Meltdown Scenario

Funny how subject matter like this never even crosses the pages of Barron's or garners a segment on CNBC.


What Happens If…
Kevin DeMerittPresident, Lear Financial
No one delights more in wondering, "what happens if" than gold investors.
It's not hard to understand why. We're a suspicious lot, uneasy with the status quo, not given to following the media-fed herd. We got into gold, in part, because-may as well face it-we don't have all the faith in the world in traditional stocks, bonds and dollars. Many of us harbor a sneaking suspicion that, one of these days, gold will return to its historically recurring role as the currency of last resort.
The fact is, if China has any say in the matter, that day may not be as far off as some of us thought.
What Happens If China Stops Buying Treasuries?
China has $1 trillion in currency reserves. That number alone is mind-boggling enough. You've probably heard an incredible analogy or two of just how large a trillion is. One researcher thought a trillion grains of salt could easily fill up an entire classroom.
No matter how you look at it, it's a pretty big number. And China has a trillion of our dollars.
No worries, though. As long as the Chinese are willing to sponge up our excesses and buy U.S. Treasuries at the rate they have been, this Rube Goldberg contraption we call an economy can, I suppose, continue. But what happens if Beijing gets other ideas?
Case in point, there's the startling bit of news Jin Renqing, China's finance minister, recently came out with. China, it seems, will soon create one of the world's largest investment funds, a fund that could give the U.S. fits in the way we finance our budget deficits.
Renqing told how his country intends to make more profitable use of China's $1 trillion in foreign-currency reserves, now mostly parked in safe, but eminently dull U.S. Treasury securities.
"We can achieve more profit from the investments," he told a news conference. To which any investor worth his salt would have to add, "Well, duh!"
Treasury securities, you see, are returning something shy of 3 percent on China's $1 trillion…even as other governments are doing a whole lot better. Temasek Holdings, the investment arm of the Singapore government, for instance, says it's averaging a whopping 18 percent annual return. Needless to say, governmental returns like that are making the Chinese mighty antsy.
But the prudence of the Chinese decision aside for the moment, this change in investment strategy could well leave the U.S. facing a monstrous deficit dilemma: If China doesn't finance our debt, then who?
What Happens If There Are Unintended Consequences…
Of course, the Chinese reserve currency question isn't quite as simple as all that.
China obviously has to be exquisitely careful its currency remains low against the dollar to keep us buying Chinese goods. It doesn't want to end up being just another "expensive foreign import" and cut its own economic throat, after all. But maybe their new investment diversification formula has found a way to account for that.
Even if it has, though-even if China believes it has thought this thing all the way through-could there still be some unintended consequences that spring from their actions?
For example, could other nations soon follow suit? Could the dollar be abandoned en masse? Could that lead to nasty economic wars? Or outright military ones? Could this be an ignition source that leads to a U.S. economic meltdown?
Who knows? Who can say what, of all the many bona fide threats out there, financial and otherwise, might actually cause our economy to go up in flames?
The one thing you can count on for sure is that gold can put out the fire.
As Bill Bonner once aptly put it, "While the dollar could never say 'no,' gold says nothing else: No to debt. No to new spending schemes. No to improving the world. No to re-electing scoundrels. No to bubbles. No to foreign wars. No to trade deficits. No, no, no, no, no."
To that I might add one more no: Gold also says no to you losing one more penny to all the financial shenanigans going on in the world, be they Chinese or American.