Various other countries, even those not hostile to the U.S., also seek to reduce their their risks by reducing their dollars. Over a year ago Italy, Russia, Sweden and the United Arab Emirates announced they would reduce their dollar holdings slightly. Sweden's 90 % dollar foreign reserve went to 85 %. The UAE said it would convert 8% of its dollar holdings to euros. Friendly Japan, the largest holders of U.S. treasuries, was a net seller of $46 billion in U.S. treasuries in the last 12 months, reducing its holding by 3 % in three years. South Korea sold $19 billion this past year.
U.S. citizens, like foreign governments, have been diversifying out of depreciating dollars. In the last two years, more than 200 internationally focused mutual funds have been launched in the U.S. When the dollar is weak, overseas gains are worth more when translated back into dollars. This is part of the reason these mutual funds gained 16.3 % last year compared with 5.2 % for U.S counterparts. In 2007 more than 95 % of net inflows of money into mutual funds went into internationally focused funds, compared to less than 10 % five years ago. This net outflow of capital adds to the underlying weakness of the dollar: mutual funds and other institutions sell increasing amounts of dollars to buy increasing amounts of currencies in which the foreign stocks are denominated.
An increasingly popular way for governments to diversify out of dollars is through so-called sovereign wealth funds. These are state-owned entities that invest central bank reserves in stocks, real estate, bonds and other financial instruments. They are typically created when central banks have reserves massively in excess of needs for liquidity and foreign exchange.
Back in 1971 the U.S. said foreign governments couldn't exchange their dollars in gold. Now they have been told they can't exchange them for certain other things either. The U.S. prevented the sovereign fund of oil-rich Dubai from buying a company that operates six U.S. ports. It also prevented a Chinese government-controlled company from buying Unocal, an oil company. The Chinese company withdrew its offer of $18.5 billion, “saying it could not overcome resistance from politicians in Washington,” according to the Washington Post.
Countries have to question the value of accumulating a currency they can't spend in the country that issued it. Fortunately for them, the credit crisis gave them another opportunity. Massive losses by U.S. banks and other financial institutions created a need for cash. In January 2008, Citigroup (formerly Citibank), the nation's second largest bank, reported a 4th quarter loss of $18.1 billion, in addition to a $6 billion loss in the third quarter. Merrill Lynch, a 94-year firm that is the world's largest brokerage, reported a 4th quarter loss of almost $10 billion after $16.7 billion in write-downs from subprime mortgages and CDOs. Morgan Stanley reported a $9.4 billion loss for the 4th quarter. UBS reported a 4th quarter loss of $14.45 billion, primarily from U.S. subprime mortgages. Sovereign wealth funds from China, Singapore, South Korea and other nations jumped at the opportunity to buy into these companies. Merrill Lynch obtained $6.6 billion in January from South Korea, Kuwait and Japan and $6.2 billion the previous month from Singapore. UBS received $9.75 billion from Singapore. China now owns 9.9 % of Morgan Stanley.
Mindful of the earlier problems of Dubai and the Chinese attempt to buy Unocal, foreign governments are well aware they may encounter further political obstacles to investing in the U.S., particularly if the current banking crisis abates. In any case, they are looking for other ways of diversifying out of dollars. Think gold. It is something they can buy without any government's permission. It has an unrivaled record of 5,000 years as a store of value. And it surely is more valuable than unredeemable paper currency. Last year Qatar tripled its reserves of gold in one month. That still was a small amount, but what if other countries with far larger dollar reserves start trading them for gold?
For more than a century, South Africa has been the world's leading producer of gold. For most of those years, it produced three-fourths of the world's output. But last year it was in second place. The number one gold producing country in 2007 was.....(are you ready for this?)......China!
Through centuries of political and economic turmoil, people in China and India have hoarded gold and silver jewelry and bars as a means of storing wealth. There were no large, organized markets; prices were determined by the haggling of local buyers and sellers. All that has changed. New opportunities have greatly expanded commerce in gold and made it much more convenient for the public, which has responded with enthusiasm. Investors can now trade in physical gold on the Shanghai Gold Exchange. Some new Chinese gold issues are traded over the internet. On January 9, 2008, China's first gold futures contract was launched, attracting thousands of investors. A spokesman for China International Futures said “about 90 % are individual investors, most of whom were moving assets after turning bearish on the stock markets.” As China's economy grows, people have higher incomes that raise the appetite for gold.
