If you are new to this blog, you are invited to read first “The Largest Heist in History” which was accepted as evidence and published by the British Parliament, House of Commons, Treasury Committee.

"It is typically characterised by strong, compelling, logic. I loosely use the term 'pyramid selling' to describe the activities of the City but you explain in crystal clear terms why this is so." commented Dr Vincent Cable MP to the author.

This blog demonstrates that:

- the financial system was turned into a pyramid scheme in a technical, legal sense (not just proverbial);

- the current crisis was easily predictable (without any benefit of hindsight) by any competent financier, i.e. with rudimentary knowledge of mathematics, hence avoidable.

It is up to readers to draw their own conclusions. Whether this crisis is a result of a conspiracy to defraud taxpayers, or a massive negligence, or it is just a misfortune, or maybe a Swedish count, Axel Oxenstierna, was right when he said to his son in the 17th century: "Do you not know, my son, with how little wisdom the world is governed?".

Friday, 29 October 2010

Currency risk: a China's advantage

Every now and then we read or listen in the mainstream media that Chinese companies are overpaying for assets. Or that they are undercharging for contracts - like building infrastructure - they are entering into in many parts of the world . Every so often we hear the same arguments from the western companies that lost in competition to their Chinese counterparts. Quite often companies that lost to the Chinese protest and make accusations about Chinese state subsidies, unfair competition, undercutting, etc. All in all, the prevailing media image of the Chinese investors is that their decisions are not commercially sound (because they are overpaying) and politically driven (by overpaying they are trying to build a political influence). Nothing can be further from the truth. Anyone who dealt with the Chinese knows that they are commercially very shrewd indeed. What is the answer? How Chinese can overpay and still be shrewd. The recent negotiations between China and Russia or Turkmenistan regarding natural gas supplies are good examples.

China is sitting on a mountain of foreign reserves, some 3 trillion of the US dollars in value. Around half of that is in the US dollars. It is impossible to spend or invest such massive reserves, or a meaningful portion of it, without undermining their value. In the current economic conditions there is also a very high risk that these reserves will lose value. On top of that Chinese reserves keep on growing, and if Chinese stopped this process, i.e. stopped buying the US securities, the dollar would have collapsed, so their reserves would have lost very significantly. A solution that China pursues is spending a significant portion of their dollar (and generally foreign) reserves on buying assets representing long term tangible value such as natural resources, or making investments that would allow to derive a long term value, e.g. in infrastructure.

In the process of making an investment decision Chinese investors have to take into account that the money they spend carries a significant risk of losing value. Something around 30% - 50%. So if a seller (or a contractor) asks a Chinese company for $1, it represents a risked value of between $0.50 to $0.70 to the Chinese. This is the fiscal arithmetic of Chinese investors that takes into account their currency reserves risk.

On the other side, western companies, especially US' operate in a different fiscal environment, albeit under the same commercial principles. Even if they make investments with their own money, and more often than not it is borrowed money, they have to account for its costs. For example with an effective interest rate of 5%, $1 investment carries costs for an investor of 5 cents a year. So $1 investment represents a risked value of $1 plus interest.

Therefore facing a competition with Chinese investors, western companies, especially US', cannot compete on price. An investment of $1 represent a spending of 50 to 70 cents to Chinese whilst it represents $1 plus interest to a US or western companies. Assuming all other factors are the same (and usually they are quite close) a Chinese company can pay 1.42 to twice the price that a western company can pay acting on the same level of commercial rationality and soundness.

Such issues fly well above the heads of mainstream media pundits, politicians and even western companies' executives. These issues are very important however. They show how western governments' fiscal policy (especially the US') heavily undermined competitiveness of the western companies in the global economy. It all also shows how China is winning commercial game with the west. Crying about and protesting Chinese uncompetitive "commercial irrationality" will not help as it is... commercially irrational.


  1. Greg, you couldn't make it any more complicated than that? Haha.

    It all started in the 1980's when the business ethos suddenly changed. Wealth was no longer to be based on assets but only on promises.

    The product of a company's business was no longer important (also, consequently, the service it offered), only it's profit margin.

    Why pay someone who knows what they're doing a lot of money when one can buy a cheap obedient graduate (de-skilling)?

    I was there, listening to these, and other, proclamations in astonishment. It never sounded either moral or rational.

    Now China is holding the assets (and accumulating more, see them in the 3rd world, where the future is) and the vast wealth of the west is comprised principally of cds's and other derivaties, valued at so far beyond the productive capacity of the western world it's hardly imaginable, such are empty promises, gambles and un-reserved insurance.

    Go check stock market indices for the 2nd half of the 20th century. Did the productive capacity of the western world suddenly jump tenfold in the 1980's? No, it did not!

    And now the British government is cutting services to the bone so it can afford to spend it's tax revenues on staying in hock to the mythical financial markets.

    Reality check requred now chaps!

    Incidentally, if the Brits and the Spanish got together and got back in touch with their ex-commonwealths, they'd wipe the floor with both the yanks and the Chinese. Devaluing the commonwealth in favour of EU? Big mistake. Just the result of British small-mindedness and Spanish parochial arrogance.

    Ah well, que sera ;)

  2. Hi crackersjv

    Thanks for your comment. I do not see anything "complicated" in my analysis. I simply touched upon a key aspect of the current global market that is not understood by western businesses, politicians and mainstream media pundits.

    If anything your great comment may be considered as a bit "complicated" but I think it is great.



  3. Hi Greg

    Good post. It makes sense that the Chinese and other dollar holders have started discounting the value of their holdings.

    Do you follow FOFOA's blog? http://fofoa.blogspot.com/2010/11/dilemma.html

    I linked to your post from the comments section, as it was relevant to the discussion.



  4. Hi Paul

    Thanks for reading my blog. If you think it merits it please spread the link to it around.



  5. Isn't this also known as Gresham's Law, bad money drives out good money because bad money is spent first.

  6. Hi Fred

    Spot on. But I think the current bad money reached the rock bottom hence there may be a change coming. For more check up: http://gregpytel.blogspot.com/2010/11/currency-wars-where-will-it-end.html