China’s Next Move in Becoming a World Power

Dear Readers,

I don’t mean to scare you, but you should pay very close attention.

Over the past years, I have been warning you about the growing tensions between world powers. The world’s declining economic growth further escalates these tensions, as nations fight to keep themselves financially intact.

It’s clear that the world’s largest economy – the US – is still shaky, evidenced by the Fed’s stance on another no-hike meeting. Meanwhile, the nation is battling terrorism, dollar-dominance, and fighting for territorial control all over the world against incredible adversaries.

The world’s second-largest economy, China, is also on the brink of what may be a disastrous collapse, evidenced by numerous problems such as liquidity issues, bad loans, and stock market collapses.

World powers are now coming to a crossroads with not just their own financial conundrums, but with each other – with the two most powerful economies leading the battle. The culmination of these events is what could lead us into the next World War.

I am not sure how close we are to a World War scenario, but I do know that we’re closer to it than we are away.

We just witnessed direct Russian verbal attacks aimed at the US during the recent UN General Assembly, which comes off their continued disagreements in the Middle East, and US intentions on expanding NATO by deploying more nuclear warheads in Germany.

Then we have the US media alleging Russians of bombing the innocent in Syria while Russia’s propaganda machine runs strong in claiming the killing of thousands of terrorists and, “halting World War III.

This is not fear mongering, but the truth – and I have warned about the growing conflicts in many past letters over recent years. I hope by now that anyone who believed I was writing about these threats to garner publicity is now starting to see the bigger global picture.

Do you think we’re close to World War III?

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As global economic conditions continue to deteriorate – much of it blamed on the monetary and fiscal actions of the US – it could trigger a global military conflict as world leaders cultivate external conflicts to maintain a unified nation.

I am not the only one who is thinking this way.

Earlier this year in May, at a speech to the Bretton Woods Committee, George Soros sang the same tune.

Via Marketwatch:

“Billionaire investor George Soros said flatly that he’s concerned about the possibility of another world war.

Much depends on the health of the Chinese economy, Soros said in remarks at a Bretton Woods conference at the World Bank.

If China’s efforts to transition to a domestic-demand led economy from an export engine falter, there is a “likelihood” that China’s rulers would foster an external conflict to keep the country together and hold on to power.

“If there is conflict between China and a military ally of the United States, like Japan, then it is not an exaggeration to say that we are on the threshold of a third world war,” Soros said.”

Since these comments, relations between economic powers have only gotten worse.

While global politics appears friendly during camera time, as we witnessed with China’s President Xi Jinping’s recent trip to the US, the latest military actions show a starkly different scenario.

China Pushes On

One look at the South China Sea and we can see a growing number of military intrusions.

The Spratly Islands of the South China Sea are a central corridor between many Asian nations and are home to a mass resource of oil and gas. China has been bullying and laying claims to the islands, but surrounding countries such as the Philippines, Malaysia, and Indonesia also claim rights.

Here’s a brief look through an infographic by Business Insider:

southchinasea

The US – claiming to protect surrounding nations from China’s brute strength – has stepped in, and clashes between the two nations have already occurred. The US has told China to stop pursuing its claims, but China not only refuses to listen but has fought back.

According to China’s state controlled newspaper the Global Times, and via the Telegraph:

“…If the United States’ bottom line is that China has to halt its activities, then a US-China war is inevitable in the South China Sea”, said the paper, which is often seen as a mouth-piece of hardline nationalists in the government in Beijing.”

Has China listened to the US? Nope…

Via WSJ:

“China has completed a runway on one of its artificial islands in the disputed South China Sea and is moving closer to making it operational, according to new satellite imagery released on Friday by IHS Jane’s Defence Weekly.

The completion of the runway on Fiery Cross Reef could allow China to accelerate construction there by flying in material, and to start patrols over the islands known as the Spratlys, where several of China’s neighbors also have territorial claims, according to the defense- intelligence provider.”

