Why China Can’t Divorce the Dollar

Friday, October 16th, 2009

Yesterday, we discussed the hype about the imminent death of the US dollar that is bubbling up these days, that is sending the Canadian dollar to parity, stocks and gold to new highs, and lifting commodity prices in general. In his FT.com column, Martin Wolf contends that it is the success of American economic policy that is sinking the dollar, and on the subject of China says:

Relevant policy is made by the Federal Reserve, which has no mandate to preserve the dollar’s external value. The only way China’s policymakers can preserve the domestic value of external holdings is to support the dollar without limit, which compromises China’s domestic monetary stability and will prove self-defeating in the end.

Wolf’s thesis is that the zeroing out of interest rates and re-liquidification of the US economy in the face of the credit crisis has crowded investors, both domestic and foreign, out of money market instruments and short term treasuries, into risk assets for yield or growth. It is the crowding out that has proven to be a success for the market and, as consequence, the devaluation of the greenback.

This presents short-term problems for China and its export recovery, but it is not yet time for China to deal with the advent of divorce from the US dollar as a reserve currency.

Mark Gimien, says China is not about to stop propping up the dollar, because in the meantime, the value of the RMB is rising, making its exports more expensive.

The dollar-renminbi trade is a perfect case study in being careful what you wish for. Though American exporters complain about an undervalued renminbi, China’s currency management turns out to have some enormous advantages for the American economy. China’s voracious demand for dollars—and the Treasury bonds to sink those dollars into—is a key reason why the U.S. government can borrow cheaply and keep U.S. interest rates low.

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For a while now, economists have wondered when China will tire of lending cheaply to the U.S. government. The longer the process continues, the more China stands to lose over the long run; China is effectively propping up the dollar, and, thanks to its enormous holdings of Treasury bonds, gets left holding the proverbial bag when the dollar falls in value—as it already has in relation to the euro. Eventually, the thinking among economists goes, China will tire of getting rock-bottom interest on U.S. Treasuries while watching the value of its dollar-hoard shrink. This is why people like Ferguson and New York University economist Nouriel Roubini—one of the more prescient (and pessimistic) observers of the meltdown—are predicting an economic divorce between the two massive trading partners.

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So should we be worried? In the long run, yes—but we probably won’t see a massive and sudden catastrophe. China does want to disentangle itself from its reliance on the dollar. To do that, though, it also has to decrease its reliance on exports to the United States. That won’t happen overnight. As bad as the financial meltdown has been for the United States, it has been even worse for much of the rest of the world. The United States is the world’s consumer of last (and, well, first, too) resort, so the irony of American economic problems is that, as an oft-repeated adage has it, a U.S. sneeze tends to cause pneumonia in its trade partners.

One of the key economic memes of the past years has been the emergence of a robust Chinese consumer middle class. It is absolutely true that China’s middle class and its domestic consumption have both grown dramatically. Even in this economic climate, Chinese retail sales are up by double digit percentages. China remains, however, an export-led economy.

Another question to ponder from the domestic China perspective is one of confidence. How confident would the Chinese be in their own currency if it were not pegged to the US dollar?

When you cut through all of the noise surrounding the fate of the dollar, and look at the economic probabilities, the conclusion you can make is that China and the world for that matter have got far more incentive at the hinge of our economic crisis to do their respective parts to defend balance, not as a favour or whim, but as a matter of economic continuity. China’s best move is a smoother and longer term transition to independence from its symbiotic co-existence with the US dollar economy.

A US/China divorce is many years away, a long term proposition at worst. The more important issues in the present still rest on how monetary authorities will rebalance currency valuations, and that ultimately will slow or reverse the flow of liquidity out of the dollar. A reversal in the dollar’s decline would be negative for equity markets and other risk assets in the short term.

Tags: American Economic Policy, American Economy, American Exporters, Canada, Canadian Dollar, China, China Currency, Commodities, Commodity Prices, Credit Crisis, Currency Management, Devaluation, Economist Nouriel Roubini, Economy China, Emerging Markets, Enormous Advantages, Export Recovery, Federal Reserve, Gold, Greenback, Hype, Imminent Death, Mandate, Martin Wolf, Meltdown, Monetary Stability, Money Market Instruments, New Highs, New York University, Parity, Policymakers, Relevant Policy, Reserve Currency, RMB, Rock Bottom, Treasuries, Treasury Bonds
Posted in Gold, Markets | No Comments »

FRONTLINE: Inside the Meltdown (PBS)

Tuesday, February 17th, 2009

On Thursday, Sept. 18, 2008, the astonished leadership of the U.S. Congress was told in a private session by the chairman of the Federal Reserve that the American economy was in grave danger of a complete meltdown within a matter of days. “There was literally a pause in that room where the oxygen left,” says Sen. Christopher Dodd (D-Conn.).

In case you missed PBS’ ”Inside the Meltdown,” aired tonight, February 17, 2009 at 9:00am, it is an in-depth 1-hour program detailing the breakdown of the financial system over the last year. Its very well done, and provides some valuable insight into the credit and financial markets meltdown we have experienced during the course of the last year. Click play to view:

Hover over the dots next to the clock for the story chapters.

Tags: American Economy, Chairman Of The Federal Reserve, Christopher Dodd, Clock, Complete Meltdown, Congress, Conn, Dots, February 17, Federal Reserve, Financial Markets, Frontline Pbs, Grave Danger, Insight, Leadership, Oxygen, Pbs, Pbs Org, Private Session, Story Chapters
Posted in Credit Markets, Economy, Markets | 2 Comments »

Jim Rogers: Outlook for 2009

Monday, December 29th, 2008

Jim Rogers speaks candidly with Bloomberg (December 23, 2008) about his outlook for 2009.

