The Chinese Connection:
The United States now faces a growing multi-billion dollar military threat from Communist China. You may be surprised to learn that a large portion of that threat is being subsidized in the U.S. bond market - money from U.S. pension funds, insurance companies, and mutual funds.
"Believe it or not, your pension fund could be financing
the military establishment of a potential enemy and investing in an
unstable government that might not honor its obligations.
The Chinese People's Liberation Army is using a speedy route
to raise cash: issue bonds in the United States."
Peter Schweizer
The Hoover Institution
You, Too, May Be Funding China's Army
USA Today
May 14, 1997
Despite a decade of increasing trade relations, the Red Chinese have identified the U.S. as their chief global rival. In 1993, the PLA (People's Liberation Army) published a book for its officer corps entitled, Can the PLA Win The Next War? In that book, the PLA identified the U.S. as its chief adversary. Red China's long-term military aim is to achieve domination of the Asia-Pacific region by controlling the sea lines of communication on which countries like Taiwan, Japan, Thailand, South Korea, and the Philippines depend. And China's number one national priority is to regain control of Taiwan, which it considers a renegade province. In Red China's grand strategy, America represents a threat to their security and their plans to grow stronger and dominate Asia.
To achieve its aims, China is spending massive amounts to modernize its military; they're also stealing and copying whatever they can from the West to build up their military power. Unfortunately, American investors, perhaps even you, are footing the bill for billions of dollars worth of military hardware - weaponry that may be aimed at U.S. forces in the future.
Moreover, thanks to China's lucrative arms export business, other hostile nations may acquire that weaponry also. Red China sells arms of all types, including weapons of mass destruction and delivery systems, to outlaw nations like North Korea, Iran, Iraq, Syria and Libya. For example, the CIA reported that Red China sold missile technology and advanced radar equipment to Iran and that the Chinese had also shipped 400 tons of chemicals used in producing nerve agents to an Iranian chemical plant.
Despite the Chinese espionage activity, military build-up, and proliferation, officials in Washington continue to pursue close relations with Red China as a "strategic partner." (Whatever that means!)
Recently, much attention has been focused on the Cox Commission Report, which detailed the Red Chinese espionage network at work in the U.S. But many Americans do not realize that the Red Chinese threat has been building for several years, despite assurances from officials in Washington and executives on Wall Street that the Red Chinese are our friends.
In 1996 the GAO (General Accounting Office), released a scathing report to the House National Security Committee that said that it was clear that the Chinese military was exploiting technology transfers in violation of specific agreements with the U.S. to modernize its armed forces as quickly as possible. The GAO expressed concern that the U.S. was beginning to sell its edge in military technology to a nation that one day may be an adversary. It also pointed out that the Red Chinese had a disturbing track record of providing nuclear weapons technology, ballistic missiles, and cruise missiles to countries like Iran, Syria, and North Korea. In the 3 years since the report was released, officials in the State Department, Commerce Department, and in the White House have continued to ignore Chinese proliferation and have facilitated dual-use (military/civilian) technology transfers to Red China.
The Money Trail:
Wall Street's Role In The Red Chinese Arms Build-Up
The Center for Security Policy is a non-partisan, non-profit, Washington-based think tank headed up by Frank Gaffney, a former Deputy Secretary of Defense under President Reagan. The Center has been warning the federal government and Wall Street since 1997 that the PLA has penetrated the U.S. securities markets by issuing billions of dollars worth of dollar-denominated bonds in the American market. This borrowing mechanism provides large Chinese government-owned enterprises and banks closely connected with the PLA with access to large amounts of cash-no questions asked.
China has issued at least $10.5 billion in dollar-denominated bonds on the U.S. market, including $800 million from CITIC (China International Trust and Investment Corporation), $2.3 billion from the Bank of China, and $3.2 billion directly in the name of the People's Republic of China.
CITIC is controlled by the Chinese General Staff, which is controlled by the Chinese Military Commission. The chairman of CITIC is Wang Jun. Wang's father, Wang Zheng, was a leader of the hard-line faction that ordered the Tiananmen Square massacre. Wang Jun is also the chairman of Poly Technologies, the arms trading company of the PLA. He has been described as Red China's most notorious arms dealer. He can no longer obtain a visa to enter the U.S. because of allegations that Poly Technologies was involved in efforts to smuggle 2,000 AK-47s to west coast street gangs. Despite this, CITIC has been allowed to raise $800 million on the U.S. bond market and, most incredibly, Wang Jun was invited to a Democratic fund-raising "coffee" at the Clinton White House in 1996!
