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

In light of recent Fed actions, I pinged Michael Pettis at China Financial Markets some questions on China's reserves
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What does China do with a dollar that's no longer risk free

Background

The reason for this topic has to do with the Fed's unprecedented decision co confiscate Russia's foreign currency reserves.

Not only was the action unprecedented, it was illegal. 

The Federal Reserve Act mandates that the Federal Reserve conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

Nowhere does the act give the Fed the right or power to confiscate the reserves of sovereign nations.

But that is exactly what the Fed did. 

If the Fed can do this to Russia, who else?

Weaponizing the Dollar

Risking Risk Free Status 

Q&A With Michael Pettis

Mish: Will China now hold more commodities and fewer dollars despite the pro-cyclical nature of it? More Euros or Yen over dollars? More gold?

Michael Pettis:

  • "Given that so much of China's "reserves" are now indirect and held by state-owned banks (all the increase since 2017) it's hard to say what the currency composition of China's reserves are. 
  • "Officially the US dollar is still by far the biggest component, but it is slowly declining. 
  • "I expect that this will continue as far as the official reserves go but, as you know, the hard part of reducing the US dollar component of your reserves is figuring out what the alternative should be, and with such high and growing reserves (once you include the indirect reserves at the state-owned banks) that is a very difficult question to resolve."

Understanding the Mathematical Difficulty

Mathematically, as a direct result of having a trade surplus with the US, China has a huge influx of US dollars. 

China can convert dollars to Euros, but what does the euro seller do with the dollars? 

Alternatives

Suppose China buys gold. Then the seller of gold has dollars. What does the gold seller do with dollars? 

And Eurobonds? There are none. The country-specific European bonds have a negative yield. One loses money holding them.

Someone must hold every dollar, every bond, every US treasury 100% of the time. Who is that someone? 

That is what Pettis meant by "as you know, the hard part of reducing the US dollar component of your reserves is figuring out what the alternative should be."

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China will buy more gold, more copper, etc, but what it would really like to do is buy Boeing or a defense contractor. 

The US would of course say no. 

It's likely China is slowly shifting. But because of indirect reserves at state-owned banks, no one can really say by how much. 

Russia did divest of US dollars for gold but that was much easier because the amounts were also much smaller.

Unprecedented Fed Action May Have Just Started a Global Currency Crisis

I discussed the loss of risk-free status in Unprecedented Fed Action May Have Just Started a Global Currency Crisis

In one quick order, the Fed electronically rendered Russia's foreign dollar reserves worthless, or at least unusable for now. 

Now, if you were in China's shoes do you hold dollars or gold as reserves? What about metals?

We are not at a full blown crisis stage yet. And perhaps we do not get there this time.

But when trade wars like these start, history suggests major wars often follow.

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. 

As noted above it's likely happening, but not at any identifiable speed. 

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

What About the Dollar as Reserve Currency?

In case you think this means the end of the dollar as reserve currency, think again: 

Note something I said above: Someone must hold every dollar, every bond, every US treasury 100% of the time.

Oil priced in euros does not change that statement. That countries hold dollars, not euros, has everything to do with reserve math and nothing to do with perceived pricing units. 

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

Don't confuse a diminishing role for the US dollar with it's demise as the global reserve currency.

It's far too early for that. For further discussion, please see the above link. 

This post originated at MishTalk.Com.

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