Under-The-Counter Coup D’etat

September 12, 2012

  • China at its most fragile since Tiananmen Square? World elites warned of “revolution”…
  • “What, me worry?” Pentagon channels Alfred E. Neuman in assessing whether China might dump its U.S. Treasuries
  • “You have to write positive reports or you get arrested”: Chris Mayer with an alarming new episode in the Chinese stock fraud scandals
  • Court rules, traders yawn… How the ethanol rip-off is reaching new heights… Reader inquiries about gold overseas… and more!


  “We shouldn’t be afraid of China’s success,” says Dr. Cheng Li. “We should be much more worried about China’s failure.”

The headlines from China this week are all about the disappearance of a man named Xi Jinping. He hasn’t been seen in public all month — a bit odd for someone who is supposed to ascend to the Chinese presidency next month. The official story is he hurt his back while swimming.

The intrigue may belie something far more serious in the estimation of Dr. Cheng: A revolution in the country that’s America’s biggest foreign creditor.

While the financial media fritter away precious airtime and bandwidth today speculating about the outcome of the Federal Reserve meeting in Washington, D.C., we figure we should make the most of your 5 Mins. and examine something big that’s flying under the radar. Here goes…

  The rifts within the upper echelons of Chinese Communist Party are worse than they were during the buildup to Tiananmen Square,” says Cheng, a China expert and research director of the Brookings Institution.

Cheng shared his thoughts last week at an elites-only event called the Ambrosetti Forum, held each year on the shores of Lake Como in Italy. His remarks got scant attention, other than from Ambrose Evans-Pritchard of the U.K. Telegraph.

All the talk of a “hard landing” in China? Irrelevant unless viewed in a political context. “You cannot forecast the Chinese economy unless you have a sophisticated view of the political landscape and the current succession crisis,” said Dr. Cheng.

“All the top officials are trying to get their money out of the country,” he added. “This level of corruption is unprecedented in the history of China and unparalleled in the world.”

And this man works in Washington!

Cheng isn’t the only one fearing revolution: Chinese Premier Wen Jiabao seconds Cheng’s concerns. Without successful political structural reform, he told the National People’s Congress this year, “the new problems that have cropped up in China’s society will not be fundamentally resolved, and such historical tragedies as the Cultural Revolution may happen again.”

Scholars estimate up to 1.5 million people were killed during the decade-long Cultural Revolution. Something to bear in mind if you’re planning a trip to Beijing…

  “China has few attractive options,” says a Pentagon report, “for investing the bulk of its large foreign exchange holdings out of the U.S. Treasury securities.”

The Defense Department has issued its first-ever “threat assessment” analyzing the $1.164 trillion in U.S. Treasuries held by China, and the possibility Beijing would “suddenly and significantly” dump its holdings.

Conclusion: The scenario poses no national security threat. It “would have limited effect and likely do more harm to China than to the United States.” Indeed, such a move “would fundamentally change the international finance and business community’s perception of China as a reliable and respected economic and financial partner.”

Note: Congress ordered up this report. Dare we suggest it might have been tailored to its target audience of professional spendthrifts looking for an excuse to justify their endless borrowing?

  Note well: China is loading up on gold at a much faster clip than it’s accumulating Treasuries.

Chinese imports of gold via Hong Kong totaled 75.8 metric tons in July – up 12% month-over-month and nearly double year-over-year. The monthly chart continues to astound…

Zero Hedge helpfully reminds us that China added $12.4 billion to its stash of Treasuries during the first half of 2012… compared with $25 billion worth of gold imports over the same time span: “For the first time in history, China has imported twice as much gold as it has ‘imported’ U.S. Treasuries.”

In that context, it’s worth revisiting a State Department cable released a year ago this week by WikiLeaks, quoting from Chinese media:

“The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold’s function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. dollar or euro.

“Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries toward reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.”

