Friday, March 27, 2009

Dollar Dominance and China

The actions in Asia, especially China, must be paid close attention to by the leaders in the US. China is integral to any of our stimulus and bailout plans, because someone must buy the Treasuries we issue to fund these efforts. Few others can help us as much as China.

China currently owns more US denominated debt than any other single entity, in the world. That allows the leaders in the US to think that the Chinese have as much reason as we do to maintain the value of those investments. Since the value of those investments will rise, or fall, on the strength of the US's ability to repay those loans, many here feel that all those that own Treasuries will help save the value of those Treasuries.

This line of thinking includes the presumption that all those that buy Treasuries will hold them to maturity, thus extending the time frame for actions that will prop up the value of those Treasuries. This thinking is also a natural extension of the US and its dollar as the reserve currency for the world. Many of the world's largest transactions, especially in certain commodities such as oil, are mainly conducted in dollars. It is hard for the leaders of the US to see the world differently, for they, as well as all Americans, have enjoyed the benefits of this position since WWII.

Every discussion of global trade, foreign policy initiatives, intervention in markets, you name it, is framed in the unstated understanding the US is the world's leading power and leading economic engine. For decades this underlying truth has been globally assumed for all dialogue and discussion, both public and private. While the world grapples with the growing economic crisis, it looks to the US for solutions. The US, because of our position in the world and the resources at our disposal, will remain at the top for the foreseeable future.

But, our leaders, and more importantly our media, should pay close attention to new ideas from other world leaders. Currently, there are powerful undercurrents to lessen not only the US's position in the world, but to diminish the US Dollar as the reserve currency for the world.

As I wrote a few weeks ago in "Chinese Economists Favor Gold Over US Bonds", more than two-thirds of Chinese Economists favor the central government invest in gold, rather than US Treasuries. That is very revealing, for most of these economists work either directly, or indirectly, for the Chinese government. What they favor must be assumed to be what the Chinese government favors. In comparison, the US is adopting the ideas put forth from its economists to solve the current economic crisis. Should we think the Chinese won't do the same?

If China does what the economists suggest, they won't be buying many US Treasuries in the future, they will use extra surpluses for purchases of gold. That may translate into a bad outcome in the near future sales of US Treasuries. In Britain, the funds needed for stimulus have already been denied. From "U.K. Bond Auction Fails for First Time since 2002";

"March 25 (Bloomberg) -- The U.K. failed to find enough buyers for 1.75 billion pounds ($2.55 billion) of bonds for the first time in almost seven years as debt investors repudiated Prime Minister Gordon Brown’s plan to stem the worst economic crisis in three decades."

"The risk of failed auctions is increasing as governments around the world boost spending to revive their economies after financial institutions incurred more than $1 trillion of losses and writedowns since the start of 2007."

Britain, prior to this failed auction, has said it will sell 146.6 Billion Pounds in debt in 2009 to try to revive its economy. The first 1.75 Billion failed to attract enough buyers. The likelihood they get to their goal of 146.6 Billion Pounds now seems remote. To repeat a line from the above article, "The risk of failed auctions is increasing....". The US has almost quadrupled its debt over the last decade. The reason Britain failed to sell even a small fraction of the bonds it needs for economic recovery is investors feel Britain already has more debt than they can service. How soon will investors feel the same concerning the US?

At this point, the Chinese economists seem to have more faith in gold, than US Treasuries.

There exists a second, and more compelling reason, the Chinese may not buy Treasuries in the near future. It is their desire to topple the US Dollar as the Reserve currency for the world. These same economists, and the central government, are slowly moving to a formal position that the volatility of the dollar, and value of US Treasuries, has them hostage. As long as they hold huge reserves of dollar denominated debt, the value of their investments is subject to the actions of the US government. Throughout Asia, the idea of reliance on the dollar, and safety of US Treasuries, is no longer guaranteed. Thus, it may not be in their best interests to be reliant on either.

The Chinese, as well as the Japanese and Koreans, bought many of the MBS from Wall Street, FNMA and FHLMC. They saw first hand the rapid decline in those investments, some as much as 50%. Convincing them future debt sold by the US will not have the same outcome has now become much harder.

China is now leading the charge to replace the Dollar with the Yuan as the reserve currency for all of Asia. From Jim Willie writing in "Financial Sense";

"A crisis of global confidence in the USDollar is upon us. Foreigners have begun to lose respect for USGovt approach to problem solving, for US bank administration, and for USDollar custodial management. Foreigner creditors have suffered deep losses from fraudulent bond export, continue to sit atop mountains of US$-based debt securities, and watch current events in horror."

"Due to USDollar instability and unreliability, Beijing is introducing a serious currency experiment, in order to aid in the stability of the Asian economy. The Chinese intention seems clearly to decouple both China and Asia from the USDollar and to introduce the yuan as the regional reserve currency."

"This is a very clever economic as well as political plan by China. The plan is a pathway for regional economic stability for Asia, centered finally in China in a monetary sense. China will proceed under the legitimate political cover of their own financial reform toward stabilization. Chinese bank leaders like Zhou Xiaochuan have begun to state publicly some nontrivial arguments about how continuation of the current US$-based global unipolar financial system bears costs and risks that far exceed the benefits........The Chinese are considering a new debt security, which will compete for Asian surplus funds and thus displace the USTreasury Bond. If successful, the Chinese will turn the tables completely, and wear the big currency boot. Chinese sentiment has changed, as has their patience."

Should the US not find a solution soon to the economic crisis, which is radically different from what is currently proposed, expect other nations to proceed on their own. China, as well as many other countries, blame the US for this mess. Since the US has refused to jail those responsible, and, over the last 18 months helped those responsible hide the carnage, China, as well as Russia, Germany, France and Saudi Arabia, have all been very vocal about reducing the US's role in world markets.

This is very bad for the US. Under the current plans, the US must sell several Trillion in US Treasuries over the next two to three years. Since those Treasuries have no physical asset backing them, such as gold, any actions like those described above, will reduce any interest in buyers. At the same time, if China creates its own set of bonds, and auctions them, most Asian countries will purchase those instead of US Treasuries.

For many reasons, the world has changed dramatically over the last decade. Most countries can diminish their anger over the Iraq War. In contrast, they are now willing to take action against the ravages of Wall Street's creative financing.

The US forced the moral argument over the last 50 years to focus on money and wealth. It is that focus that may end our current system as we know it.

1 comment:

Unknown said...

So sad but so true. Very well written.

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