The State Bank of India plans to launch an exchange traded fund (ETF) this year that will enable investors to trade gold like a regular stock. Dubai also hopes to launch an ETF in gold this year. In August, 2007, the Osaka Securities Exchange in Japan began offering a gold-linked bond aimed at smaller investors. In January the Hong Kong Exchanges & Clearing Ltd. announced plans for ETFs and other gold-related investments.
Gold buying in the U.S. used to be a clumsy process. For decades, thanks to President Franklin Roosevelt's prohibition on owning gold, U.S. citizens could not even own the metal except for jewelry and coins classified as collector's items. After gold became legal again, the investment process was small-scale and cumbersome. Investors buying gold coins or bars were faced with varying—and sometimes hefty—commissions plus storage and transportation costs. Investing in gold became more convenient and efficient with the advent of ETFs. These allow investors to buy or sell shares of stock shares tied to the value of the underlying commodity. When people buy shares of stock in such a fund, the fund buys an equivalent amount of gold, which is stored in vaults. When shares are sold, the fund sells an equivalent amount of gold. The ease and simplicity of the process, with the same commissions as for regular stocks, has resulted in investors pouring billions of dollars into these funds on stock exchanges in the U.S., Paris, London, Australia, South Africa, Mexico, Singapore, and some other countries. The most active gold ETF is SPDR Gold Trust, which trades on the New York Stock Exchange. It holds more gold than the European Central Bank or China's Central Bank. Meanwhile, gold futures are trading robustly on the world's most important gold market, the Comex division of the New York Mercantile Exchange, and on the London Metal Exchange. Other gold plays include a five-year gold bullion CD from Everbank Financial, common stocks in gold mining companies, and mutual funds specializing in those stocks.
Both foreign governments and individuals are turning away from the dollar as it loses value. The dollar is in danger of losing its status as a reserve currency. The international monetary system that has existed since the post-World War II Bretton Woods agreement is coming apart at the seams. Recently Bill Gross, CEO of PIMCO, the world's largest bond fund manager, wrote, “What we are witnessing is essentially the breakdown of our modern day banking system.” Vladimir Putin has called for a “new international financial architecture,” a call that resonates with emerging economies such as China, India, Brazil. At an international economic forum in St. Petersburg in June 2007, Putin pointed out, “Fifty years ago, 60 % of world gross domestic product came from the Group of Seven industrial nations. Today 60 % of world GDP comes from outside the G7.” In view of this growing global economic trend, it is hard to see the current monetary system enduring when the linchpin of that system, the U.S. dollar, is continually undermined by the inflationary policies of its own government.
Regarding a recent hint from China about dumping a portion of its dollars, Judy Shelton, Ph.D., a professor of international finance and author of books and articles on monetary issues, said: “The prospect of such a shock to the U.S. economy in the midst of a housing slump threatens to bring the whole edifice crashing down. Throw in statements of support from oil-producers Venezuela and Iran, and you have the makings of a devastating dollar rout.” Incidentally, last July Japan agreed to pay for its oil imports from Iran in yen rather than dollars.
Even if China does not dump its U.S. treasuries on the market any time soon, the longer term outlook for the dollar is still bleak. It seems unlikely any of the trends that brought us to this point will reverse; more likely, they will worsen. Earlier I mentioned that the U.S. national debt is now $9 trillion. But that does not include unfunded Social Security, Medicaid and similar obligations. If those are included, the debt is $59 trillion. There is no way those future bills can be paid in terms of current dollars. As a “solution,” future administrations will simply employ larger doses of the same inflationary measures that created the problem. Because of structural changes in our government many years ago, which I discuss at some length in my book Makers and Takers, the system has evolved to favor the politicians who spend more and promise more. “A lot of people, including me,” said Paul Volcker, former chairman of the Federal Reserve, “have been saying that the country has been spending more than it's been producing, and that will have to come to an end. The question is: Does it come to an end with a bang or a whimper?”
The attempt to kick the problem down the road to the next generation and let them pay off future obligations with trillions of dollars worth a fraction of today's dollars will no longer work. As the dollar loses its stature as a reserve currency, as countries one by one defect from their formal links to the dollar, as U.S. dollars pile up abroad from financing our deficits, and as our borrowing becomes increasingly expensive, the monetary framework becomes ever more fragile. The danger of creating a run from the dollar could easily snowball like the run to gold prior to Nixon's action in 1971. The dollar may survive this crisis, or the next one, but there will always be one more, to which the U.S. will be more vulnerable than to the previous ones. Long before that $59 trillion debt comes due, the dollar will have lost too much value to be trusted any more. The end will not come with a whimper.