Meanwhile, the Pentagon and the pundits act as if gold is a mythological creature, reserved only for the childish minds of cockeyed eccentrics.

Peering back through the Pentagon’s report, China does have one “attractive option” aside from U.S. debt. And a trillion dollars could buy a whole lot of it.

130  “Cash Squeeze Tightens Abroad Sections of China,” one headline reads this week. “Fragile China,” another says.

The Financial Times reports that a third of publicly traded Chinese companies reported cash outflows for the second quarter.

“Local governments have amassed piles of debt,” Chris Mayer writes, keeping the China dart flying. “The FT says these debts represent one-quarter of Chinese output. Yet China continues to announce ambitious plans to build railways and highways.

“But one of the most-damning things I’ve come across on China hit my desk over the weekend.”

Chris encountered the story of a “researcher in China whom police arrested — and detained — because he works for a fund manager who writes negative reports on Chinese companies. (The researcher is a Canadian citizen, by the way, yet sits in a Chinese jail on flimsy evidence and no due process whatsoever. I can’t believe the Canadian government lets that stand.)”

The gentleman appeared to cross the line by taking shots at Silvercorp Metals — which is traded on the New York Stock Exchange.

  Chinese companies have had lots of fraud issues, as you may know,” Chris goes on. “Investors have uncovered discrepancies and outright frauds in U.S.-listed Chinese companies. This sent the stock of many such companies tumbling.

“This in turn, hurt these companies’ ability to tap Western markets for more money, which hurts their ability to pay local taxes. And that hurts the local governments who labor under a pile of debt. It’s all an ugly, corrupt circle.”

What can we learn from this? “If you are in China,” Chris writes, “you have to write positive reports or you get arrested. That’s the message here. There is no respect for independent research in China. There is no value on transparency. In fact, the organs of the state work against such things.

“So in a reversal of my normal preference for ‘boots on the ground’ research, I say you can’t trust anything coming out of China. Oh, and if you own Silvercorp, dump it. Avoid China as a general rule.

“Of course, this has broader implications, as we’ve talked about before, especially for commodity markets (because China is such a large consumer of commodities). If the Chinese market is really propped up by government stimulus, then commodity markets are too.

“This warning does not apply to precious metals,” Chris concludes, “which I think are moving higher.”

  Stocks are flat today — the blue chips up a bit, small caps down a bit.

Traders could barely rouse themselves to react to a breathlessly anticipated court ruling from Germany. The nation’s highest court refused to block German participation in the eurozone’s permanent bailout fund. It’s full speed ahead for the bailouts of debt-ridden eurozone countries.

  You might think this blessing for new money printing would put the hurt on the euro this morning… and you would be wrong.

At last check, the euro is up to $1.2905. That’s pushed the dollar index decisively below 80 for the first time in four months.

 Gold is treading water today at $1,732. Silver, however, is backing off a bit — currently at $33.05.

  “Corn prices are officially through the roof,” writes Laissez Faire Today’s Jeffrey Tucker, “spiking to record highs.

“The implications are quite radical, especially given the food price riots around the world last time this happened. Everyone blames the drought,” Jeffrey observes, “as if the market can’t normally handle a supply change.

“The real problem,” he goes on, “is that the corn market is fundamentally misshaped by government interventions that have made a mess of this and many more markets. The distortions are never contained, but spread and spread.

“Corn is the single most important commodity for retail food,” Richard Volpe, an economist for the USDA told the Los Angeles Times. “Corn is either directly or indirectly in about three-quarters of all food consumers buy.

“Fine, then, answer me this, Mr. Government Economist Man,” Jeffrey scoffs. “Why is 40% of the corn crop being burned up in our gas tanks?”

Unfortunately, they’re both right. Corn is now in three out of four food products, fueling obesity’s 300% jump since 1970 by jacking up Americans on high-fructose corn syrup. Meanwhile, each year we make ethanol out of enough corn to fatten up more than 400 million more people for an entire year.