Obama has told the world that he would try and persuade China from continuing its advancement in the South China Sea during Chinese President Xi Jinping’s visit to the US. Clearly, Obama’s attempts have gone without progress.

Via Reuters:

“Chinese President Xi Jinping on Friday said China was committed to resolving any disputes in South China Sea in a peaceful manner and protecting the freedom of navigation and overflights, saying that construction in the sea did not target any country.
“Islands in the South China Sea since ancient times are China’s territory. We have the right to uphold our own territorial sovereignty and lawful and legitimate maritime rights and interests,” Xi said after a meeting with U.S. President Barack Obama.”

China then fired back at the US with warning shots of its own.

Via USNI after China’s visit to the US:

“Chinese officials again affirmed territorial sovereignty for a series of newly created artificial islands in the South China Sea and warned the U.S. against taking “risky and provocative action” by attempting to come within 12 nautical miles of the islands, according to a Friday press statement from Beijing.”

China’s continued progress in the South China Sea is yet another episode in a series of world conflicts – one that could provoke or ignite a World War.

Who will win in the battle for the South China Sea?

War is Not Inevitable

There is a glimmer of hope that war can be avoided – or at least postponed.

Continued via Marketwatch:

“…To avoid this (war) scenario, Soros called on the U.S. to make a “major concession” and allow China’s currency to join the International Monetary Fund’s basket of currencies. This would make the Yuan a potential rival to the dollar as a global reserve currency.

In return, China would have to make similar major concessions to reform its economy, such as accepting the rule of law, Soros said.

Allowing China’s Yuan to be a market currency would create “a binding connection” between the two systems.

An agreement along these lines will be difficult to achieve, Soros said, but the alternative is so unpleasant

“Without it, there is a real danger that China will align itself with Russia politically and militarily, and then the threat of third world war becomes real, so it is worth trying.”

Over the past years, China’s has been aggressively pursuing the international recognition of its currency.

However, one of the biggest roadblocks to achieving this lies in a hopeful inclusion into the Special Drawing Rights (SDR) of the IMF.

What is the SDR?

Via my Letter, “The Truth About the Currency Wars“:

“The SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies (currently the U.S. dollar, Euro, Japanese Yen, and the British pound), and SDRs can be exchanged for freely usable currencies.”

The inclusion of the Yuan in the SDR will have drastic ramifications on the balance of global currencies. It would make China’s Yuan one of the premier currencies in the world, as it becomes a recognized international reserve currency – one that other foreign nations may eventually hold in their reserves.

However, for the Yuan to be included in the SDR, it must meet two specific criteria laid out by the IMF:

  1. The issuing country must be a major exporter, and;
  2. The currency must be freely usable.

China is already one of the world’s largest exporting countries and trade with China continues to expand. Criteria 1 met.

The second one, however, is up for debate.

Most would assume that the term “freely usable” would mean fully convertible. If that were the case, China wouldn’t make it.

Why?

First, China currently limits foreigners to strict quotas for investing in its capital markets – potentially to prevent the manipulation of its market by US banks and entities. It also forces foreign corporations to do stacks of paperwork before they are allowed to bring money into China. And lastly, it places caps on how much cash residents are allowed to take out of the country.

However, the IMF explains “freely usable” as something else.

Via the Economist:

“…As the IMF explains in its paper, freely usable means something else.

It refers to whether a currency is widely used in international transactions and whether it is widely traded in global markets. Full convertibility would help a currency meet these standards but is not a prerequisite.In theory judging this ought to be clear-cut. Across a range of indicators considered by the IMF, the Yuan seems to sit just outside the SDR club. In 2014 it ranked 7th among currencies in countries’ official reserve assets. It was the 8th-most used for both international debt securities and cross-border payments. As for trading, it ranked 11th in global currency spot markets.

