February 6, 2007 – There are a healthy number of analysts that argue against the continued devaluation of the dollar due to China’s enormous position of about U.S. $1 trillion of dollar denominated reserves. The argument being made in very simple terms goes like this: (1) All discussions about the dollar’s demise are false because if China believed that the dollar was going to weaken, why would it hold on to such a huge amount of dollar denominated reserves; and (2) China will continue buying and holding dollars because it makes their exports cheap, and in order to sustain the growth of their economy they must keep their exports cheap compared to American goods. In fact, here are some quotes from a newsletter that was forwarded to me the other day from a believer in dollar strength that encapsulate almost all the problems I have with professional investment newsletters, including their massive failure to adequately address economic situations and stock market implications from a global perspective.
But on to the newsletter’s comments and my rebuttal to them: “In the case of China’s trillion, the loss of a single percentage point in valuation, a measly cent, means that the value of the foreign currency reserve (the “Wealth of the Nation”) drops by $10 billion in the blink of an eye.” This comment was in the same newsletter that stated this: “Now, nobody exactly knows the exact composition of Beijing’s pot o’ gold. I think it’s safe to assume that at least 70% of it is kept in dollar-denominated bonds. Maybe even more.” And then this newsletter further denigrated gold as an investment because according to them: “Over the past 30 years, the inflation-adjusted performance of gold — which is denominated in dollars! — is actually quite horrible! As a long-term inflation hedge, buying gold is like hiring Ted Kennedy as a lifeguard for your community pool!”
Ok. So let’s deconstruct that newsletter’s comments with a dose of reality. The overwhelming majority of analysts make the mistake of boiling down the world’s markets to China and the U.S., as if no other markets exist. Russia is now a huge player in the global financial markets with its central bank having grown to the 4th largest central bank in the world. The nations that comprise the emerging oil-exporting nations have a half-trillion dollar petrodollar surplus as a result of the enormous run up in oil prices in 2006. Often analysts’ comments are a mere reflection of various reports distributed within the mass media without a more intensive and thorough analysis of additional market elements that influence the behavior of assets. There is little transparency on behalf of Middle Eastern governments regarding what they do with their petrodollar reserves.
Furthermore, the majority of Middle Eastern nations don’t report to any major international agency their transactions and investments that deal with petrodollars. So the “out of sight, out of mind” approach is the approach that most global stock and currency analysts take. The actions of emerging oil-exporting countries regarding their petrodollar reserves are not reported in the mass media, so rather than discovering what these countries are doing, analysts ignore half a trillion dollars of petrodollar reserves and say “Whatever China does with its American dollars is the only actions that can drive the direction of the U.S. dollar.” Now I believe there are only two possibilities for the future of the U.S. dollar. Read my blog tomorrow to discover my beliefs. But back to the topic of this blog.
I wonder how a newsletter can make a comment like “nobody exactly knows the exact composition of [China’s reserves]” but yet immediately follow that with the contradictory statement “it’s safe to assume that at least 70% of it is kept in dollar-denominated bonds.” If “nobody exactly knows” then how is it “safe to assume” anything. A few months ago, I blogged that if one was looking to invest in the financial sector in Asia, that India (and now Japan), were far better countries to search for opportunities to buy banking stocks than China despite the frenzied purchases of Chinese banks by foreign banks in 2006. After researching Chinese banks, I stated that I did not like the fact that many of the major Chinese banks were sacrificing risk management protocols in pursuit of growth and that the lack of transparency that still existed was troubling. The fact that the Chinese government’s lack of transparency in their dealings with their U.S. dollar reserves apparently doesn’t prevent analysts from having confidence that they know what the government is doing with their massive dollar reserves. And they use these assumptions to make major calls about the direction of the U.S. dollar.
How much of China’s American dollar surplus is being invested in Africa’s oil-exporting nations in deals that provide for China’s growing need for oil? Apparently, the answer to this question doesn’t matter to many analysts. Furthermore, the other problem I have with many U.S. based newsletters is their nation-centric analysis in an increasingly global economy. They assume that the global economy is static and that the export of American goods will remain constant, thereby assuring that major holders of U.S. dollars will continue to be major holders of U.S. dollars. However, this again, is far from the truth. If the Chinese yuan remains weak, various emerging economies will continue to increasingly import more Chinese goods versus American goods, especially if their aversion to receiving U.S. dollars continues and/or increases. In fact, it’s safe to say that trade with other emerging economies will also increase in the other direction as well, with China importing more goods from emerging economies and select other developed nations. All of these factors include the economies of emerging nations in the Middle East, major economies in Europe like Russia and Germany, and emerging and developed economies in South America, Africa, and Asia. Sill, almost every single article I stumble across regarding the valuation of the dollar discusses only China’s future policy plans.
Finally let’s look at this newsletter’s last comment regarding gold: “Over the past 30 years, the inflation-adjusted performance of gold — which is denominated in dollars! — is actually quite horrible! As a long-term inflation hedge, buying gold is like hiring Ted Kennedy as a lifeguard for your community pool!” This is by far the most egregiously poor comment of all the comments in that newsletter. To begin with, there are many ways to invest in gold, of which physically holding gold bullion is nowhere near the best way to benefit from a run up in the price of gold. So to just look at the price of gold bullion as an inflation-hedge has no value.
Secondly, the past 30 years has included a 21-year bear market in the price of gold. Global developments have reached a tipping point today that makes the economic climate drastically different than it was 30 years ago, so to take this period and say gold today is a horrible investment is again irrelevant and a statement that really holds no value. Furthermore, such a statement is akin to looking at the decade of the U.S. stock markets that included the great depression, and say. “Obviously investing in stocks is a self-defeating behavior!” No analysis of the relevant conditions today, or a glaring omission of important components of the global economy that drastically affect a certain asset class equates to analysis that isn’t worth your time.
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J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.
