What's China Really Up To?

Friday’s thinned out markets were not what the currencies wanted to see, as the bias to risk aversion was magnified in the thinned out markets, only making the selling of the currencies even worse… Some “levels” were hit in the thinned out markets, and that caused even more selling in the overnight markets as Japan and Asia came on board.

I’m really kind of shocked at the Asian selling… You may recall that last week we had the wild swing Thursday, after there were reports that China had obtained approval to attend the G-8 meeting this week in Italy, and discuss replacing the dollar as the world’s reserve currency. The dollar was sold like funnel cakes at a state fair, after that report hit the news wires… But it was quickly turned around when the Chinese denied they knew anything about the contents of the report.

But… This weekend, while the charcoal was burning everywhere, the splashing in the swimming pools, and the display of fireworks had everyone’s attention, the Chinese admitted that they were going to G-8! Where’s the selling now? Isn’t this confirmed now? Has something changed?

The answer to that last question, is yes… Currency strategists have come to the conclusion that China won’t get anywhere with their desires to replace the dollar with SDRs (special drawing rights). Even with France throwing their two-cents into the discussion, and having their Finance Minister (Lagarde), and Bank of France Governor (Noyer) calling for an increased discussion of currency coordination, the currency strategists just aren’t budging… They believe there’s no way China, even with the backing of Brazil, Russia, and India, will get any traction.

Hmmm… So… It’s over? Not hardly, folks! I think that the comments coming from the French officials says… “We need to give the emerging markets more say in how the world’s economy is run”… A foot in the door, if you will… And… When you have the war chests that Brazil, Russia, India and China have, a foot in the door is like having a wide enough space that you could drive a Mack Truck through!

Of course that’s just my opinion… I could be wrong… But then, somewhere in the back of your mind, you’re thinking… Hey, this Chuck guy may just be right!

OK… Playing games with your mind isn’t what I was trying to do there… I was simply crossing the T’s for the legal beagles.

So… We begin the week with the currencies weaker than they were last week, and the euro (EUR) about ready to lose the 1.39 handle. The high yielders are taking it on the chin too, with the exception of Brazil (BRL), but once that market opens we could very well see the real play catch-up.

The data cupboard is relatively empty this week, with the Initial Jobless Claims on Thursday, and the trade deficit data on Friday, the only “real” data this week… So, the G-8 meeting on Wednesday will have center stage, and any comments from the “outsiders” (China, etc.) creating pressure points for the dollar this week.

One of the worst performing currencies in the past couple of weeks has been the Canadian dollar/loonie (CAD). And no wonder… With the price of oil dropping and gold stuck in a rut, there’s nothing to give the loonie a boost. And overnight, the price of oil has “gapped” down to $64, putting even more pressure on the loonie.

Let me explain what I think we’re seeing in the price of oil… I think a large part of the run-up in the price of oil was caused by investors taking positions to hedge versus inflation… And in recent days, those fears of inflation have been put on hold… And these investors have no patience… So, those positions are getting sold, and… That’s what’s pushed oil down so much in the past week.

Tonight, the Reserve Bank of Australia (RBA) meets to discuss rates… I fully expect the RBA to keep rates unchanged at an internal level of 3%. But, I also expect them to muddy the euphoria of unchanged rates, by leaving their easing bias intact. Put yourself in the shoes of the RBA… You may want to say the end of rate cuts has been seen and the next move, whenever that is, will be higher… But! You don’t want to open Pandora’s Box of currency rallies… The RBA would be the only central bank in the world that had removed their easing bias, with an eye on higher rates… The floodgates of investors seeking a currency with rising interest rates, would be thrown open, and an “unwanted at this time”, run-up in the Aussie dollar (AUD) would take place.

So… The RBA will be cautious with their words, and keep their rate hike cards in their back pockets for now… Waiting for the right time to pull them out and throw them on the table!

Did you hear about China and Hong Kong agreeing to settle cross-border trades in renminbi (CNY)? I know, you’re scratching your head and saying, but Chuck, isn’t Hong Kong a part of China? I could swear I saw the U.K. hand it over to China years ago! Ahhh grasshopper, you are correct… But, Hong Kong retains their own currency, the Hong Kong dollar (HKD), or “honkers” as currency traders call them. And… Renminbi has never been allowed outside of the mainland China… But now Hong Kong Banks will be able to borrow or buy renminbi!

I know this sounds like small potatoes… But, these are baby steps for China and what I believe their goal is… And that is, to gain wider acceptance for their currency… It’s how they will be able to spring the coup someday to replace the dollar as the reserve currency… I truly believe their call to use SDRs is just a smokescreen. These currency agreements that China has signed with Argentina, and the Southeast Asian countries, and have on the table with Brazil, is the real thing to watch. I see the SDRs as a sort of stalking horse for China’s wish for wider acceptance for the renminbi.

And to round out our discussion today… Our old friend, Jim Rogers, was back in the news last night. Let’s listen in to Jim Rogers, author of a few best selling books, and long considered an excellent investment mind.

“The government is printing lots of money and borrowing even more; that’s not the basis for a sound currency. The idea that anybody would lend money to the U.S. government for 30 years at 3 or 4 or 5 or 6 percent interest is mind-boggling to me.” Jim also said that he holds fewer dollars than a year ago, and plans to short U.S. government bonds someday.

Of course this is a reoccurring theme with yours truly… I have harped and harped about this since the beginning of this year. In fact, in February, the title of my Currency Capitalist letter was: U.S. Treasuries the next great bubble.

The number of bonds being issued… And the question of who’s buying them? For instance, the U.S. had more than doubled bond issuance to $963 billion in the first half of this year, with another $1.1 trillion scheduled to be sold by then end of the year. U.S. debt issues have lost 4.46% in the first six months of this year, and I just don’t see how that trend can be turned around, when $1.1 trillion in new issuance will be forced down the throats of investors before we sing Auld Lang Syne for 2009!

The Bank of Japan believes that they are seeing signs of an end to their recession, saying that they are more optimistic about the economy since 2006… I wonder how many times since 1990 that Bank of Japan officials have said those words? Probably enough times to make you wealthy if you had a gold coin for every time they said it!

Speaking of gold… Another $10 off the price this morning, down to $922… Silver is in danger of losing the $13 handle! Did I hear someone say… Bargains? Well, only if they go up from here, eh?

The Daily Reckoning