Default Softly, While China Carries A Big Stick

What happens when you can’t cash in that stack of bonds you’ve been holding?

Is there any protocol to liquidate the halls of Congress?

Can we pawn Air Force One?

While the U.S. wallows in its own default worries… the Chinese are marching.

What about selling all of our National Parks to China?

Ah ha! Now we’re finally getting somewhere! Today we’ll take a look at what a U.S. government default really looks like – even in lieu of yesterday’s last minute “fix.” There’s one clear winner in this scenario, as you’ll see…

I like to call it a “soft default.”

Although the U.S. hasn’t actually defaulted on its debt — which is prettttty tough to do when you have a printing press – over time the country is slowly shooting itself in the monetary foot.

It’s the same thing that happened in 2011. Although the government never defaulted, our credit was downgraded by Standard & Poor’s. Here in 2013, it’s a Fitch downgrade we have to be concerned with.

Over time these things are going to slowly add up. It’s a soft default. And it’s already started.


While the U.S. wallows in its own default worries, a Fitch downgrade looms and the dollar weakens – the Chinese are marching.

In short, China wants to be the world’s next financial power. They want to have a seat at the table for their currency, the yuan. It’s a strategic storyline we’ve outlined in these pages many times before.

Can you blame the poor blokes?

China is the largest holder of U.S. treasury debt. So while the U.S. balks and talks about default, the fellow holding the largest stack of IOUs is getting a little itchy. We’ve seen the nagging itch get stronger over the past five years, too. Congress making a mockery of the U.S. debt discussion isn’t helping soothe the pain.

With a growing stack of someone else’s liability, China has been strategically trying to reduce its U.S. default risk – or, at minimum, reduce its exposure the declining purchase power of the greenback.

Sure the Chinese are trying to spend their bucks as soon as they can. They’re buying oil, farmland, gold and other commodities. It’s a global resource grab – but to China it’s a way out of holding U.S. debt.

But there’s a bigger part to this story…

An article in yesterday’s Wall Street Journal – pushed back to page two in the C-section, mind you – was another testament to China’s underlying strategy.

In short, ambassadors from China were on a five day trip to the U.K. – laying the groundwork to get the yuan on the world stage.

“Beijing has moved to broaden [the yuan’s] use to give it a higher global profile and eventually challenge the dollar as the world’s de facto currency” the WSJ reports.

To put this in perspective, the Chinese are on a good faith mission to advance their currency while the U.S. is in the midst of a fiasco that further tarnishes the dollar’s reserve status. Indeed, the tide is starting to flow away from the U.S. dollar.

It’s a sign of the times, really — China, benefiting from our loss. Our multi-decade-long trouble trying to defend and democratize the Middle East has done nothing more than give the Middle Kingdom a foot in the door. It’s the Chinese, not us, that are benefiting from Middle East oil.

The same “good for China, too bad for us” process is playing out in the global currency market. You and I can agree that the contrived default debate won’t change much in the way of our daily life. The U.S. is still the strongest economy in the world, we’ve got plenty of natural resources, a willing workforce and the most innovative tech sector the world has to offer. That, however, won’t stop our currency from being dethroned. It won’t stop the slow default.

To keep a currency stable you need leaders with integrity. They’ve got to be on the same page in protecting the dollar’s long-term value. After all, that’s in the best interest of the people, right?

But that’s not what we’ve got. We’ve got buffoons in Congress and maniacs at the Federal Reserve.

Meanwhile, this week alone, China made leaps and bounds forward in its strategic goal.

There are two important takeaways to this story.

First, I’m not saying that China is set to be the new world power. The U.S. is still the world’s only real super power – that won’t be changed by contrived “government default” chatter. The point is the U.S. economy is still set to thrive.

The U.S. dollar, however, may not share the same positive outlook. We could be in for years if not decades of inflation ahead. The soft default.

Second, China’s currency ambitions are nothing without collateral. As Theo Roosevelt said, “speak softly and carry a big stick.”

For the Chinese to succeed in furthering their currency they need more than just chatter, they need a big stick! That stick won’t come in the form of a world-power military – but it may very well come from an absurd amount of gold.

Indeed, if you can’t persuade the world to consider you a financial equal, and you can’t force them with military power, you’ve got to have a big stick, some collateral – in this case that collateral is gold.

How big of a stick is China carrying? Here’s a look at our latest data:

Infographic Showing China's Total Gold Reserves

In the graphic above you’ll see three columns. The first column hasn’t changed since 2009 and the third column is my educated guess.

The second column, however, is filled with live data. As I type China is producing gold in-country and importing bullion via Hong Kong. Add it all up and as of August 2013 imports from Hong Kong, since 2009, total 2,395 metric tons. Yeah, you read that correctly. China, over the past four years, has imported more gold from Hong Kong than double its “official” holdings.

Meanwhile China is still the number one gold producer in the world. When you add in Bloomberg’s 2013 production estimate of 440 metric tons, you’ll see that since 2009 China has produced over 1,800 metric tons of gold!

Add it all up (including “official” holdings), China could easily be sitting on 5,316 metric tons of gold. That’s enough to earn them the world’s second largest gold stash. Talk about a big stick. That places them ahead of Germany and second only to the U.S. — elite company, eh?

This is a storyline you won’t want to miss. While the U.S. flounders in its ability to act fiscally responsible (slowly defaults), the Chinese are strategically moving forward to create a global currency (carrying a big stick!) Their action in the U.K. is yet another testament.

Come 2015, we could see the next massive run-up for gold. 2015 is the date the Chinese have circled on the calendar to have their currency fully convertible (meaning it can trade freely on the world market.)

When Chinese officials show how much golden collateral they hold, I expect to see a strong surge in gold prices. Stay tuned, but in the meantime be aware of this very important storyline.

Keep your boots muddy,

Matt Insley
for The Daily Reckoning

Ed. Note: The gold market has been a tough nut to crack recently. But that doesn’t stop Matt from trying. He’s watches the gold markets like a hawk, every day, to try to get a leg-up on what’s about to happen next. If you’re a self-respecting gold bug, you owe it to yourself to read his Daily Resource Hunter newsletter. You can sign up for free, right here.

This article first appeared at Daily Resource Hunter

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