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A China Conversation



Professor John Succo and Professor Scott Reamer had a spirited conversation earlier regarding John's earlier column on the Chinese Yuan. The following excerpts are shared with the Minyanship in the interest of education and are not intended as advice.

Succo: I want to talk to you about China. It could be very concerning; our government should be at least thinking about this possibility. I don't think anyone is thinking about this posibility. What if China wants to eventually derail our economy? So for now they keep buying some U.S. bonds, but they are also accumulating massive amounts of gold as all other central banks sell .

Reamer: I don't think they would want to. It's not YET in their interest. Remember the massive SOE (State Owned Enterprises) problem they have that would only be exacerbated by killing their major export partner, us.

Succo: Yeah, I'm not talking now.

Reamer: Something like 2/3 of their 5 largest banks are basically bankrupt because of the failed SOE "assets" they have on the books

Succo: They continue to accept inflation for now, stabilize and grow their economy. We continue to export jobs to them, and they accumulate gold

Reamer: So 'killing' us would have the effect of 'killing' them economically and more importantly (b/c it's what they value) creating massive social unrest...think Tiananmen square x10

Succo: No wait. They grow their economy and build infrastructure. When ready they announce revaluation of the yuan and float it but that it is fully backed by gold then they sell our bonds and strangle the credit-dependent U.S. economy.

Reamer: Long term I think you are right, that scenario is highly plausible/probable. They will be the single best place to invest, but they need to get thru 2 transitions: (1) social (population exodus from rural to cities; they need jobs - export jobs - to facilitate) and (2) economic (SOEs, failed banks, etc.)

Succo: Agreed. On execution they could lose $100 billion in their Treasury holdings, but gold rallies like crazy and they make it back. That would destroy us economically

Reamer: I think in the end you are right, I just think that is a 2008/2010 thing. But you are correct, I believe that scenario is possible/plausible.

Succo: Yeah, I'm not saying now.

Reamer: Wow, Yuan backed by gold. That would be revolutionary and so out of left field. No one even thinking about that let alone saying it.

Succo: We are so politically unwilling to do the tough thing, we are potentially playing right into that scenario. Even if this is not true, we are exposing ourselves to it.

Reamer: I have read speeches however from their central bankers and none of them are libertarians or hard money activists, so it might be a stretch to see the yuan backed by gold, but it would be incredible if it happened.

Succo: They wouldn't tell us. They could easily keep it secret.

Reamer: I think they believe that, if the U.S. could get away with a fiat currency for so long (as least since Nixon but in reality from FDR), they could too, so long as they had a strong balance of payments (current account), strong domestic demand (middle class), and a still-strong export engine (which they will certainly have for decades owing to their cheap labor pool). So all of those: current account surplus, developed middle class (no social unrest) and still strong export industries would still be strong backing for a fiat yuan...let alone a gold backed one.

Succo: Yes, but an announcement that the yuan was backed by gold would give them immediate credibility and at the same time immediately discredit our stance that a fiat currency is acceptable. It would also rally gold like never before. And there is also some circumstantial evidence that the U.S. financial system, namely a few large money center banks, are short massive amounts of gold through derivatives.

Reamer: I know they wouldn't tell us, but the logistics of doing something like that - acquiring that much physical gold, would be impossible to keep quiet, even in communist China.

Succo: I don't agree. What if only the highest in their gov't knew they were buying gold?

Reamer: Producers and the London market would HAVE to know, right?. You can't have that kind of demand without someone noticing.

Succo: They have all the time in the world to pick away at it.

Reamer: Good point, if they did it real slow it could do it, but that argues even more for a 2008-2010 timeframe

Succo: We know they are buying it, just don't know how much. They could definitely conceal it. They could have 100 different corporations buying it .

Reamer: Do we know if the buying is the central bank (PBOC) or is it citizens? The Chinese have a long history of accumulating gold, and even Chinese citizens don't yet believe in the yuan. Good points. on corporations potentially doing the buying.

Succo: Even if this is not true, we are putting ourselves in the position of exposure to it. We are dumb.

Reamer: Totally, financial darwinism. We're so confident (a man on Mars for chrissakes?) that we open ourselves up to these risks. Analogy is someone who doesn't take care of their health, opens them up to opportunistic infection.

Succo: Yes, our government is so worried about military stuff that they are ignoring (burying) the fact that our achilles' heal is debt and that we no longer control it.

No positions in stocks mentioned.

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