (as well as the local bond and bill system).


Dollar worries persist

   The Chinese government is worried about the appreciating Yuan and needs to protect its value. Selling the $ is just not an option at this stage, the fall in the $ would be disastrous on the balance of the reserves. If the US dollars depreciate against the Yuan by 5% this year, which is almost certain, the reserves will "shrink" by $50 billion against the Yuan, equivalent to the amount of capital the Central Huijin Investment Co has injected into Industrial and Commercial Bank of China (ICBC), Bank of China (BOC) and China Construction Bank (CCB).

   Now the government has handed the responsibility out and to a body that will spend these $ overseas for productive assets or future supplies of strategic materials. This is an effective "switch" from the $ to assets, not other paper.

   Some also believe that the government is considering hedging the risk on their $. With that many dollars that will be interesting. But you would accurately say that 200 billion is now lower than one year’s accumulation of foreign reserves, leaving a trillion to invest still after this year’s surplus. No doubt they will be able to expand their foreign investments in this way, if this proves successful.

   But still far more has to be done to handle present and future reserve growth.


SAFE & the People’s Bank of China

   The new policy is bound to change China's current foreign exchange management regime, which is dominated by the State Administration of Foreign Exchange (SAFE). According to the central bank, the People's Bank of China (PBoC), the SAFE is responsible for the stewardship of the largest foreign exchange reserves in the world. It is estimated that over 60% of the reserves are invested in US Treasury bonds, with an annual return rate of about 3.5%. The foreign exchange system has to be capable of hosting one of the globe’s future key reserve currencies, the Yuan and developments will head that way. Meanwhile, SAFE will also set up an overseas company to prudently invest in low-risk, long-term Treasury bonds and housing mortgage bonds denominated by the US $ and the €.

   Perhaps the largest difference between the West and the East in terms of dealing with emerging (minor) nations and their resources is in the concept of dominance. Governmental morality comes with investments from the West pushing these nations to adopt democracy and certain policies promoted by the West – however well meaning.

   Investment from the East (i.e. China) comes in the hope of securing long-term strategic supplies without commenting on local politics or practices. China also likes to get its feet under the table of these nations through "soft" loans (we imagine little expectation of repayment), infrastructural development and other favors making them the preferred buyer of these strategic reserves.

   China likes to invest in areas practically beyond the reach of the West and as close to home as they can. It is a policy that is not only meeting with success, but causing many of these nations to strut loudly against the US. To date they have been successful, but we have to recognize this is just a start.

   With the above investment corporation now set up, a trillion to invest with $250 billion more per annum at least, expect to see them popping up everywhere. With no imposition of democracy on some despotic nations and few strings attached to China they would call the Chinese extremely pliant partners. Yes, it will foster the worst in minor world leaders, but it will get them the resources they want and spread their influence globally. They appear unstoppable...?

Zambia

   Chinese President Hu Jintao announced an $800 million investment package in Zambia on the second day of a two-day visit to the southern African country where a Chinese rush on resources is the source of growing unease.

   The two also agreed on the creation of a special economic zone, in the town of Chambishi in the Copper Belt north of Lusaka, where Chinese firms would operate free of import duties and VAT. The Zambian and Chinese leaders signed a total of eight cooperation agreements on aid and investment. These included agreements on Chinese technical training for Zambian agriculture experts, an interest-free loan toward road-making equipment, the building of two rural schools and a football stadium, special treatment for Zambian exports to China, and work permits for Chinese workers. China also agreed to write off $3 million in Zambian debt owing to Beijing.

   Chambishi is home to Chinese-owned Chambishi Mines, one of the world's largest copper producers. China last year announced the construction of a $200 million smelter at the mine.

   Hu said he was committed to the development of African economies, "China is looking for the strategic and mutual friendship of a win-win situation in Africa," he said. Mwanawasa described Hu's visit as a milestone that would strengthen economic cooperation between the two countries and vowed the planned Chinese economic zone would not jeopardize Zambian business interests.

   The Chinese-assisted construction of a stadium at Ndola is designed to help Zambia attract business from teams practicing for the 2010 World Cup in South Africa.


Sudan

   The United States said on Monday that a visit by China's president to Sudan, when he offered a loan to build a presidential palace, sent "mixed signals" about Beijing's intent to press Khartoum over Darfur...

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JULIAN PHILLIPS – one half of the highly respected team at GoldForecaster.com – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

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