China’s Strategic Coup, Stress Tests, Deficit Warning, Stimulus Slip-Up, and More!

by Addison Wiggin & Ian Mathias

  • China’s strategic coup… A Byron King prophecy fulfilled
  • More fallout from China’s gold, dollar moves
  • Another "stress test" leak… Move along, nothing to see here
  • Interesting indicator: Financial crisis no longer crowding out deficit news
  • Why you might have to return some of your stimulus payment

  “It’s not our world anymore!!!!!” concludes an e-mail from scarcity bug Byron King. We’ve spared you the large font, the all caps… the expletives. But for dramatic effect, all five exclamation points are yours to keep.

For years, Byron’s been warning us about China’s quest for “rare earth elements.” One development over the weekend puts this quest front and center and sets the stage for our “China Resurgent” issue of The 5 Min. Forecast. Enjoy…


  “Rare earth metals” are little-known metals that are critical for little things like appliances, computer screens, TVs, hybrid cars… and guided ballistic missiles. Household stuff.

Before this weekend, China already controlled 95% of world production. The biggest non-Chinese source was a mine in Australia being developed by a little company down under called Lynas Corp. Now we’ve learned the Chinese are taking a majority stake in Lynas.

“This is a massive strategic defeat for the West,” laments Byron. “The Chinese are winning the Great Game of control over resources… game-set-match. Our kids will grow up aspiring to be houseboys and maids to Chinese mandarins.

“Your ‘leaders,’ the Ivy League-credentialed policymakers in D.C., are clueless.”

Again, that was among the more mild comments. Since we adhere to what our founder Bill Bonner calls a “Presbyterian standard” of commentary (at least today, anyway) we’ll refrain from reprinting the rest of Byron’s missive.


  “The 50% fall in the Australian stock market worked out well for the Chinese,” says Dan Denning, offering insight on the Lynas deal close up and personal from his perch in Australia.

“The smaller miners [such as Lynas] who had finance to roll over simply couldn’t find the money they needed from Australian investors or institutions. The government set up a bank to provide bridge financing to commercial property developers. But miner after miner has shuttered operations or, in some cases, given up the ghost.”

Enter the Chinese.

“That’s always the way it works in capital intensive cyclical industries,” continues Dan. “Strategically, the Chinese have played the cycle better than others. Whichever government bureaucrat or union official is now running GM and wanting to build hybrid cars had better learn to speak Mandarin.

“Or just get used to hearing the word ‘No.’”


  The capital-intensive mining cycle is not the only one being strategically mastered by the Chinese.

"It would appear," Illinois Rep. Mark Kirk said in a statement of the obvious over the weekend, “quietly and with deference and politeness, that China has canceled America’s credit card.”

Kirk made the comments after witnessing firsthand at the Bureau of the Public Debt how much the Chinese have curtailed their purchases of U.S. Treasury Debt. Suddenly, the Congressman is alarmed by how much debt the Federal Reserve is buying in lieu of any other buyers.

"There will come a time where the lack of Chinese participation may have a significant impact," Kirk said. “We should track that, because up until last month they were the No. 1 provider of currency to the United States, and now they’re gone."

Who could have seen that coming? Uh… yeah.


  Kirk’s comments jibe with cryptic statements from Chinese state-run media over the weekend, too.

Last week, they announced their gold reserves have grown 76% since 2003. In a follow-up report, China Radio International sought out reaction from a researcher at the Chinese Academy of Social Sciences. He said China should further increase its gold reserves “to decrease the risk of a possible U.S. currency devaluation affecting the country’s foreign exchange reserves.” Doing so “will lay a foundation for the internationalization of China’s currency.”

Beijing, we assume, wouldn’t put this on state radio without an agenda. Of course, we could just roll our eyes, as did Barney Frank a few weeks agoand assume the Chinese are bluffing.

As an investor, it’s your choice whom to believe. But to us, it sounds like confirmation of Byron’s conclusion that “China is monetizing its gold” and one of the major themes we outlined in Demise of the Dollar.


