"Don't count on us to bail you out!"

by Randy Klein, randy.klein@Heraeus.com


In reference to Bailout Questions – Answers from the Engine Room, it’s worth noting China’s recent public announcement regarding greater diversification away from the USD appears meant to send the message to the Fed: 'Don’t count on us to bail you out' It doesn’t look likely monetization (M) through (G) can come any other way than cranking up the output at the Mint!

With the long-running devaluation of the USD vs. RMB there was great pressure to achieve better returns on China’s USD foreign reserve investment beyond that of treasury notes.



Against China’s typically conservative approach, they followed other countries such as Norway and Russia and create last year a $200Bn Sovereign Wealth Fund through CICC (China Investment Corp).

This was lesson #1 in USD investment for China, as the fund took a beating after investing in Blackstone and 10% of Morgan Stanley.



Lesson #2 for China came when ¼ of China’s $2 Trillion foreign exchange reserves, held in Freddie Mac and Fannie May debt, had to be backstopped through the US Government's effective nationalization of the two GSEs.

Ha Jiming from CICC recently said, “The crisis has made Chinese officials realize it’s a bad idea to put all their eggs in one basket and will likely lead to greater diversification of foreign exchange reserve investments. It is likely to reduce the portion of reserves in dollar assets from the current 60 percent by purchasing more non-dollar assets with new reserves.” This public announcement by Ha, a departure from China’s private nature regarding financial policy, was made the Friday before the recent run-up in gold prices resulting in the greatest single day gold price increase in history. China will continue to move away from the USD and diversify with a larger percentage of reserves in gold and other currencies.

Finally, it’s inevitable, (M) must increase through (G) of some form and we will pay inflation consequences down the road.

A few questions:

1) Has there been enough discussion regarding how to add (M) and (G), rather than the debate of if to add (M) and (G)?

2) Is the urgency of dumping liquidity into the system so much that a 'dump and let’s wait and see approach' is justified?

3) How close are we to a liquidity trap? If we are close or already there, is this short term approach of adding liquidity by lending money to banks destined to fail?

4) Why does it appear the Fed is averse to pursuing more covert ways of adding liquidity such as reducing the risk of commercial papers through a federal insurance plan? [ UPDATE 7-OCT - The Fed seems to have listened to our advice - WSJ: FED TO PURCHASE COMMERCIAL PAPER IN NEW PLAN BACKED BY TREASURY ]

5) Why is the Federal Government averse to other stimuli which would spur activity and add jobs such as subsidizing state and local municipality deficits or direct investment in new technologies and infrastructure?



Comments are invited...