Clever China Commodity Charge

Everyone looks to explain things away. China buying commodities? It must be growth, they say. Maybe decoupling is real. I say not. Yesterday's NY Times headline, "China Fills its Pantry With Global Commodities". Commentators cheered on China's consumption. If this is the consensus view, it’s likely to be wrong. This isn't consumption. It's investment. It's diversification. Away from the US Dollar.

We have a debt overh ang. The options are simple: pay your debt or don't. You can pay it in cash or kind. Pay it in cash, you're clear. Pay it in kind (collateral—whether a house or a stock), you may be 'cleared out'. Since most debtors can't pay, lenders must either take debtor's stuff by seizing and selling their collateral or take their stuff by converting their debt to equity. Rule of law and bankruptcy allows for orderly procedure of this last option, unless the rule of law is suspended by government to prevent riots and revolutions from the working class that elected the government. The US government isn't really willing to let the prices of stuff (collateral) fall. So the other option is to let the value of the stuff that the stuff is valued in (ie. dollars), fall. We devalue our houses or we devalue our dollars. We do the dollar-devaluing thing by printing more of them. Many, many, more of them. More supply, less value. This is inflation. When there is a lot of money going around, it will eventually find itself into the prices of some other stuff. This way, the pain gets spread to those holding lots of dollars—like say China.

China officials have already jawboned the US publicly about maintaining a strong dollar, about finding alternative stores of currency reserves. And THAT dear reader is my opinion of what China is doing. They are doing what Dave Swensen did when he arrived at Yale as a 31-year-old. He looked at Yale's holdings, saw 50% of their equities in US Stocks and the rest in US bonds and thought that no matter how diversified Yale was within those two asset classes, having a total of 90% in US marketable securities was definitely NOT diversified. He embarked on, and others later emulated, the now famous endowment model—diversifying into commodities, real estate, private equity and active managers—that has outperformed and compounded Yale's endowment to be the envy of institutional money managers.

China may be diversifying its reserves into hard assets. If inflation comes, the value of those assets, especially in dollars will rise. If hyperinflation comes, the value, especially in dollars will skyrocket.

Clever. And what you might expect from the academic pedigree that comprises their government officials. In the US ours are mostly lawyers and career politicians. In China, theirs are mostly engineers, geologists and mineralogists. Who's got the edge?

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