  Gold itself perked back up past $900 this morning, while the dollar index treads water at 84.6. Oil is steady at $53.


  “None of these banks are insolvent,” a “senior government official” told The New York Times this morning, dropping another hint about the results of the Geithner “stress tests” administered to the U.S.’ 19 largest banks.

Results were supposed to be released, but that’s been delayed ’til Thursday, while the banks argue with the examiners over the meaning of the results.

On reflection, the metaphor we offered on Friday is inadequate: It’s not just that the heart patient, huffing and puffing after getting off the stress-test treadmill, is arguing with his doctors over the lines on the scope. Now the doctors themselves are trying to figure out how to enable the patient… and keep up his high-fat, heavy-drinking diet, while giving him a cigar and a few chips for the poker table.

Hence Treasury Secretary Geithner’s latest scheme is to convert the government’s preferred shares in the banks to common. That raises the banks’ assets-to-common equity ratios. Never mind all those rotten assets still sit on the books.


  Even the National Association of Realtors is putting a cautious spin on today’s pending home sales numbers. They rose 3.2% in March. The index now stands 1.6% higher than a year ago. But the NAR acknowledges some of that’s probably been fueled by the new tax credit for first-time homebuyers, part of the stimulus package.

We also offer our own proviso, and stop us if we’ve offered it before: Pending sales aren’t the same as completed sales. A lot can happen on the way from one to the other. Like the buyer not qualifying for a mortgage… a roadblock that actually does impede sales these days.


  “Suppose,” says the Richebacher Letter’s Rob Parenteau, “you are on a jumbo jet flying from New York City to London and you notice two of the four plane engines have smoke pouring out of them, and the plane is slowly losing altitude.”

“Somewhere over Iceland, let’s say, the plane hits an unexpected downward wind shear and begins hurtling toward the Earth. The pilot gets on the intercom, scares everyone to death by acknowledging the reality of the situation, but says he knows the corrective procedures that will stabilize the plane – it will just take more effort and ingenuity than he has ever used before.”

“Three of the longest minutes in the world later, the pilot gets back on the intercom and announces that he has good news. His extraordinary efforts are, indeed, working. The plane is no longer plunging 3,000 feet per minute: It is falling only at 2,998 feet per minute! Would you then expect your fellow passengers to start applauding, dancing in the aisles and ordering drinks?”

That’s Rob’s take on some of the “less awful” economic data we brought you last week, including GDP and the ISM manufacturing index.

“The reality remains that the United States is struggling through the most severe post-World War II recession with a rather compromised credit system, and the only sure area of rising final demand over the next year will be coming from fiscal deficit spending.”

“So far, the equity market has failed to correct from very overbought conditions. Investors are still barreling into equities.”

As the French would say upon abandoning their trenches in World War I, we recommend: ‘Sauve qui peut!’


  It’s Monday… two more banks failed over the weekend. Atlanta’s Silverton Bank, whose customers were other banks, got the padlock-and-chain treatment at closing time Friday afternoon. It’s the biggest failure so far in 2009. Cost to the FDIC: $1.3 billion.

Citizens Community Bank of New Jersey is also toast.

Total bank failures this year: 31. That puts us on a pace for over 90 by year’s end. Total for all of 2008: 25.


  Still, soaking up the salve, major stock market indexes spiked 2% by midday today. Friday both the Dow and the S&P tacked on about a half-percent gain.


  Panic over the financial system is no longer crowding out discussion of the federal deficit here in I.O.U.S.A.


Even The New York Times is noticing the deficit as a percentage of GDP will likely shoot above 10% this year – a post-World War II high.

Bond investors caught onto this even sooner than the Times. They’ve driven yields on the 10-year Treasury note to their highest since last November – above 3%.

Ben Bernanke and co. can keep short-term rates as low as they like, but the bond market clearly sees signs of trouble on the longer end of the yield curve.


  “With earnings season upon us,” our income-investing specialist Jim Nelson writes, “the last thing investors want to read in their company’s press release is ‘[Our] portfolio of mortgage securities increased to $5.9 billion at March 31, 2009, compared with $5.2 billion at the end of the previous quarter.’”

