China Seeks Ways to Avoid US Sanctions But a Deadly Embrace Complicates Matters

Deadly Trade Embrace Complicates Matters for China

Tweet Thread by Michael Pettis 

• Beijing is very worried about the potential effects of sanctions on China’s vast holding of foreign assets, but the fact that they weren’t able to come up with any solution shows the extent to which China is locked into a structural problem. https://www.ft.com/content/45d5fcac-3e6d-420a-ac78-4b439e24b5de
• As long as China runs large trade surpluses, it has no choice but to acquire foreign assets in exchange for the surpluses, and as long as it is incapable of rebalancing domestic demand, it has no choice but to run large trade surpluses.
• What is especially interesting, according to the FT, is that “when one official asked Chinese bankers if they could diversify into more yen or euro-backed assets, they replied that the idea was not practical.”
• They are right. It isn’t practical because if China stops acquiring American assets and instead acquires Japanese or European assets, the resulting capital inflows into those countries would cause the huge American trade deficit to shift to those countries.
• Unlike the US, Japan and Europe are unable and unwilling to run the huge deficits that correspond to China’s surpluses. In fact they rely on their own trade surpluses to resolve their own domestic demand weakness.
• It is mainly the US (and the anglophone economies) that are willing to run the huge deficits that allow other rich countries and/or commodity exporters to run surpluses. This means that the US provides the mechanism which allows other countries to repress domestic demand.
• In order that they can continue doing so, the US must run permanent trade deficits and accept the unemployment or (more likely) soaring debt and asset bubbles that balance these deficits. Europe and Japan, rightly, refuse to play this role. The US, weirdly, embraces it.
• The world, and especially the US, would be much better off if the problem of where to acquire foreign assets in exchange for permanent trade surpluses were resolved by preventing the net foreign acquisition of US assets by foreigners.
• This would immediately force surplus countries to choose between either surging unemployment or a redistributing of income domestically that would boost domes
• Put another way, if the US stops countries like China, Germany, and Russia from recycling their export surpluses by acquiring American assets, these countries would have to choose between either exporting less or importing more American products.

Understanding China’s Dilemma

China benefitted from Nixon’s move but is very concerned about the the US weaponizing the dollar as president Biden did to Russia.

Understanding Actual Reserves 

China’s has currency reserves far bigger than widely reported. 

Nixon Shock, the Reserve Currency Curse, and a Pending Currency Crisis

None of the above should be too shocking to long-time Mish readers. The subject comes up again and again.

For example, please consider my September 30, 2019 post Nixon Shock, the Reserve Currency Curse, and a Pending Currency Crisis

Many problems today including deficit spending, trade deficits, and income inequality have their roots in 1971.

Every country wants to devalue its currency to raise exports and have a current account surplus. It’s mathematically impossible but math never stops politicians.

Who Really Want’s Reserve Currency Status?

Despite moaning about the dollar, China does not want to have the world’s reserve currency because it implies running trade deficits in which other nations accumulate yuan reserves.

Japan and the EU (led by Germany), don’t want to have the reserve currency “advantage” either, for the same reason:

An export-based, current account surplus economy is incompatible with reserve currency status.

Reserve Currency Curse

The reserve currency irony is that despite protestations of US advantage, no country wants the alleged advantages the US purportedly receives.

Trump would be very pleased if the Yen, yuan, and Euro rose vs the dollar, and US exports rose.

Does Japan want a strong currency? China? The EU?

Since no one really wants it, having the reserve currency is best viewed as a “curse” not an “exorbitant privilege“.

Global Consumers of Last Resort

The US is stuck with the reserve currency because we have the largest, most open capital markets in the world, the world’s largest bond market, and a far better business climate than the EU, China, or Japan.

To ensure the US remains the curse holder, the EU and Japan have negative rates, China does not float the Yuan but props up corrupt SOEs, and Germany punishes the rest of the EU.

Everyone wants to export to the US, and they do.

For the above reasons, The Yuan Will Not Replace the US Dollar, Nor Will It Be Backed by Commodities

The current situation was not possible under a gold standard because deficits were self correcting. 

Now, no nation wants to give up the printing press and the bubbles printing creates. 

Bipolar System

Treasury Secretary Yellen is worried about Russia avoiding sanctions via China, India, etc

The irony in this madness is the US is concerned about China and India breaking US sanctions when the EU transacts with Russia, hidden in plain sight.

For discussion, please see Janet Yellen Warns China on Russia and Creating a Bipolar Global Financial System

Using Ethereum and Bitcoin, Not the Yuan, to Avoid US Sanctions on Russia

Numerous countries have established ways of avoiding the US dictating sanction policy for the world.

In case you missed it please consider Using Ethereum and Bitcoin, Not the Yuan, to Avoid US Sanctions on Russia. 

How Russia Avoids Oil Sanctions: Transfer at Sea to “Destination Unknown”

For more on sanction avoidance please see How Russia Avoids Oil Sanctions: Transfer at Sea to “Destination Unknown”

China is simply too big and manufactures too much stuff for similar measures. 

But as Pettis notes “when one official asked Chinese bankers if they could diversify into more yen or euro-backed assets, they replied that the idea was not practical.” 

What Does China Do With a Dollar That’s No Longer Risk Free? Buy Gold?

On March 18, I asked What Does China Do With a Dollar That’s No Longer Risk Free? Buy Gold?

Unmistakable Message

Team Biden just sent unmistakable message to China, Saudi Arabia, Russia, well actually everyone

• We can make your fiat reserves worthless overnight
• Buy gold
• Buy base metals.
• Hoard things you have everyone needs.

But guess what happens if everyone starts hoarding things that others need?

There is no practical measure China can take, but it can chip around the edges. 

Meanwhile, de-globalization is underway but the New Supply Chains Are Inefficient and Will Drive Up Inflation.

It’s a complicated mess globally, for literally the entire world. 

I do not know when this explodes into a major currency crisis, but it will. Gold, not Bitcoin will be the beneficiary.

This post originated on MishTalk.Com.

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