By issuing bonds in the U.S., Japan, and other western countries, the Chinese military has been given a remarkably efficient mechanism for using American mutual funds, pension funds, insurance companies, and other market participants to help undermine activities that threaten U.S. national security. Through this method, the PLA has access to large sums of cash with no enforcement restrictions on their use.
Furthermore, these Chinese funding arrangements have forged symbiotic relationships between China's military and Wall Street. Now there is a politically and financially powerful constituency in America with a vested financial interest in ensuring that Red China is not subject to future economic sanctions and other forms of international isolation or penalties. In other words, through a growing number of American holders of Red Chinese debt instruments, the Chinese could gain even greater influence in Washington.
It is no accident that former Treasury Secretary Robert Rubin's old firm, Goldman Sachs, had executives appear on CNBC and CNN to discourage retribution against their friends in Beijing after the Cox Commission Report was released. Goldman Sachs has a huge financial stake in Red China; they were the lead manager in at least 2 CITIC U.S. bond issues.
The fact that a corporation with direct links to the PLA could become so closely tied to the American investment industry calls into question whether that industry can be relied upon to help protect U.S. national security interests in the case of foreign bond issues. After all, the corporate leader of Red China's military-industrial complex has been attracting large sums of money from American investors. In this type of environment, U.S. securities markets may be the most attractive funding source for potential adversaries.
What All This Means
Not only does the Red Chinese penetration of the U.S., Japanese, and other free world securities markets pose a threat to our national security, it also poses a threat to individual and institutional investors' portfolios. According to Peter Schweizer, a fellow with Stanford University's Hoover Institution, "These bond sales pose a very real national security problem and could severely undermine the health of any pension funds that invest in them." As many investors learned the hard way with Russia, communist countries can be poor credit risks. Red China views the U.S. as an adversary. They steal our secrets and are building a military force designed to defeat us. At the same time, they are ruled by a ruthless oligarchy with expansionist designs on the rest of Asia. Some sort of political or military conflict with Red China may be inevitable. When and if that happens, the first victims could be American investors who will be left holding billions of dollars of Red Chinese paper as the communists choose to ignore their debt obligations. But, even if the Red Chinese do not default on this debt for political reasons, this paper is suspect for purely economic reasons.
The Chinese economy is plagued with serious structural problems. Chinese exports, investment and retail sales are all falling. Their government, financial and industrial communities are completely intertwined and just as completely corrupt. Moreover, the Chinese banking system is overrun with billions of dollars worth of bad loans. The Economist described China's banks as "unstable and mired in debt." The Chinese financial sector is in bad shape, but the government "cooks the books" to cover up just how serious things are. U.S. pension funds and other investors who hold Chinese bonds could end up holding worthless paper.
If the Chinese default on their debt, it could touch off a new financial crisis in Asia and, if any of your pension plan or mutual funds hold Chinese paper, it could very well affect your financial future.
No Safeguards
Almost unbelievably, there is no national security screening of foreign borrowers in the U.S. bond market. As a result, large sums of money have flowed from U.S. investors directly into Red China's arms build-up. Any money sent to Red China can end up being used in military activities because there is no division between government and business in China. And, next to the Communist Party, the PLA is the most powerful government institution in China.
Clearly, the United States needs to establish market entry procedures for the U.S. bond market with national security in mind.
THE OTHER SIDE OF THE COIN:
Red Chinese Penetration of the U.S. Treasury Market
Despite all the euphoria over the balanced federal budget and even budget surpluses on the horizon, the U.S. remains the world's largest debtor nation. Our national debt stands at more than $5.5 trillion. Foreign investors have rushed to U.S. Treasuries. They have been attracted to Treasuries by a variety of factors, including the strong U.S. dollar and uneasiness in global markets. Foreigners now hold a large portion of U.S. Treasury debt. In the case of Red China, this poses a potential threat to U.S. financial stability.