Edmund Contoski is the author of MAKERS AND TAKERS: How Wealth and Progress Are Made and How They Are Taken Away or Prevented (American Liberty Publishers, 1997). www.amlibpub.com
Wednesday, August 27, 2008
Saturday, August 23, 2008
Mortgage Crisis, the Dollar and its Future, Part 3
The Fed, of course, hopes to pick the optimum rate for increasing the money supply, but it will always prefer to err on the side of being a little too loose rather than a little too tight. Everyone on the Fed board is aware of the role of tight money during the Great Depression and wants to avoid a similar outcome at all costs. The danger of just a little more inflation will always seem preferable to the risk that an economic correction will slide dangerously further than expected. The latter can pose a far more difficult problem for the Fed. The leverage which was so attractive to investments on the upside now works in reverse, accelerating the decline. Sharp losses in the stock market, real estate and elsewhere can be wipe out assets rapidly on a colossal scale that monetary policy cannot quickly replace. Moreover, the Fed can make credit available, but it can't make people use it. It's actions have been compared to “pushing on a string.” People have to want to “pull” on the available credit for the Fed policy to have effect. When an economy gets so bad that pessimism pervades society, businesses are afraid to hire new workers or invest in plant or equipment, and consumers are afraid to spend. Then central bank policies are ineffective. A case in point is Japan after the collapse of its stock market in 1989. During the 1990s, even an interest rate as low as zero couldn't revive the economy. The country still has still not fully recovered. Its stock market (Nikkei Index) is barely one-third of its peak in 1989. Trillions of dollars (or yen) of assets were wiped out that have never been recouped.
Another factor favoring continued inflation in the U.S. is the growing national debt, which has accelerated wildly under President George W. Bush. Congress increased the debt limit five times since he took office in January 2001. At that time, the national debt stood at $5.6 trillion. Now it is $9 trillion. The $3.865 trillion increase is the largest of any administration ever, despite the fact he ran for office as an economic conservative.
A growing portion of our national debt is held by foreigners, particularly foreign governments. Foreign investors own only about 13 percent of U.S. equities but 44 percent of U.S. Treasury debt. And it is likely to get worse. As Peter Orzag, director of the nonpartisan Congressional Budget Office, recently testified on Capitol Hill, “Under any plausible scenario, the federal budget is on an unsustainable path—that is, federal debt will grow much faster than the economy over the long run.”
Our government finances its deficits by auctions of U.S. Treasury securities. It deposits the proceeds from the sale of the securities into it own checking account, against which it writes checks for employee salaries, federal contracts, government grants, goods and services.. The recipients of these checks deposit them in their own accounts at commercial banks. Those banks then are required to set aside a percentage (currently 10 %) as a reserve—but can loan out the remaining 90 %. For example, if someone receives a government check for $1,000 and deposits it in his bank account, his bank sets aside $100 as the required reserve and can then loan out the other $900. When someone else borrows that $900 and deposits it in his account, his bank sets aside $90 and loans out $810. The next time around, the amount loaned out will be $729. The cycle repeats until there is nothing left to loan. At that point it will be seen that the total amount of deposits is $10,000, which consists of the original $1,000 plus $9,000 in credit created by the banks. That's how the increase to our money supply can be ten times the amount borrowed to finance our debt. Is it any wonder we have price inflation?
It should be noted that the ten-fold increase in the above example increases the money supply only when treasury securities are purchased by foreigners. If those securities are purchased by Americans, no new credit is created, because the money that the government receives has already been part of the U.S. money supply; it is simply transferred from the private sector to the government, with the multiplier being the same for both. But when foreigners buy treasury securities, the proceeds are added to the previous money supply.
In 1971 President Nixon severed the last link between the dollar and gold by declaring that the U.S. government would no longer allow foreign central banks to redeem their dollars in gold. Prior to this, the dollar had been a “reserve currency” because of its gold convertibility, and foreign banks held their reserves in both dollars and gold. But as they accumulated more and more dollars, they knew the U.S. had nowhere near enough gold to back the outstanding dollars. So they wanted to get gold while they could. The U.S. paid out several billion dollars in gold but could not stem the tide of demands. It was obvious that further redemptions would soon exhaust our reserves. So Nixon simply declared that no more gold would be paid out.
