Why US Dollar Investments Are A Ticking Time Bomb

Source: http://feeds.feedburner.com/~r/ContrarianProfits/~3/472758707/9391
Posted on Tuesday, December 2nd, 2008 | In Market Commentary

Contributed by: Contrarian Profits (http://contrarianprofits.com) -

China’s economic rescue programs could be devastating for American investors, says Manraaj Singh. The country is sitting on $2 trillion in US dollar reserves. And it will likely sell a large chunk of this to fund its domestic bailout. Manraaj says this makes US dollar-denominated investments a ticking time bomb.

This from Fleet Street Invest:

The fools in Washington, Wall Street and in the City cheering on China’s spending binge are really missing the big question. Where exactly is all that money going to come from?

I’ll tell you. China will pay for its economic boost by destroying the US dollar. Let me explain… China is sitting on some $2 trillion in foreign currency reserves. Between 60 and 70% of that is invested in dollar assets like US Treasury bonds and government-backed companies.

All that cash has effectively subsidised American consumers. It has allowed them to live far beyond their means. But it really does little to benefit China’s citizens. Right now, the ten year US government bond yields just 2.99%.

At the same time, the American government is set to issue a record level of new Treasury bonds to fund its own bail-out plans. The Paulson and Obama plans together will cost at least $1.4 trillion. That is a colossal amount of money. And it will have to be funded by issuing new debt.

As far as I can see, that leaves the US Federal Reserve as the only reliable buyer of Treasuries. And to pay for that flood of new paper they are going to have to run the printing presses overtime. They are going to have to create more “money” out of nothing air. The faster those presses spin, the faster the dollar is going to lose value.

The analysts are living in a fool’s paradise

The threat to the US dollar is so glaringly obvious you would think that just about every analyst would have picked up on it. But they haven’t. Because they are still stuck in a view of the world that should have died when the global financial crisis began last year.

They argue that China benefits from subsidising US consumers. Why? Because it means they keep buying cheap Chinese goods.

Most analysts still believe that China wants to preserve the status quo. So they will borrow or print the money to fund their economic stimulus plan. Some analysts go even further. They actually expect that China will help bankroll America’s bailout with a major increase in their dollar holdings.

They are living in a fool’s paradise.

You see, American consumers aren’t buying Chinese goods the way they were a year ago. Just look at the figures. US retail sales had their biggest monthly fall since 1992 last month. China has no great incentive to prop up the US.

Bailing out America would be not just stupid, but highly dangerous

The plain fact is that China won’t unnecessarily debase its currency or burden the country with debt to fund their stimulus plan when they have $2 trillion in foreign currency reserves sat there earning paltry returns.

It would not just be stupid to do this. It would be incredibly dangerous…because it risks unleashing massive inflation. Soaring inflation in the late 1980s was a major cause of the social unrest that culminated in the Tiananmen Square protests in 1989. China’s leaders won’t risk a re-run.

China is going to start selling down its US dollar holdings massively in order to fund its domestic investment programme. That means the US dollar is going to have its teeth well and truly kicked-in.

This is vital to bear in mind as a non-US investor. If you have any dollar-denominated holdings in your portfolio, you had better be jolly sure that the profit that you expect to make on them is enough to cover losses from the collapse of the dollar.