Foreign ownership of U.S. Treasuries has important possible implications for the U.S. investment markets. When Bill Clinton took office, foreigners held just 20% of our Treasury debt. In fact, throughout the 1970s and 1980s, holdings of Treasury debt accounted for an average of 19% of our outstanding debt. It wasn't until the Clinton presidency that foreigners began their stampede to buy our debt. Today, the number has almost doubled to 38%! Republican Senator Pete Domenici of New Mexico, Chairman of the Senate Budget Committee, warned officials in the Clinton administration when it became apparent that the foreign share of our national debt was growing at an unprecedented rate. The long-term problem is simply that a growing share of U.S. government interest payments is being sent abroad. Domenici called this "an unambiguous loss to American incomes." He went on to say that "continued purchases of Treasuries amounts to mortgaging away our future standard of living a little bit at a time." With America already running a record trade deficit, you would think that the Commerce Department and the Treasury Department would be working with the White House to slow the capital flight down. They're not - probably because Clinton wants foreigners to keep buying our Treasuries to keep interest rates down, so that the economy and the stock market keep rolling along, even at the expense of a skyrocketing trade deficit. After the 2000 election, when the chickens start to come home to roost, it won't matter to Bill Clinton any more.
Some observers have indicated that foreign buying of Treasuries has been largely responsible for low interest rates in this country, and, thus, are an indirect impetus driving the U.S. stock market higher. There are many factors that have contributed to the rise in stock prices over the last several years, but had interest rates been higher than they have been, stocks certainly would not have benefited. For those of you who do not believe that there is any connection between the bull market in stocks and rising foreign ownership of U.S. Treasuries, just take a look at the chart above. There is a 97% correlation between the two lines on the chart.
In the event that foreigners might choose to stop buying U.S. Treasuries, or even to become net sellers of them, the result could be an abrupt end to the bull market in stocks, touched off by a decline in U.S. Treasury prices.
Foreigners could choose to liquidate Treasury positions for economic and/or political reasons. Lest you believe that this scenario seems far-fetched, no less authority than Current Issues in Economics and Finance, published by the Federal Reserve Bank of New York, devoted an entire issue to foreign ownership of U.S. Treasury securities in May 1998. In that issue, author Dorothy Meadow Sobol pointed out the "potential vulnerability of the U.S. financial markets to sudden decisions by foreign holders of U.S. debt to undertake large-scale sales of their dollar assets." The journal went on to explain the sequence of events that such a scenario might touch off:
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If these sales were to take place in a substantial amount,they could drive up U.S. interest rates and have wide-ranging effectson U.S. financial markets. For example, sharp increases in U.S. intrestrates stemming from such sales could significantly raise thecosts of borrowing and investing for U.S. residentas well as the costs incurred by the U.S. government in financing its debt. Any widespread sell-off ofU.S. Treasury securities, of course, could also potentiallydrive down the prices of the remaining Treasury assets held andcause substantial losses on further sales."
Dorothy Meadow Sobol
Foreign Ownership of U.S. Treasury Securities:
What the Data Show and Do Not Show
Current Issues in Economics and Finance
Vol.4 No. 5, May 1998
The Federal Reserve Bank of New York
From 1994 to 1997, the Red Chinese increased their holdings of U.S. Treasuries from $14 billion to $40 billion, making them the 5th largest holder of Treasuries in the world. Then, with the takeover of Hong Kong in 1998, the Chinese instantly became the 3rd largest Treasury-debt holder. At the end of February 1999, the Treasury Department reported that the Chinese now held over $91 billion of U.S. Treasury debt! More ominously, this is probably just the tip of the iceberg. The Chinese probably hold a lot more U.S. debt than the $91 billion that the Treasury Department will admit to. The fact is, according to the New York Fed's Current Issues in Economics and Finance, it is actually impossible for the Treasury Department to know "precisely who owns U.S. Treasury debt and how much of this debt is in foreign hands," because the Treasury's reporting system is designed to record only those capital movements that cross U.S. borders. The Treasury has no way of measuring the huge secondary market that exists overseas between foreign institutions! In other words, foreigners, like the Red Chinese could begin dumping Treasuries overseas and the U.S. Department of the Treasury would not even know it until after it was happening.
