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Tuesday, April 12, 2005 10:33 AM

Massive Capital Losses on Forex Reserves - Part 2

Mish Moved to MishTalk.Com Click to Visit.

George J. Paulos, Editor/ Publisher Freebuck.com replied to my blog response to Nouriel Roubini. Let's recap for any latecomers:

Here is Nouriel's post on China'a potential Massive Capital Losses.
Here is my original reply to Nouriel.
Tonight George Paulos weighed in on the discussion:

Western analysis tends to apply Western values and perspective to a uniquely Chinese situation. China is NOT a capitalist society. They are still highly centrally planned. There is only one bank (The People’s Bank of China). The bank does not evaluate borrowers the same as western banks. They are willing to accept severe loan losses in order to keep people employed.

The truth is that many if not most Chinese export companies lose money. In the West we force companies to make money, so the real problem is that unsubsidized Western companies are forced to compete with subsidized Chinese companies and cannot prevail. So what if they lose money on their paper assets, they have conquered the capitalist world at far less cost than a military invasion.

George Paulos continues with a discussion on social unrest in China: Dr. Joe Duarte reports that “China is focusing its population’s frustrations with an increasingly difficult set of economic choices for the country, on Japan. But, rising instances of social unrest beyond Beijing suggest that the population is just as angered with its own government. The situation, while not out of hand, could easily worsen if just a few things go wrong, setting in motion a cycle of social unrest, and raising the risk of a major internal crisis for Beijing.“

Here are some links to what Joe Duarte and George Palos are referring to:

Japan must act to calm ties after protests
China called on Japan on Monday to do more to repair soured relations between the Asian powers, as a government wary of popular protest kept riot police on guard after violent anti-Japanese demonstrations at the weekend. Japan in turn demanded that China protect Japanese firms and expatriates but said the best way to resolve the bilateral tensions was through dialogue. Thousands took to the streets in Beijing, Chengdu, Guangzhou and Shenzhen at the weekend in an eruption of anger at what many Chinese see as Tokyo's whitewashing of World War Two atrocities and its bid for a permanent seat on the U.N. Security Council.

Several demonstrations and a riot were reported in China over the weekend. According to Cybercast News Service: “Relations between East Asia's two rising powers took a new dip at the weekend with the spread of anti-Japanese protests in Chinese cities. The protests stemmed from accusations that Japan is glossing over wartime abuses, but they also focused on Tokyo's bid for a permanent seat on the U.N. Security Council.”

40,000 demonstrators take to the streets during an anti-Japanese rally Sunday in Guangzhou of Guangdong Province, south China.

Japan protection call over protest
Japan's ambassador has called on the Chinese government to take stronger measures to protect its citizens as thousands of protesters demand a boycott of Japanese products and shout anti-Japanese slogans.

OK Mish, just what do Chinese protests against Japan have to do with "Massive Losses on Forex Reserves"? Of course that is a good question and enquiring Mish readers deserve an answer. Here goes: China is in a delicate situation. China needs to develop jobs and lots of jobs to keep its massive population happy. Protests against Japan are just the tip of the iceberg of what we will see if China's population starts to stir over jobs. I do not know how to put a price tag on that, but rest assured it is non-trivial.

Mr. Palous seems to agree as he goes on to say:

Despite conquering much of the worlds manufacturing, China is still falling behind on the demands of its citizens. And the situation is becoming explosive.

China needs to further expand its export markets but, globally, everything is at extremes without much leeway for any country to expand either import or export markets.
I think that Mish is right about global recession. I don't see a way out. The US consumer is now finally getting squeezed. The RE market is stalled. I think that is all it will take to tumble the dominoes. – George J. Paulos, Editor/ Publisher Freebuck.com

Here is what China has to say. I believe it echoes the sentiment expressed by George Paulos: China´s Ruogo asserts autonomy in yuan decisions. The deputy governor of the People's Bank of China said foreign monetary policy commentators were generally ignorant of economic conditions within the country. "Outsiders don't know what exactly is happening in China. The idea that China has the key to the balance of the whole world's economy is totally wrong. The imbalances are attributable to many reasons, but not whether the yuan exchange rate is flexible or not flexible" he said.

Mish comments:
Not only is this a blatantly obvious as well as unusually candid public statement by a high ranking Chinese banking official, it is a forceful statement that US economic pundits do not really know what is happening in China. Perhaps Chinese officials do not even want us to know what is happening in China. Personally I think this applies to not only the repeg situation but to solvency of Chinese banks, US treasuries, Chinese employment situations, currency issues, as well as other "unrest" situations that outsiders may not be aware of but Chinese officials certainly are!

Why is it not possible, perhaps even PROBABLE that currency losses are nowhere near the top of China's concern list?

The discussion on China's forex losses was debated on the Motley FOOL today:
Here is what Rien had to say:

There is a way out, at least a "kind of" way out.

If China were to float, and sell their USD holdings, then they would experience deflation and a subsequent depression. But they can also simply not sell at all, ever until such a time that their USD holdings have become insignificant in the global scheme of things (normal inflation).

That way they would accept that they have worked "for naught". But as you point out, "naught" is not really "naught" as they have gained:
1. Internal political stability
2. A technology transfer
3. A manufacturing base
4. Their main competitor(s) has(have) become unstable.

So I think (like you probably) that the Chinese are the real winners out of this. A masterpiece if it was done on purpose.

Thanks Rien, support is always welcome but not everyone agrees. (Should by chance we ever all agree I know we will all be wrong.)

Russ Winter on SI certainly disagrees : It will be interesting to see Roubini pick you apart here, Mish. I will defer to him first, but let me know if he doesn't respond, and I will be more than happy to chime in.

OTOH Jambutty replied to my original blog post with
"All very good points; Nouriel Roubini seems to have found the one item that he thinks overrules all others, and he focuses on it to the detriment of the quality of his work (I think). As Mish says, the Chinese are getting something from the deal as it stands; who knows if they have an ultimate plan? Also, I think it is very pertinent to point out that a plunging $ doesn't just make it more expensive for the US to import, thus correcting the trade balance; it also stops Chinese growth, and hence Japanese growth, in its tracks. What price stability?"

Indeed, what price is stability worth? As I have stated all along I certainly have more questions than answers and the discussion is not really about being initially right or wrong but in stimulating the debate and coming to the correct conclusions ahead of the crowd.

I keep repeating my questions but once again I can not resist: Why is it not possible, perhaps even PROBABLE that currency losses are nowhere near the top of China's concern list?

I welcome a rebuttal from Roubini and/or anyone else. Let the debate continue.


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