The system of fixed exchange rates broke down, and currencies were set free to float against each other. But the dollar was still a reserve currency. Central banks had large quantities of them, and have been accumulating more. More than 60 % of foreign exchange reserves are still kept in U.S. dollars, which have been losing value rapidly. Priced against a basket of major currencies, the U.S. dollar has lost 38 % of its value in the last six and a half years. It lost 7.5 percent in 2007 alone. It lost 17 % last year against the Canadian dollar, falling to its lowest level in well over a century, and nearly 17 % against the Brazilian currency. It lost more than 10 % last year against the Turkish, Thai, and Indian currencies. And it lost 9.5 % last year against the euro, the common currency of 15 countries in the European Union. At one point in 2000, a dollar would buy 1.176 euros; now only .6250, a decline of more than 47 %.
Foreign governments are alarmed that the large and growing percentage of their monetary assets in dollars is rapidly losing value. They have been buying U.S. treasury securities, for which they collect interest, but the interest is clearly no longer keeping pace with the loss of value in the currency. So they are looking to reduce their risk and diversifying into assets that will better retain their value.
It is the oil-producing countries and China, with its rapidly growing economy, that find themselves with mountains of dollar reserves. The Persian Gulf nations originally pegged their currencies to the dollar to stabilize oil revenues, because oil was priced in dollars. But this forces them to accept U.S. inflation and monetary stimulus. It also makes their imports from countries with stronger currencies more expensive. Now the Fed is cutting interest rates to fight the slowdown in the U.S. economy. This policy is exactly opposite to the interests of the oil producers who are fighting inflation and overheated economies. An official spokesman for Qatar has stated that pegging its currency to the dollar has “many disadvantages, especially if that country adopts monetary policies that clash with ours." In November, Nasser al-Sulweidi, governor of the United Arab Emirates central bank, while acknowledging that the dollar peg has “served the economy...very well in the past” ended by saying: “However, we have reached a crossroads.” Kuwait severed its peg with the dollar in May 2007, linking it instead to a basket of currencies. Since then, its currency has strengthened about 5 % compared to the dollar.
Since oil is priced in dollars, the depreciating value of the dollar gives oil-exporting countries an incentive to try to keep oil prices high, by restricting production, to avoid eroding their own purchasing power. It also gives them another incentive to move away from the dollar, with the euro being the most attractive currency for pricing oil. Beginning in 2003, the oil price tripled in U.S. dollars but only a little more than doubled in euros.
Thus far Saudi Arabia, though it is struggling with inflation, has said it will retain its link to the dollar. Its foreign minister, Saud al-Faisal, said such a move would damage the U.S. economy. Other countries, however, are not so considerate of U.S. interests, because they do not have the long relationship that Saudi Arabia has with the U.S., which includes military protection. Russian President Putin, who has visions of restoring his country to its former stature as a world power, would be only too happy to advance his ambitions at the expense of the U.S. He would like to see the ruble become a global currency and has expressed interest in a Russian stock exchange pricing oil and gas in rubles. That is not realistic now—though Russia is the world's second largest exporter of oil—but in 2005 he severed the ruble's link to the dollar and aligned it with the euro.
Russia has $475 billion in reserves, but China has $1.7 trillion, with which it could do a lot of damage to the U.S. dollar if it so chose. Deng Xiaoping, who turned China away from Mao's communism, urged the country to “bide time” and “seek cooperation and avoid confrontation.” His successor Jiang Zemin had big ambitions for his country, but he continued Deng's approach because he saw the benefits of cooperation with the U.S. and its allies. Current President Hu Jintao has changed directions. In the words of China scholar G.G. Chang, he “appears to see his country working against the U.S.” (italics Chang's). Last year China refused to provide shelter for two U.S. minesweepers seeking refuge from a storm. In November, a long-arranged port call for the carrier Kitty Hawk was denied at the last minute. A routine flight to resupply the American consulate in Hong Kong was denied. Veteran China analyst Willy Lam has noted that Mr. Hu and the party leadership structure have decided “to make a clean break with Deng's cautious axioms and, instead, embark on a path of high-profile force projection.”
In October 2006 a Chinese submarine surfaced for the first time in the middle of an American carrier group. In January 2007, China “in an unmistakable display of military power,” said Chang, “destroyed one of China's old weather satellites with a ground-based missile.” Its military exercises last August “were remarkable in scope and sophistication” and were “apparently rehearsals to take Taiwan and disputed islands in the South China Sea.” Hong Yuan, a military strategist at the Chinese Academy of Social Sciences, says China's new posture shows it intends to project force in areas “way beyond the Taiwan Strait.”