However, if the Yuan is judged based on its trajectory, rather than a snapshot of its current standing, the case for its inclusion in the SDR is much stronger. Its international use has grown rapidly in recent years, albeit from a low base….In 2014 it accounted for 1.1% of countries’ official reserve assets, up from 0.7% in 2013. Some 0.6% of international debt securities are now denominated in Yuan, up from just 0.1% in 2010. For cross-border payments, 1% are conducted in Yuan, up from 0.2% in 2012. International trading of the Yuan has had a similar, if slightly slower, ascent: 0.8% of currency transactions in the global spot market involved Yuan in 2013, up from 0.3% in 2010.Moreover, while capital controls make it difficult for ordinary foreign firms to invest in Chinese markets, the government has started to open its door more widely to other countries’ central banks.”

It is interesting to note that while the Economist notes China’s currency use rankings, it didn’t note that last year, the Yuan actually overtook the Euro as the second most-used currency in global trade finance. That means by IMF definitions, China may well meet criterion number two.

China also knows that in order to compete with the dollar and become recognized as an international reserve currency, it must begin to open its doors to foreign markets.

And that is precisely what China has been doing.

Over the past years, the Chinese have been spreading the use of the Yuan in international markets via many different means. I’ve talked about the BRICS Development Bank, the Asian Infrastructure Bank, and the growing currency swaps with nations all around the world – and how all of them were being used to internationalize China’s currency.

China has also slowly began to accept foreigners into its massive US$6.8 trillion bond market – a market that’s third only to the US and Japan.

Last week, China announced that it would begin to allow offshore lenders to issue Yuan-denominated debt sold on its domestic market. This is a big step as China has rarely allowed outsiders to participate in its mostly closed bond market.

But that’s not all.

Just this past week, for the first time, China reported data on its official reserves to the International Monetary Fund.

Via Bloomberg:

“China is reporting data on its official reserves to the International Monetary Fund for the first time in an effort to provide more transparency as it pushes to have the yuan recognized as a reserve currency.

…The move comes as China lobbies to have the yuan included in the IMF’s basket of reserve currencies, known as Special Drawing Rights. The fund is assessing whether the Chinese currency meets the requirements of being “widely used” and “widely traded,” with the IMF’s executive board expected to vote on the matter in November.”

But you wouldn’t expect the Chinese to give up everything without a guaranteed inclusion into the SDR. And so that is precisely how the Chinese have played it.

“…Only part of China’s official reserves will be included in the Cofer data released Wednesday. The Chinese government has informed the IMF that the composition of the partial data being released is broadly representative of its overall holdings, according to the fund. The country has agreed to move to full coverage within two to three years, Heath said.”

This strategy not only shows the world that China is willing to play ball, but it also gives China ample time to manipulate its reserves (I’ll comment on this in a bit, as there is something important we should pay attention to).

Why Isn’t China Already Included in the SDR?

By most definitions, China’s Yuan clearly meets the requirements for inclusion into the SDR. So why isn’t it already included in the special basket?

This is where the US has the upper hand in George Soros’ view of preventing war: it stands as the gatekeeper of currency power.

Via my Letter, “The Truth About the Currency Wars“:

“A while ago, I wrote how the majority of the members of the IMF have already agreed and voted on China’s inclusion into the SDR as part of the wide-ranging governance reforms to reflect the increasing importance of emerging market countries back in 2010. However, nearly five years later, nothing has happened as a result of the US’ voting power:

“… As of March 4, 2015, 163 members having 80.17 percent of total quota had consented.

That means that the majority of nations approve the new quota increase.

Yet, the quota hasn’t changed. Why?

Because, as mentioned above, the quota increase is still dependent on the approval to reform the Executive Board.

In order for the proposed amendment on reform of the Executive Board to enter into force, acceptance by three-fifths of the Fund’s 188 members (or 113 members) having 85 percent of the Fund’s total voting power is required.

As of January 27, 2015, 146 members having 77.07 percent of total voting power had accepted the amendment.

There’s only one country that can change that: the United States of America.

