"Andy Xie: "If China loses faith the dollar will collapse"
It's easy for Americans to pooh-pooh bearish talk about the dollar. Yet the sterling was once the reserve currency, and has fallen, what, by 80% since it lost its standing.
With increasingly dubious accounting and lax enforcement, the US capital markets no longer stand out by virtue of being better regulated. Yes, they still may be deeper and more liquid. But overseas buyers have to look hard at foreign exchange risk. The direction for the dollar in the long term is certain to be down. Overextended debtors trash their currencies (see the Great Depression, the Nordic and Swedish banking crises, and the Asian crisis for a few of many examples).
What is interesting about the Xie piece is that even the stalwart Chinese retail investor has become leery of the dollar. Despite th logic of "oh if you sell, you only hurt yourself", the flip side is if you become certain you are indeed holding a depreciating asset, it makes sense to exit. You want to be early, not late, out.
And that logic, if it starts to take hold, in classic run on the bank fashion, could lead to a disorderly fall in the dollar. It isn't clear what the trigger might be, but Bob Shiller contends that sudden flights from markets don't necessarily require an event to kick them off. And given that Willem Buiter, who though fond of colorful writing, is hardly an extremist, foresees a collapse in dollar assets if the US fails to contain its fiscal deficit, talk of a dollar plunge isn't a a radical view.
From the Financial Times:
Emerging economies such as China and Russia are calling for alternatives to the dollar...Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets...Me:
....emerging economies...have amassed nearly $10,000bn (€7,552bn, £6,721bn) in foreign exchange reserves, mostly in dollar assets. Any other country with America’s problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world’s dominant reserve currency. The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse.
The faith of the Chinese in America’s power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar’s global status. Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets....
The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility. The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy ethnic Chinese tend to send their children to the US for education. They treat the dollar as their primary currency.
The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts rather than on dubious spending to prop up the economy. When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. The country’s vast and unexplored natural resource holdings could be auctioned off. Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out.
The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings. Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies. Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.
Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. China’s bulging foreign exchange reserves reflect the lack of private demand for dollars...
America’s policy is pushing China towards developing an alternative financial system. For the past two decades China’s entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar. The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces. This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China’s dual approach to be effective; its inefficiency was masked by bubble-generated global demand.
China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse."
Don said...
"America’s policy is pushing China towards developing an alternative financial system."
China has two main complaints against the US:
1) We're using our currency to help us get out of this crisis
2) We don't guarantee assets, such as bonds
They have already taken numerous steps:
1) Swap lines in their own currency
2) A regional bailout fund
3) Telling everyone that we're unreliable, and it's working
Although we are still a flight to safety port, the flight from agencies to treasuries, from implicit to explicit guarantees, was not a good deal for us. It was a deflationary move of some magnitude, and showed the beginnings of lack of trust in us.
Oddly, Geithner's mocked total guarantee is exactly what the Chinese wanted and expected. China believes that being the economic powerhouse brings with it certain responsibilities. In the Asian Crisis, for example, China believes that it never used its currency for its benefit, or reneged on deals. The Chinese claim that this is acting responsibly, while we, in this crisis, are not.
The threat of defaulting on bonds, loans, especially if we are de facto running or backing these companies, is very irresponsible from the Chinese perspective.
Truly, the Chinese are making headway in this crisis worldwide in portraying us as irresponsible, and not worthy of having the position in the world financial system that we do. It will matter going forward because of foreign investment, and the desire for US goods.
But hey, let's keep telling ourselves that we have the upper hand, right up until the point that we don't. If people don't believe that much of the world blames us for this crisis, they're going to be in for a rude awakening. Solving our crisis at the expense of foreign countries and investors seems a really poor move.
Don the libertarian Democrat
"If China loses faith the dollar will collapse
By Andy Xie
Published: May 4 2009 19:28 | Last updated: May 4 2009 19:28
Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the Federal Reserve’s liberal policy of expanding the money supply to prop up America’s banking system and its over-indebted households. Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves.
The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have amassed nearly $10,000bn (€7,552bn, £6,721bn) in foreign exchange reserves, mostly in dollar assets. Any other country with America’s problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world’s dominant reserve currency. The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse.