All the while, by one estimate, ethanol consumes six times more energy than it produces. It clogs up your gas tank with continued use. And if greenhouse gases are a concern for you, ethanol generates twice the emissions of plain ol’ gasoline.

[Infographic excerpt from LearnStuff.com]

The question: Why is corn being used as fuel if it’s so inefficient, costly and bad for the environment? “The answer is a Soviet-like, stupid-like government mandate,” Jeffrey responds, clearly bitter about the issue.

“It is actually relatively new,” Jeffrey explains. “It came about in 2005 and 2007. It mixes nearly all the gas we can buy with a sticky product now in rather short supply.

“Of all the government regulations I’ve looked at in detail over the last 10 years, the ethanol mandate is, by far, the worst. There are no grounds on which it is defensible,” Jeffrey concludes. “None!” There is, however, a workaround: Check out Jeffrey’s essay in full.

“What’s the point of storing your gold where the feds can’t get it?” writes a reader after the subject of overseas gold storage came up on Monday.

“Once any sort of confiscation happens, how do you think you are going to be able to access the wealth you have stored in any way that the ‘feds’ won’t be able to intercept?”

The 5: Daily Reckoning contributor Terry Coxon tackled this one a few months back: We won’t fix it if it ain’t broke.

“A new attack on gold ownership probably wouldn’t be a point-for-point reenactment of 1933,” he writes. “There are many weapons for mugging gold investors. It could be a prohibition on gold ownership coupled with a prohibition on sales of gold to foreigners. The only one left to buy would be the government, and being the only bidder, it would be a very low bidder.

“It could be a commandeering of privately owned gold,” he continues, “with token compensation like the $15 per day paid for jury duty. It could be a super tax, say 90%, on gold profits, which would get the job done slowly… or quickly if it were accompanied by a mark-to-market rule. Or it could be something none of us has thought of yet.

“Owners of gold stored outside the U.S. would be a minority of a minority. Their gold wouldn’t be the low-hanging fruit — it would be higher up in the tree and more trouble to get to. That’s why, in a casino sense, gold overseas is a different bet and a better bet than gold at home.”

Would PHYS be a better vehicle for buying gold than GLD for the express purpose of keeping it out of the U.S.?” asks one reader looking for a safety zone.

“PHYS holds physical gold (no contracts), and it is sitting in vaults in Canada — not in the U.S.

I’m guessing it’s not totally safe from a U.S. government snatch-and-grab, per se — since we are on such good terms with Canada, they’d likely roll over and give to it Uncle Sam if he asked — but are there any advantages that we would have with PHYS in this situation?”

The 5: We like PHYS if you insist on an exchange-traded product… for the reasons you cite. We like, well, physical metal even better. And among the bewildering array of bullion sources, we especially like the Hard Assets Alliance. We’ve known the folks there for years, and they’ve lined up an impressive list of locations where you can have them store your gold (or silver or platinum or palladium.)

While we believe that PHYS hit the nail on the head for backing it up with real, hard assets, we still believe Hard Assets Alliance takes the cake. Unlike PHYS, with Hard Assets Alliance, you have a growing list of countries to have your gold stored in for you. For more information, click the link and it’ll tell you everything you need to know. To learn more about the unique advantages of the Hard Assets Alliance, check this out. Please note we may be compensated once you fund your account… but we wouldn’t bring the opportunity to your attention if we didn’t believe in it.


Dave Gonigam

The 5 Min. Forecast

P.S. Treasuries are taking a hit this week; the yield on the 10-year note is up to nearly 1.75%. That’s great news for readers of Options Hotline: Their bearish bond market play is up 19% in only two days.

In the seven weeks since editor Steve Sarnoff began putting out explicit sell alerts, he’s recommended six sells for an average 70% gain, in a holding time of only 21 days.

Don’t feel bad if you missed out. As Steve says, “There’s always opportunity in options.” His next recommendation comes this Sunday.


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