Why does this threaten the U.S. economy and your investment portfolio? If the Chinese decided to dump their Treasuries, it would touch off an unprecedented financial crisis in America. Such a scenario could result from conflict with China over a variety of issues:
Chinese aggression toward Taiwan
Chinese espionage activities
Chinese interference in U.S. elections
Chinese aggression in the South China Sea
Chinese proliferation of weapons of mass destruction and ballistic missiles
Conflict on the Korean Peninsula
Chinese anger over the bombing of the Chinese embassy in Belgrade
If Red China sold their large position in our Treasury bonds, the prices of those bonds would decline. When bond prices decline, interest rates go up. Rising interest rates are also bad for the stock market for the following reasons:
Rising interest rates prompt people to pull money out of stocks and put it into short-term, interest-sensitive investments, such as money market funds and CDs.
Higher interest rates squeeze disposable income as credit card payments and mortgage payments go up. This leaves less money to invest in stocks.
Higher interest rates squeeze corporate earnings as revenue from consumers declines and the cost of borrowing money increases at the corporate level. Declining earnings can lead to lower stock prices. If Red China dumps its Treasuries, you will feel it in your pocketbook. Your credit card payments and mortgage payments could rise. The value of your stock and bond holdings will decline. Because your retirement fund will suddenly be worth a lot less, if you are close to retirement, the Red Chinese could be in a position to torpedo your retirement plans! You need to protect your savings with financial insurance.
To be sure, the Chinese might lose money if they dumped their Treasuries, but, just as surely, you can bet that they will not risk losing face on the world stage if they can attack America at such a vulnerable point in the event of a conflict. Moreover, Chinese officials have already alluded to the possibility that their country may want to reduce its exposure to the U.S. Treasury market in the future.
In recent stock market corrections, investors have sought the safety of U.S. Treasury bonds. However, in the event of a correction touched off by a decline in Treasuries, investors would need an alternative safe haven, such as gold. Since gold has historically had a negative correlation to stocks and bonds, it may prove to be the best investment in the event of a conflict-induced Red Chinese sell-off of U.S. Treasuries.
GOLD: THE UNIVERSALLY RECOGNIZED
STORE OF VALUE
For centuries, gold has been treasured for its ornamental appeal and economic value. Emperors, kings, sultans, and sheiks coveted gold as the one secure asset in an unsecure world. As empires fell and the monetary use of other commodities declined, gold proved to be the best guardian of assets--a store of value.
For instance, in the 1970s, Americans invested in gold as protection against inflation. During periods of high inflation and weakness in the U.S. dollar, the value of gold has tended to increase, acting as a "hedge" for dollar-valued investments such as stocks, bonds, and cash. The very forces that weaken traditional investments often cause gold to rise.
Many investment advisors believe that gold should be part of every well-balanced portfolio because, historically, it has been one of the few ways to protect assets from high inflation and economic uncertainty.
What Influences the Price of Gold?
Gold has been referred to as the crisis commodity because it tends to appreciate in value in response to negative economic, monetary, or political conditions. The forces that weaken paper investments usually cause gold to rise:
Rising inflation
Weakness in the U.S. dollar
Rising interest rates
Budget deficits
Oil price shocks
Stock and bond market turmoil
Increases in the money supply
Bank failures
International loan defaults
World tensions
Today sophisticated investors own a variety of investments to provide proper diversification. This often means investing in stock mutual funds, perhaps some bonds or bond funds, and some cash equivalents, such as Treasury bills and money market funds. However, such a portfolio remains incomplete. In order to achieve complete diversification you need to include an investment category that has historically performed well when many other investments are doing poorly. Gold is a good place to invest during bad times.
A "balanced" allocation of stocks and bonds no longer gives a portfolio sufficient diversification. The main reason for this is that the prices of stocks and bonds no longer move reliably in opposite directions. This means that bonds are no longer a good diversifier for a portfolio of stocks and vice versa. Graph 1 demonstrates this trend and also that gold is the most negatively correlated asset with U.S. stocks and bonds. This makes it an excellent diversifier for a portfolio made up of stocks and/or bonds.
Graph 2 illustrates how, from 1970 to 1997, gold predominantly moved in the opposite direction of stocks. In addition, history clearly proves that the price of both equities and gold tends to revert to the mean over the long-term. A crucial question then arises. When will equities move down to their mean, and when will gold move up? Maybe the Red Chinese have the answer.
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