The faith of the Chinese in America’s power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar’s global status. Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets. You have to check the asset allocations of wealthy ethnic Chinese to understand the dollar’s unique status.
The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility. The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy ethnic Chinese tend to send their children to the US for education. They treat the dollar as their primary currency.
The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts rather than on dubious spending to prop up the economy. When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. The country’s vast and unexplored natural resource holdings could be auctioned off. Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out.
The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings. Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies. Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.
Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. China’s bulging foreign exchange reserves reflect the lack of private demand for dollars, which was driven by the renminbi’s appreciation. Though this was speculative in nature, it shows the renminbi’s rising credibility and its potential to replace the dollar as the main vehicle of wealth storage for ethnic Chinese.
America’s policy is pushing China towards developing an alternative financial system. For the past two decades China’s entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar. The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces. This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China’s dual approach to be effective; its inefficiency was masked by bubble-generated global demand.
China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.
The writer is an independent economist based in Shanghai and former chief economist for Asia Pacific at Morgan Stanley"
And:
Don said...Walter,
Yes. That's why I said 'believe'. Let me get you the best place that they've argued this:
http://www.pbc.gov.cn/english//detail.asp?col=6500&ID=138
"2. The role and contribution of China, as a responsible big country, in Asian financial crisis
In order to mitigate the impact of Asian financial crisis and help crisis-stricken Asian countries walk out of the plight, then China's Premier Zhu Rongji promised, on behalf of the Chinese government, to the world that the RMB would not depreciate, followed by a series of active measures and policies.
(1) China made vigorous efforts to participate in the IMF's rescue operations to help related Asian countries. After the outbreak of financial crisis, under the arrangement framework of the IMF, the Chinese government provided a total of over US$4 billion assistance to Thailand, as well as export credit and emergency free medicine assistance to Indonesia and other East Asian countries, although China had inadequate foreign exchange reserves at that time.
(2) China actively cooperated with relevant parties to participate in and advance regional cooperation. At the sixth ASEAN informal leaders' meeting, then China's President Jiang Zhemin unveiled three proposals of strengthening regional cooperation to refrain the crisis from spreading, reform and improve international financial system, and respect self-selected measures of relevant countries and areas to overcome financial crisis. At the second informal ASEAN+China, Japan and Korea leaders' meeting and the informal ASEAN+China leaders' meeting, then Vice President Hu Jintao emphasized that East Asian countries should vigorously engage in reform and adjustment of financial system, with the most pressing need to intensify the management and supervision over short-term capital flow. He called on the East Asian countries to strengthen exchange on macroeconomic issues such as financial reform, have dialogue between deputy finance ministers and deputy governors of central bank, and form expert team at appropriate time to launch in-depth research on specific measures on managing short term capital flow. The above measures adopted by the Chinese government received positive response and support from most crisis-stricken countries.
(3) China promised that the RMB would not depreciate. Being a highly responsible country, the Chinese government made the decision of no depreciation of the RMB with an aim of safeguarding regional stability and promoting development, which played a pivotal role in maintaining economic and financial stability of the Asian countries and the world at large, as well as Asian countries' economic recovery and regaining of rapid growth in later years.
(4) China implemented policies to boost domestic demand and stimulate economic growth. While sticking to no depreciation of the RMB, the Chinese government took a wide range of measures to boost domestic demand and stimulate economic growth, which safeguarded health and stability of domestic economic growth, mitigated difficult situation in the Asian economies, and fueled recovery of Asian economy.
The adoption of these measures by the Chinese government embodied that as a part of Asia, China had a full awareness of collective interests and responsibility and has made its due contribution to the rapid recovery and regaining of growth momentum of the Asian economy."
Now, of course, there's something amusing about China saying that it doesn't use currency considerations in its planning. However, they're making a more salient point, which is that they did not use their currency for their own advantage during a crisis.
Bottom line, whether true or not, China is getting very good at playing the capitalist game very fast. They have problems, but, even so, they do make some at least plausible sounding criticisms against the US in this crisis.
Take care,
Don the libertarian Democrat
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