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One of the more interesting stories this week has been reported by Bloomberg. The People's Bank of China is said to stop increasing its foreign currency reserves. What implications will this have? I believe that we'll see the start of a U.S. dollar collapse.

(click to enlarge)
Chart 1: PBOC Balance Sheet

All these years, the Chinese bank had increased its balance sheet up to $3.66 trillion of which $1.3 trillion are U.S. treasuries (Chart 1). This is almost half of the PBOC's balance sheet. Other assets include U.S. agencies, U.S. corporate debt, U.S. equities and other non-U.S. assets (Chart 2).

If the PBOC is going to stop the purchases of foreign currency reserves, this means that they will stop buying the assets above and mainly stop buying U.S. treasuries. That's what it all comes down to. This also means that their excess of U.S. dollars will need to be converted to other assets like the yuan, or even gold. In fact, one of the ideas of China is to prepare the yuan as a reserve currency and I believe this is a first step in that direction. We know that China has amassed a lot of gold, when considering the amount of gold imports from Hong Kong. I believe the PBOC should have added significantly to its gold positions since 2009. The PBOC hasn't reported its gold holdings since 2009 but it is said that they own around 4,000 tonnes of gold right now. Needless to say this will be very bullish for the yuan going forward. If we take a look at the chart of the USD/CNY exchange rate we see that the yuan has already increased a lot. I believe the yuan will continue its ascent. To bank on this trend, investors can buy the WisdomTree Dreyfus Chinese Yuan Fd ETF (NYSEARCA:CYB).

(click to enlarge)
Chart 3: USD/CNY

People are still wondering: "If the Chinese stop supporting U.S. treasuries, why has the U.S. dollar strengthened so much?" Well, reality is that the Chinese have bought many treasuries in the past (Chart 4), but are only now showing their plans to start the unwinding process.

We can already see this "unwinding" in the U.S. bond market as U.S. treasury yields are starting to move up (Chart 5).

Chart 5: U.S. Treasury Yields

As you know, the Chinese own mostly longer dated U.S. treasuries. They will do everything to shorten their maturity and sell the longer dated treasuries. The reason why they do this is that shorter maturities have less price risk. Longer maturities are more volatile and the losses would be greater during a U.S. bond market collapse. While this conversion happens, the U.S. government is eagerly buying up these longer dated treasuries and helping the Chinese to unload. I can't blame the Chinese for doing this. If you look how the Western central banks are increasing their balance sheets (Chart 6) and increasing their debt piles, U.S. treasuries are not a good investment going forward. I believe Quantitative Easing (QE) is never going to end because the unemployment picture is very bad at the moment. We hear from the New York Post that the unemployment rate numbers have been falsified by the U.S. government, so that's even more incentive to have QE to infinity.

I believe the Chinese will diversify from U.S. treasury holdings soon and will buy other depreciated assets. One of these depreciated assets is of course gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV). While these assets are going under the cost of production right now, there is no reason not to buy these. The inflationary prospects are going to start arising in the near future because there are many signs appearing. First off, we see that art prices, real estate and equities have been rising considerably. When all of these capital goods start flowing their earnings into the consumer market, we will start to see consumer inflation. Second, we have seen the capacity utilization rate for the U.S. total industry rise to new highs, this is a sign that inflation is about to rise in the coming years. Third, we see that the average hourly earnings have bottomed out and this will translate into a higher price structure in the economy. And finally, the money supply has continued to rise and eventually all of this extra money will have inflationary effects.


This important event will mark the start of the U.S. dollar collapse as the Chinese will back out of U.S. treasuries. U.S. treasury yields will start to increase and QE will be increased to keep these U.S. treasury yields down. This in turn will accelerate the fall of the U.S. dollar. To play this, investors can buy precious metals or buy Chinese currency ETFs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.