Wanna Be A Miner?

Now being stuck for sixty-nine days in a cramped, dank cave with thirty-two other sweaty men is probably not what anyone wishes for. However the exhilaration and joy of emerging into the fresh air probably was the sweetest breath taken for each of the famed Chilean miners. It also doesn’t hurt that they have a movie deal, various endorsements and designated hero status in pretty much every country around the world – except maybe North Korea where being kept underground is a form of punishment like everything else. In short, after more than two months of hell, the miners are consuming the most precious of all US exports – the American Dream. Good for them.

We live in a world of interconnected imbalances. Helped by rapid advances in broadband communications, the world has begun to resemble the Net itself – nodes and branches. The interconnections are everywhere. For example, the US depends on India for cheap customer service, and in turn India depends on the US for routers and other gear. The imbalance is driven by the US net trade balance relative to overall world trade. Or more simply, the US imports significantly more than it exports - so much more in fact that roughly half of the total trade surplus generated by countries running a surplus is generated from the US.



When a country runs large trade balances it is generating foreign currency. In today’s world this is seen in the large dollar reserves held by the world’s central banks most notably China. Once a country obtains the currency, they have to decide what do with it. They can leave it in cash (dollars), use the dollars to buy an asset, or convert the dollars to another currency. Since cash pays no interest, most holders of dollar reserves have elected to buy high quality US government guaranteed obligations or Treasuries. By doing this they earn a slight interest rate and maintain their reserves in dollars.

Dollar reserve accumulation has been the trend for many years as evidenced by the persistent negative US trade balances. Since dollars have been viewed as the preferred global reserve currency post WWII, central banks have been willing to accumulate them.



Many headlines predict catastrophe by the large foreign exchange reserves held by China worried that the US is being “bought”. This is the wrong way to think of it. The US is not like a corporation; there would be no bankruptcy, foreclosure or liquidation of the US in any circumstance. The country in a precarious position is China. They hold large amounts of US debt that is backed only by the US promise to pay (ie, “full faith and credit”). Remember if they want to change their holdings out of dollars, they have to sell the bonds and then convert the currency. But how can they do this? At $2.5 trillion, China cannot easily sell. Selling the Treasuries may be the easiest of the actions as the Fed is a committed buyer. What about converting out of the dollars? What would they buy and how much could they buy?

As a thought experiment, let’s assume they wanted to allocate 10% of their dollar reserves (assume $200bn) to another currency. If it’s the euro or yen, this can likely be done with minimal market impact over several weeks. But the euro and yen have their own issues. The euro is plagued by sovereign credit concerns and the yen is facing its own structural issues, so these may not be the best options. There are smaller currencies that may be better bets such as the Swiss Franc or Singapore Dollar, but these are too small to allow any meaningful percentage.

What about gold? How easy would it be to buy $200bn of gold? At a price, $1400/oz they would need to buy about 143mm ounces or 4400 tons. Given the annual production of gold is less than 3000 tons, this volume would be impossible. The same would hold true for almost every other store of value.

Adding to their woes, they are growing their reserve position by over 10% every year. When you add the fact that most of the world’s resources are owned, controlled or influenced by the West, you arrive at the simple conclusion that China cannot get out of their reserve position!

What is likely is that spurred by their ever increasing position and the new willingness by the US to debase the currency (ie., Bernanke’s QE2), China will become more aggressive in securing non-dollar assets such as mines, pipelines, ships, gold, silver and other goods in regions where the US has less sway (ie., Africa, Cuba, South America, Russia). China will also take a longer term approach to diversification and this will be supportive to commodity prices globally. The dual forces of continued development in emerging markets and the need to diversify reserves may bring about a commodity price boom that we have not seen in history.

Higher commodity prices will create the incentive to produce and extract more resources and this will have ripple effects on the demand for equipment, labor and logistics – which brings me back to wanting to be a miner. Chile with its massive copper reserves will likely be the preferred destination for Chinese delegates for a long time. Even with the risks, being a miner wouldn’t be so bad.