Balance of Global Financial Power Shifting to China

By: Money_and_Markets

Mike Larson writes: So this is what it’s come to: Our Treasury Secretary, Timothy Geithner, has to jet off to Beijing to beg for mercy from our biggest global creditor.

He has to sit by and be lectured in the ways of finance by Chinese officials.

He has to endure the laughter of Chinese students at Peking University, who openly scoffed at his reassurances that “Chinese financial assets are very safe.”

And he has to abandon plans to pressure China on its currency. The Obama administration had previously been arguing that the yuan was undervalued, artificially subsidizing Chinese manufacturers at the expense of U.S.-based firms.

The bottom line? The balance of world financial power is shifting and not in a good way for America. Worse, I see no evidence that we’re doing anything about it! Instead, we get a bunch of happy talk and spin, with little or no action.

Washington Happy Talk vs. Reality on the Ground in China

Before, during, and after Geithner’s China trip, the Washington spin machine was shifting into overdrive. I’ve already seen a few reports calling Geithner’s trip a success. Geithner himself has been making statements like the following:

“I’ve actually found a lot of confidence here in China, justifiable confidence, in the strength and resilience and dynamism of the American economy and I think a very sophisticated understanding … of the steps we’re taking and why they’re so important not just to the United States but to China and the rest of the world.”

“We will be watching you very carefully.” —Yu Yongding, a former Chinese central bank adviser

Excuse me, but does anyone believe that for a second? I sure as heck don’t. And neither do the Chinese. The reality on the ground in China is much more skeptical and severe.

For example, Bloomberg recounted a conversation in which Geithner was lectured about U.S. profligacy:

Yu Yongding, a former central bank adviser who acted as the interviewer for The China Daily newspaper, told Geithner: “I worry about details. We will be watching you very carefully.”

A report from The Washington Post was even more blunt, warning that “Geithner’s remarks stand in sharp contrast to the commentary in China’s official propaganda papers.”

According to the Post …

• The China Daily said it will be “regrettable if [Geithner] underestimates and shuts his ears to voices from China’s civil society,” noting that there are worries that “Washington’s mushrooming deficit, generated by massive government borrowing to fuel its economic recovery plan … will undermine both the dollar and U.S. bonds.”
• The Global Times, which is affiliated with the Communist Party, said an online poll found that 87 percent of respondents believe China’s dollar-assets are unsafe. The paper concluded, “Ordinary Chinese people are discontent with the declining value of China’s huge foreign exchange reserves denominated in U.S. dollars.”
• And The Economic Information Daily, which is part of the official New China News Agency and affiliated with the State Council, in a headline demanded to know of Geithner: “How do you propose implementing fiscal discipline? How will you maintain the stability of the dollar after the crisis?”

Why Aren’t the Chinese Buying The Washington Party Line?

Well, the Obama administration and members of Congress on both sides of the aisle have been paying a lot of lip service to getting the deficit under control. We’re getting plenty of talk, talk, talk. But policymakers are taking steps that have the exact opposite effect! They’re spending like crazy and borrowing like mad!

The administration itself was just forced to raise its 2009 budget deficit estimate to a staggering $1.84 trillion, up 5 percent from a projection made just two months earlier. The 2010 estimate was jacked up by more than 7 percent to $1.26 trillion.

Geithner tried to sell the Chinese his pipe dream. But they’re not buying it.

Geithner told the Chinese that we plan to eventually shrink the deficit to 3 percent of GDP. But that’s a pipe dream. Right now, we’re on track to hit 12.9 percent — by far the worst since the founding of the Republic (excluding an anomalous period during World War II when the war effort was the dominant force in the entire economy).

Getting that under control will require a massive boost in economic growth or a large increase in taxes. To anyone who believes those scenarios are in the cards, all I can say is: I’ve got a bridge to sell you!

Or as Pimco Chief Investment Officer Bill Gross put it in his latest monthly outlook:

“While policymakers, including the President and Treasury Secretary Geithner, assure voters and financial markets alike that such a path is unsustainable and that a return to fiscal conservatism is just around the recovery’s corner, it is hard to comprehend exactly how that more balanced rabbit can be pulled out of Washington’s hat.”

The Market is Extracting Its Pound of Flesh — Make Sure You Protect Yourself …

The approach from Geithner, Fed Chairman Ben Bernanke, and others in the political establishment continues to be akin to Alfred E. Neuman’s. You know, the Mad Magazine character whose signature line is “What, me worry?”

They keep telling us to relax. They say the Chinese, the Russians, and everyone else have no alternative to the dollar. They figure they can continue getting away with shafting our creditors, with no consequences.

REAL MONEY investors are dumping the dollar and loading up on hard assets, like gold, oil and silver.

I’ve argued the opposite — and the market action shows I’m right. Just look at what REAL MONEY investors are doing. They’re dumping bonds. They’re dumping the dollar. They’re buying gold, oil, and other hard assets.

The broad-based dollar index is down roughly 12 percent in just the past three months. Crude oil has soared as much as 113 percent from its December low. Gold is closing in on $1,000 an ounce, while silver has almost doubled.

Meanwhile, The New York Times recently reported that the Chinese are hiding in short-term Treasury bills because they don’t want the risk that comes with long-term bonds. A key advisor to the Qatari ruling elite advised that country to diversify away from dollars. Then this week, Russian president Dmitry Medvedev proposed forming a new multi-national currency that would supplant the dollar as a central bank reserve asset.

Is any of this going to happen overnight? Is the dollar going to go to zero next week? Are 10-year Treasury Note yields going to hit double-digits next month? No on all counts. In fact, we could see a short-term bounce in the dollar and bonds here.

But the LONG-TERM trends should be abundantly clear by now. The forces I warned you about months ago are coming to a head, and the ramifications are clear for investors like you. You simply have to take steps to protect yourself from these out-of-control bureaucrats in D.C. and adjust to the new financial reality — that the balance of global financial power is shifting.

Until next time,

Mike

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