With gold leading silver along by the hand, we feature this week’s article on China and its burgeoning reserves problem, which we believe will be the most significant event in the global monetary system ever to affect both gold and silver.   Indeed if it continues to grow in influence on the value of the $, it may well be that silver begins to be treated as a monetary metal at some point in the future.

Invoicing in other currencies

The simplest way to slow down the rate of accumulation of the U.S.$ in Chinese reserves is to insist that companies invoice customers in their own currencies only.   So when Argentina or South Africa wants to buy goods from China they will be allowed to pay in Pesos or Rands.   Ask for a price from a Chinese company at the moment and you can be sure that you will be quoted in the U.S. $.   If they were to ask what country you came from then accepted your currency [as well as the U.S.$], then they would receive the currencies of all those that trade with them.   Then at some time in the future they can pay for imports in those currencies.   Meantime, the countries from whom they import will still accept the U.S.$ in payment for imports.   Diversification is then achieved and without entering those markets which will rattle the exchange rates.

But the U.S.$’ left unused after that in the international monetary system will then wash this way and thus lowering the $’ value as they become excess to requirements.   As in the case of Britain, the drain of capital investment will be like a tsunami hitting the state international trade.   The only way they could retain their value would be for the U.S. authorities to mop these up, bringing this liquidity back to Treasury instruments and the rest.   But the sheer volume of these excess $’ will prove far too great for such an exercise and will send inflation racing and interest rates trying to keep up.

Threats to global trade stability

As this happens, other holders of the U.S. $ will be forced to follow the Chinese to attempt to retain the value of their reserves through diversification too.   The $ will be dropping like a stone at this point.   It is then the U.S. will have to decide whether or not too impose Capital Controls.

At this point oil producers will be forced to follow the same route of accepting other currencies for their oil or simply raising prices to compensate for a falling $.   This will exacerbate U.S. inflation enormously.   

Those nations dependent on the U.S. for their trade will follow suit or lose their competitiveness as U.S. goods cheapen at the net rate of inflation minus the exchange rate fall against their currencies.   

There will be rising confusion in international trade as exchange rate moves destroy stability in prices.  The wounds such an event will produce in the international monetary system will be catastrophic and precipitate precious metal prices we currently may think impossible.

And the Trade deficit will continue until growth and import demand are slowed considerably, or measures are taken by the government to slow them down.   

As to financing the Trade deficit, it would be most surprising if there were any [except the closest of unwise friends] nations willing to finance the deficit anymore.   

Is this diversification from the $ a near term likelihood?  Yes, it is for China which will diversify its $1 trillion foreign exchange reserves, the largest in the world, across different currencies and investment instruments, including in emerging markets, Chinese central bank Governor Zhou Xiaochuan said last week.

Chinese reserves are about 70% in U.S. debt securities.   "(Diversification) includes currencies, investment instruments, including emerging markets," said Zhou.  He then confirmed that "We do not have any new preparations for selling any currencies."    China has to diversify as its future as the leading global manufacturer is pointing the way to the Yuan fully convertible at some point in the future in future.   Zhou said that a mushrooming trade surplus meant China needed stronger policy adjustment both on the Yuan and through boosting internal demand.   But he said any changes to the Yuan would be gradual to avoid unbalancing the domestic economy.

China has allowed the Yuan to appreciate 2.1% since last July only. "The reason why we adopt a gradual approach for exchange rate reform is because China has a very large amount of labor working in the trade-related sector," Zhou said, “So we have to consider this.   We should avoid too much or too sudden closing-down or bankruptcies of enterprises and laying-off of workers.   We are trying to manage to adjust the balance of payments and meanwhile to keep domestic economy in the good (state)."

China is growing at its fastest pace since 1995, but Zhou expressed satisfaction that the pace of growth was easing from the first quarter's 11.3%.   "It has already slowed down to some extent so we have reached the expected result of macro-economic adjustment," he said.

HIGHLIGHTS in “Silver Forecaster”

Market Forecasts / Metal Stocks - HUI/Commodities – CRB/ Silver/ Platinum/ Speculative Fund Activityxy

China Reserves Diversification/ The importance of Marginal Supply/Demand in Currency – Oil – Gold – Silver Market

Silver Technicals / New Applications for Silver/ Silver Trust activity/ Gold: Silver Ratio/ Silver Portfolio/ Silver Share Technicals 

Platinum Technicals / South Africa Platinum Producer/ Johnson Matthey Report / Leeuwkop Platinum Mine

© 2006 Julian D. W. Phillips
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