China's U.S.$ Holdings, Banks and Accounting

China's U.S.$ Holdings, Banks and Accounting

China's U.S.$ Holdings

An article late last week titled 'China:  The US Is 'Insolvent and Faces Bankruptcy'' talks indirectly about 'U.S. Centricity', a phrase I have been using in recent weeks and in fact may have 'coined' as I see no one else using it.  To me 'U.S. Centricity' is a descriptor for what I see as the attitude of many (but thankfully not all) Americans and American writers whose cocktail talk and articles suggest the world centers on the U.S. - and most of what happens outside U.S. borders is unlikely to change either the lifestyle of Americans or U.S. economic prospects.  A second article titled 'China Rating Agency Condemns Rivals' can be read at the same URL.

Together the two articles say (my words):

·        it is unlikely China is sitting on its pile of cash like the child's cartoon character 'Richie Rich' and doing nothing to protect the purchasing power of the U.S. Treasuries it holds.  Rather, China undoubtedly is securing as much of its U.S.$ hoard that it can through hedging and other financial strategies; and,

·        China wants a bigger say as 'the biggest creditor nation in the world' in the rating of other governments and their respective debt.  In what I think is a telling statement the second article quotes Guan Jianzhong, Chairman of Dagong Global Credit Rating as saying "The western rating agencies are politicized and highly ideological and they do not adhere to objective standards" and "China is the biggest creditor nation in the world ... and we (China) should have a say in how the credit risks of states are judged".

I don't know if China has adopted a hedging or other strategy to protect as best it can the purchasing power of its fiat U.S.$.  It would only make sense to me that it would, in combination of course with spending those $'s as quickly as possible on the 'real (resource and other) assets' it believes are strategic to it.  A difficulty China has, at least as I see it, is their U.S.$ holdings are so vast that it will take China a very long time to expend them strategically.  China's U.S. Treasury holdings are now widely estimated to be in the order of U.S.$2.5 trillion.

I previously have discussed in my e-mails 'how much is a trillion' - for example, one could circumvent the globe 40 million times if one travelled a trillion miles.  Think of a trillion in the context of 'strategic asset purchases' this way:  if China really does hold U.S.$2.5 trillion in reserves, China would have to make 250 U.S.$10 billion strategic investments or 500 U.S.$5 billion strategic investments to spend those reserves.  Conclusion:  It will take China many year to spend the U.S.$ it has accumulated, let alone the U.S.$ it continues to accumulate each month. Moreover, presumably China will continue to 'cherry pick' and purchase - or take economic interests in - the best and not the worst of the world's valuable 'real assets'.

I suggest you think hard about the likely consequences of a 'China Strategic Asset Spend' on what I see as the ongoing world economic power shift away from the U.S.   In my view this ought to be 'serious food for thought' for equity market investors generally, and for equity market resource investors in particular.

Banks and Accounting

Aside from the change in the U.S. 'mark-to-market' rules I wrote about recently, an article titled 'Bank Profits Depend on Debt-Writedown 'Abomination' in Forecast' says that U.S. Banks are depending on an accounting rule that enables them to record gains related to writing down their debt to market value - presumably on the basis that a bank could buy its debt in the open market at the reduced price and retire it.  On a realized basis this actually makes sense to me, although as a practical matter I would think of the resultant after-tax gain as a positive shareholders' equity adjustment instead of as a income item.  To the extent it is treated as an income item it is unlikely to a recurring one and is certainly non-operating income.

Public accountants (I was once one, a very long time ago) are, as a generalization to which there are exceptions, an interesting, 'theoretically-bent', crew.  In my experience, most have little or no hands on operating background - save that of perhaps having some involvement in the management of their own firms which generally 'cash flow like a dream' unless they are seriously mismanaged.

The value of a business properly is based on 'after-tax free cash flow', not accounting earnings - although not every public accounting partner (or security analyst for that matter) necessarily would agree with that.  For fun, think of theoretical public accountants who generate accounting rules as a staid crew of a rowboat (they usually don't move that fast) who are interested in ensure the technical correctness of their respective rowing strokes.  Sometimes that focus leads to missing the far more important fact that a reef is only 5 feet away and that there are a lot of sharks and barracuda circling the reef looking toward the surface with eager anticipation.

In context, if U.S. banks are in fact reporting quarterly accounting profits by showing as income gains write-downs on their own debt obligations - and the equity markets see those earnings as more positive than they would see Bank reported quarterly earnings but for that being done - I say 'look out below'.

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