“One of my Lifetime Income Report positions did just that.”

But it’s not the horror one might expect. Jim has uncovered a rare gem among the toxic debris of mortgage debt. “This company, along with its five or six peers, owns special mortgage securities that are backed by the full faith of the U.S. Treasury. Meaning the government will pay the company for every single defaulted mortgage it owns.”

“It’s a bank without any toxic assets… unless you think the Treasury will dissolve in the next year – about as long as this deal should be around.”

“Here’s the best part: these companies AVERAGE 17.12% dividend yield. Ours maintains a slightly higher yield, with extra 39% capital gain potential by year-end.” Get details on Jim’s find here.


  What the stimulus giveth, the taxman taketh away. If you draw a regular paycheck from more than one job, there’s a good chance you’ll have to pay some of your stimulus back next April 15.

The IRS screwed up the tax schedule and failed to let anyone know. Bottom line: If you’re married and both partners work, you probably got too much stimulus. If you hold down two jobs, you probably got two much stimulus. If you’re retired and still have earned income… yeah, you probably got too much stimulus.

Uh… yeah.


  “As a geologist,” chimes in a reader on our ongoing and -going and -going global warming debate, “I can safely attest that the Earth has been warning since the end of the last ice age, 12,000 years ago. We have established a trend. Humans have had very little impact on the first 10,000 (or maybe 11,500) years of that trend.”

“Through geologic time, the Earth’s climate has been constantly changing. To think that the Earth’s climate was at any point immutable is a silly idea. Just like many of the ideas today.”


  “Here in Wisconsin,” notes a Badger State reader along the same lines, “we have had both tropical environments and ice ages. By the way, this is proven by fossils found around the state. Therefore, I would think it safe to say that the Earth is in constant change between warming and cooling, dry and wet conditions. I also find it hysterical that with a planet age of 4-5 billion years and a worldwide data base of weather conditions of less than 400 years, a ratio of 12,500,000-to-1, anyone could possibly state with any certainty that ‘global warming’ is man-made and not just a cycle in natural climate change.”


  “I’m not an environmental activist,” writes a third, “a tree-hugger or any similar ilk. I’m simply an engineer who tries to look at the root cause problem (energy production) and ask, ‘What is the best way to produce energy?’

“I think if we can produce energy that doesn’t consume a finite resource, like coal or oil, and is renewable, like wind, water, sun, trees or sugar cane (for ethanol, not corn), algae, that makes sense. It’s illogical to base a critical system like energy on a source that once used up is gone. Let’s put engineers into all decision making positions and get some sense and logic back into that process.”

The 5: Perhaps. The writer Peter Huber makes the case that it’s not the U.S. or Western economies’ prerogative to replace carbon-based energy sources. In fact, the more we tax and control them in our part of the world, the cheaper they become to third-world users. The only viable alternative is nuclear. His argument is worth your consideration.

“At last this sort of analysis is getting out a bit,” our own thorium nuclear advocate Patrick Cox wrote upon reading Huber. “This has all been clear for more than a decade. Marlo Lewis at CEI has written a lot on this stuff.

“It’s so obvious, in fact, that anything we do to cut consumption will simply lower costs for Third Worlders. I have to assume this is really a case of what psychologists are currently calling ‘pathological altruism,’ which is, in turn, a form of masochism.

“I really believe this has nothing to do with the environment and everything to do with some bizarre S&M ritual.”


Addison Wiggin

The 5 Min. Forecast

P.S.: “Brief, concise, interesting. One of my favorite stops in the deluge of e-mail,” a reader writes. We weren’t fishing for compliments by noting this letter’s two-year anniversary (which even we had forgotten about until days after the fact), but a few were forthcoming anyway.

“Thanks for the effort and resulting insights that you provide. I like that your commentary is focused and brief,” says another reader. “Continue to be honest and direct,” writes a third. “It is most appreciated. Congratulations on your second anniversary. Hope there are many more.”

The 5: Many thanks. We’re planning on it!


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