As I mentioned earlier, the US has just over 16% of the voting power at the IMF. If the remaining 7% of the votes accept the amendment, it still leaves us with only 84% – 1% shy of the required 85%.”

In other words, until the US gives the OK, the Yuan won’t make it into the SDR.”

In China’s recent visit to the US, Obama finally leaned toward the suggestion of Soros by potentially allowing the Yuan into the SDR, and thus, avoiding a war scenario.

Via Bloomberg:

“The Obama administration took a step toward backing China’s bid to have the Yuan recognized as a global reserve currency, as the U.S. softened its insistence that the Chinese implement financial reforms to win support.

After U.S. President Barack Obama and Chinese President Xi Jinping met Friday in Washington, the two sides issued a statement saying the U.S. supports the inclusion of the Yuan “provided the currency meets the IMF’s existing criteria in its SDR review,” a point Xi highlighted in his press conference with Obama.

At least $1 trillion of global reserves will convert to Chinese assets if the Yuan joins the IMF’s reserve basket, according to Standard Chartered Plc and AXA Investment Managers.”

If China’s Yuan becomes recognized as an international reserve currency, and becomes fully convertible, or “freely usable,” it would most certainly attack the dominance of the US dollar. As Soros suggested, it would not be the best outcome for the US but it could avoid a war.

Will China’s yuan make it into the SDR?

Is this China’s Plan?

Now let’s go back to what I was alluding to earlier about China slowly reporting its full official reserves over a few years and why.

If China were to report its full official reserves now, it would disclose to the US and others exactly what it has been up to, and more importantly, it would disclose its strategies for currency domination.

This, I predict, includes the mass accumulation of gold – gold to challenge America’s unaudited gold vaults at Fort Knox.

We already know that China, and other central banks such as Russia, are continuing to increase their gold positions. We also know that China is likely hiding the full truth when it comes to how much gold it actually owns. I suspect that the primary reason for this is that it wants to accumulate as much gold as it can at low prices, and exchange much of its foreign reserves for gold.

Via my Letter, “A Critical Shift“:

“China has been secretly buying gold (who knows how much) for years, but hasn’t revealed how much it has accumulated since 2009, when it announced that it has increased its reported holdings by a stunning 75%, to 1,054 tonnes.

What we do know is that China’s gold imports have been growing for years, and in November, exports from Hong Kong rose to their highest level since February.

The recent decline in Treasury holdings by China, in conjunction with record inflows of gold from Hong Kong, could suggest it has been using the funds to buy gold (or transferred to Russia for future purchases of oil?).

There’s no doubt that China has a plan, and likely won’t announce its holdings until it gains the support of other nations for its yuan. But you can quote me on this: “When China finally announces its gold holdings, it will shock the world.”

And – unlike the Fed – I bet China won’t have a problem showing its gold to the world*.

(*Here’s something to think about: Since the Fed won’t let anyone – not even its own officials – see the gold in its vaults, what would happen if China does? Will “trust” eventually shift from the U.S. to China?)”

If China’s Yuan is accepted into the IMF’s SDR, China could very quickly open its gold vaults for the world to see – that is, if it’s been able to accumulate enough physical gold. I suspect that this will be the next big trigger for gold – and I mean BIG.

Quick Opportunity Update

If what I insinuated to in this Letter begins to reveal itself, we could see gold stocks finally break through its slump.

As I have mentioned, I have slowly begun to look for opportunities within the sector, including a recent investment in Newmarket Gold Inc. (TSX: NMI) (OTXQX: NMKTF) – which I, despite a recent 80%+ run, continue to hold.

As I mentioned in my last Letter, new analysts are beginning to jump on board. Last week, RBC Capital’s Head of Global Mining Research, Stephen Walker – a well-respected mining analyst – was the latest to initiate coverage with an Outperform rating. This brings the total number of analysts covering Newmarket Gold to four since our first report. I suspect more will follow.

Seek the truth,
Ivan Lo
The Equedia Letter
www.equedia.com

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