So don't expect China to do us any favors in regard to the U.S. dollar. It will use its dollars against the U.S. when it considers it most advantageous to do so. It continues to fund our deficits by buying U.S. treasury securities because actions destructive to the dollar would also be destructive to its own hoard of dollars. That hoard, however, continues to lose value anyway because of U.S. inflation. As the value of the dollar continues to slide, not only China but other countries, too, will demand higher interest rates on U.S. treasuries to compensate for inflation. Those rates, in turn, will slow the growth of the U.S. economy, making us more dependent on foreign financing of our debt and at odds with our own monetary objectives for economic growth. As China's mountain of dollars grows, it becomes an ever more potent weapon to use against the U.S. at some future date. Meanwhile, China also seeks to mitigate its own growing risk by diversifying out of dollars.
To be concluded.
Another factor favoring continued inflation in the U.S. is the growing national debt, which has accelerated wildly under President George W. Bush. Congress increased the debt limit five times since he took office in January 2001. At that time, the national debt stood at $5.6 trillion. Now it is $9 trillion. The $3.865 trillion increase is the largest of any administration ever, despite the fact he ran for office as an economic conservative.
A growing portion of our national debt is held by foreigners, particularly foreign governments. Foreign investors own only about 13 percent of U.S. equities but 44 percent of U.S. Treasury debt. And it is likely to get worse. As Peter Orzag, director of the nonpartisan Congressional Budget Office, recently testified on Capitol Hill, “Under any plausible scenario, the federal budget is on an unsustainable path—that is, federal debt will grow much faster than the economy over the long run.”
Our government finances its deficits by auctions of U.S. Treasury securities. It deposits the proceeds from the sale of the securities into it own checking account, against which it writes checks for employee salaries, federal contracts, government grants, goods and services.. The recipients of these checks deposit them in their own accounts at commercial banks. Those banks then are required to set aside a percentage (currently 10 %) as a reserve—but can loan out the remaining 90 %. For example, if someone receives a government check for $1,000 and deposits it in his bank account, his bank sets aside $100 as the required reserve and can then loan out the other $900. When someone else borrows that $900 and deposits it in his account, his bank sets aside $90 and loans out $810. The next time around, the amount loaned out will be $729. The cycle repeats until there is nothing left to loan. At that point it will be seen that the total amount of deposits is $10,000, which consists of the original $1,000 plus $9,000 in credit created by the banks. That's how the increase to our money supply can be ten times the amount borrowed to finance our debt. Is it any wonder we have price inflation?
It should be noted that the ten-fold increase in the above example increases the money supply only when treasury securities are purchased by foreigners. If those securities are purchased by Americans, no new credit is created, because the money that the government receives has already been part of the U.S. money supply; it is simply transferred from the private sector to the government, with the multiplier being the same for both. But when foreigners buy treasury securities, the proceeds are added to the previous money supply.
In 1971 President Nixon severed the last link between the dollar and gold by declaring that the U.S. government would no longer allow foreign central banks to redeem their dollars in gold. Prior to this, the dollar had been a “reserve currency” because of its gold convertibility, and foreign banks held their reserves in both dollars and gold. But as they accumulated more and more dollars, they knew the U.S. had nowhere near enough gold to back the outstanding dollars. So they wanted to get gold while they could. The U.S. paid out several billion dollars in gold but could not stem the tide of demands. It was obvious that further redemptions would soon exhaust our reserves. So Nixon simply declared that no more gold would be paid out.
The system of fixed exchange rates broke down, and currencies were set free to float against each other. But the dollar was still a reserve currency. Central banks had large quantities of them, and have been accumulating more. More than 60 % of foreign exchange reserves are still kept in U.S. dollars, which have been losing value rapidly. Priced against a basket of major currencies, the U.S. dollar has lost 38 % of its value in the last six and a half years. It lost 7.5 percent in 2007 alone. It lost 17 % last year against the Canadian dollar, falling to its lowest level in well over a century, and nearly 17 % against the Brazilian currency. It lost more than 10 % last year against the Turkish, Thai, and Indian currencies. And it lost 9.5 % last year against the euro, the common currency of 15 countries in the European Union. At one point in 2000, a dollar would buy 1.176 euros; now only .6250, a decline of more than 47 %.
Foreign governments are alarmed that the large and growing percentage of their monetary assets in dollars is rapidly losing value. They have been buying U.S. treasury securities, for which they collect interest, but the interest is clearly no longer keeping pace with the loss of value in the currency. So they are looking to reduce their risk and diversifying into assets that will better retain their value.
