A warning to China?

September 9, 2008

If China decided to diversify even a small fraction of its current US dollar reserves into gold, they would certainly cause the price to increase dramatically which could prove to be quite a lucrative strategy, especially given the size of their domestic gold production today. Is it possible western powers are flexing their muscles by demonstrating how unprofitable such a move would be by dropping the price of gold and reversing the course of the dollar with such ease? I can imaging the conversation between a Chinese and American official would go something like this…

China: You convinced us to hold all these worthless treasuries when you knew their value would plummet. Our return has been terrible. You deceived us. We are considering alternative investments.

America: We do not control your inflation. No investment is without risk, our imbalances are largely the result of your currency suppression.

China: If we let the market set the price for your dollar it would drop even faster! Your rates are too low! You should be thankful, we are responsible for maintaining the purchasing power of your people. You eat with our permission.

America: Unfortunately, we simply can not raise rates in this environment. You took too many risks with your money. Lenders need to understand the finances of their borrowers. When money is so cheap and plentiful, can you blame people for indulging? This is not a problem we created.

China: If rumors spread of a plan to divert our reserves into other assets, your people will not indulge in anything for a long time. We should cut you off. We don’t need all your paper, we have all the factories.

America: Relax, it’s all taken care of. We have an agreement with the ECB to stabilize the market. When our financial institutions are re-capitalized, we will defend the dollar.

China: That will take too long, I don’t trust you. If you give your banks and your people enough money to survive this mess it will cause too much inflation. Give us back our money or let the banks fail. If we buy more bonds at these rates they will be worthless in a few years.

America: You have no choice.

China: You have no money.

…Just a thought.