Monday, October 25, 2010

Chinese bailing out Greece

On the surface, this article seems benign enough: China, flush with cash reserves, wants to bail out Greece--and by extension, the Euro zone, in order to maintain Europe's consumption of Chinese exports. They intend to do this with the purchase of soon-to-be-worthless Greek bonds, an IOU issued by a bankrupt government (sound familiar?). Fine.

But let's think a couple moves ahead, as the Chinese rarely make a move without surveying the landscape several years down the road. Like their developing world peers, the Chinese are getting increasingly nervous with their overweighted holdings in US Treasury bonds, as the Fed continues to feverishly devalue the USDollar. Selling US Treasuries with abandon would only undermine the value of Chinese holdings, increasing selling pressure and plummeting the value of said US bonds.

The solutions? Buy tangible assets supportive of their growing industrial base, including securing natural resources and resource companies in the energy and metals complex. Another solution? Buy the Euro. How? Through the Greek back door (no pun intended).

Of course, the Chinese will put on a varnished exterior, bailing out a valued customer, and buying assets from a trading partner--and all of that will be true, as they aim to increase market penetration in the Euro zone. But the ulterior motive is to find another resting place for their bulging reserves, as they slowly divest their US Treasury holdings.

Meanwhile, Congress and US Treasury Secretary Geithner cry "Wolf" and whine about Chinese currency manipulation. If the US really wanted the Chinese to stop devaluing the yuan, the Fed should stop devaluing the USDollar. But of course, that won't happen because the Fed needs to feed the Congressional beast.

And as the Chinese and other sovereign funds further divest of US Treasuries, interest rates will inevitably rise, as bond buyers demand higher yields to compensate for rising default risk. This will undermine any interest rate-suppression effects of further quantitative easing. Which means QE will fail--again.

And around and around we go, circling down the drain.

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