It is the oil-producing countries and China, with its rapidly growing economy, that find themselves with mountains of dollar reserves. The Persian Gulf nations originally pegged their currencies to the dollar to stabilize oil revenues, because oil was priced in dollars. But this forces them to accept U.S. inflation and monetary stimulus. It also makes their imports from countries with stronger currencies more expensive. Now the Fed is cutting interest rates to fight the slowdown in the U.S. economy. This policy is exactly opposite to the interests of the oil producers who are fighting inflation and overheated economies. An official spokesman for Qatar has stated that pegging its currency to the dollar has “many disadvantages, especially if that country adopts monetary policies that clash with ours." In November, Nasser al-Sulweidi, governor of the United Arab Emirates central bank, while acknowledging that the dollar peg has “served the economy...very well in the past” ended by saying: “However, we have reached a crossroads.” Kuwait severed its peg with the dollar in May 2007, linking it instead to a basket of currencies. Since then, its currency has strengthened about 5 % compared to the dollar.
Since oil is priced in dollars, the depreciating value of the dollar gives oil-exporting countries an incentive to try to keep oil prices high, by restricting production, to avoid eroding their own purchasing power. It also gives them another incentive to move away from the dollar, with the euro being the most attractive currency for pricing oil. Beginning in 2003, the oil price tripled in U.S. dollars but only a little more than doubled in euros.
Thus far Saudi Arabia, though it is struggling with inflation, has said it will retain its link to the dollar. Its foreign minister, Saud al-Faisal, said such a move would damage the U.S. economy. Other countries, however, are not so considerate of U.S. interests, because they do not have the long relationship that Saudi Arabia has with the U.S., which includes military protection. Russian President Putin, who has visions of restoring his country to its former stature as a world power, would be only too happy to advance his ambitions at the expense of the U.S. He would like to see the ruble become a global currency and has expressed interest in a Russian stock exchange pricing oil and gas in rubles. That is not realistic now—though Russia is the world's second largest exporter of oil—but in 2005 he severed the ruble's link to the dollar and aligned it with the euro.
Russia has $475 billion in reserves, but China has $1.7 trillion, with which it could do a lot of damage to the U.S. dollar if it so chose. Deng Xiaoping, who turned China away from Mao's communism, urged the country to “bide time” and “seek cooperation and avoid confrontation.” His successor Jiang Zemin had big ambitions for his country, but he continued Deng's approach because he saw the benefits of cooperation with the U.S. and its allies. Current President Hu Jintao has changed directions. In the words of China scholar G.G. Chang, he “appears to see his country working against the U.S.” (italics Chang's). Last year China refused to provide shelter for two U.S. minesweepers seeking refuge from a storm. In November, a long-arranged port call for the carrier Kitty Hawk was denied at the last minute. A routine flight to resupply the American consulate in Hong Kong was denied. Veteran China analyst Willy Lam has noted that Mr. Hu and the party leadership structure have decided “to make a clean break with Deng's cautious axioms and, instead, embark on a path of high-profile force projection.”
In October 2006 a Chinese submarine surfaced for the first time in the middle of an American carrier group. In January 2007, China “in an unmistakable display of military power,” said Chang, “destroyed one of China's old weather satellites with a ground-based missile.” Its military exercises last August “were remarkable in scope and sophistication” and were “apparently rehearsals to take Taiwan and disputed islands in the South China Sea.” Hong Yuan, a military strategist at the Chinese Academy of Social Sciences, says China's new posture shows it intends to project force in areas “way beyond the Taiwan Strait.”
So don't expect China to do us any favors in regard to the U.S. dollar. It will use its dollars against the U.S. when it considers it most advantageous to do so. It continues to fund our deficits by buying U.S. treasury securities because actions destructive to the dollar would also be destructive to its own hoard of dollars. That hoard, however, continues to lose value anyway because of U.S. inflation. As the value of the dollar continues to slide, not only China but other countries, too, will demand higher interest rates on U.S. treasuries to compensate for inflation. Those rates, in turn, will slow the growth of the U.S. economy, making us more dependent on foreign financing of our debt and at odds with our own monetary objectives for economic growth. As China's mountain of dollars grows, it becomes an ever more potent weapon to use against the U.S. at some future date. Meanwhile, China also seeks to mitigate its own growing risk by diversifying out of dollars.
To be concluded.
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