• The American economy will likely be the worst since World War II.
• Policy mistakes could precipitate a depression, as in 1929, when policy makers made horrendous mistakes. Politicians are getting in on the action today as they did then, so its possible to have a depression in this period.
  • “I’m negatively impressed by what I see this time. Its unfathomable what they’re (central bankers and politicians) doing. You would think that some of them had read history, or interpreted history properly.”
• Pres. Obama has made his platform to (1) tax capital and (2) protect America.
  • “This is a world that is short of capital…what a genius.”
  • “Protectionism led to the Great Depression.”
  • “If that happens (taxing capital and protectionism) its all over.”
• In 1918, The UK was the richest country in the world; by 1939, it was a shambles; Exchange controls, the economy was a wreck; it was a horrible period.
  • “The same thing is in the process of happening in America and if America continues to make mistakes, you’re going to see that quick a transition.”
• I moved to Asia because I see enormous opportunities there, and I’ve got my two little girls who I want to grow up speaking Chinese and grow up knowing Asia as well as they know America.
  • I’m convinced that China is going to be the great country of the 21st century.
  • I want to prepare my little girls for that; I don’t see how America is going to become the great country of the 21st century again.
• The (biggest issue) right now is that “the American government is printing gigantic amounts of money right now and that in the end is going to be the worst problem.
  • They’re propping everyone up everybody in sight; throughout history, when you’ve printed that much money its led to inflation, and in some cases runaway inflation.
  • I think in the end, the credit problem is not going to be the serious problem.
• Its too bad the American government would not let people fail.
  • The big problem is (a) that they have not let people fail, and (b) they’re printing money to try to solve the problem.

Regarding Commodities:

• The facts are, during this period in time the only thing to have its fundamentals unimpaired is commodities.
  • Farmers can’t even get loans for fertilizer now.
  • The supply of things is going to be in even worse shape coming out of this.
  • The IEA recently came out with a study showing that the worlds reserves of oil are declining at the rate of 7% per year.
  • you can do the arithmetic, the supply of everything is going down; oil and everything else;
  • we’re going to have serious supply problems before too much longer.

• The fundamentals for General Motors are impaired, the fundamentals for Bank of America are impaired.
• The fundamentals for Zinc are improving, the fundamentals for cotton are improved
  • Commodities will be the place to be if and when we come out of this crisis, but even if we don’t come out of it
  • In the 1970’s the economies were bad, but commodities went through the roof.
  • In the 1930’s commodities were a much better place to be than stocks, because there was no supply.
• I own some Gold, if gold goes down I’ll buy some more, if gold goes up, I’ll buy some more.
  • Gold will probably go much higher
  • I think I’ll make more money in Agriculture for a while, but I own some gold.
• Platinum is more industrial, and certainly tied closely to the Auto industry; I own some, but not a lot, but when its time to buy Automobiles again, Platinum will be a spectacular play.
  • There are shortages, and then demand will suddenly come racing back, and there won’t be any inventories left; this is how economies have always evolved.

His ideas:

• I’m the worlds worst market timer so don’t ask me for the timing of all of this - but we do know that people are closing mines; we do know that the cost of producing Zinc is below the cost of production now,
  • Things can stay below the cost of production for a while, because often it costs more to close a mine than to keep it running at a loss, but eventually, you will have less supply of everything, and you’re certainly not going to have any new mines opened in the next several years because the economics of opening a mine are out the window now, and it takes ten years to bring a mine on stream,
  • The supply and reserves are going down so you’re not going to have nay new mines coming on stream
• I have not sold any of my metals since the commodities bull market began.
  • I was short Fannie Mae, short Citibank, still am short the investment banks.
  • My way of investing is: I try to be long the good things where the fundamentals are improving, and short the things where the fundamentals are deteriorating. That’s the way I invest and always have.
  • Rogers is not buying any specific metals
  • Buys his own indices to avoid conflicts
• The best way for investors to invest in commodities is through ETFs or ETNs or indexes. These are the best ways to invest in anything else.
• I amass things for as long as like them and would own them forever if possible, so long as the fundamentals are there.
• Covered many of his short positions in the US stock market in October.
• Has recently been buying more commodities (which he started buying ten years ago), China, Taiwan, and the Yen. For metals, he’s been buying the Rogers Metals Index, and gold coins.

• Oil is crushed, its below the cost of production in many places, its below the cost of alternate sources of energy, so oil is going to make a huge comeback when it does. The IEA conducted a massive study of the world’s oil fields and concluded that oil reserves are declining by 7% per year.
• You can do the arithmetic. In 15 years there isn’t going to be any oil left unless somebody discovers a lot of oil quickly in accessible areas, and the price of energy has to go through the roof again.

To Watch the entire interview, click on the image:

Tags: 1918, 21st Century, American Economy, American Government, Bloomberg, ETF, Genius, Great Depression, Jim Rogers, Knowing Asia, Obama, Politicians, Precipitate, Prob, Protectionism, Richest Country In The World, Runaway Inflation, Shambles, Taxing Capital, Transition, Two Little Girls, World War Ii
Posted in Commodities, Credit Markets, Economy, Gold, Markets, Oil and Gas, Outlook | No Comments »

BCA Research: The Oil “Tax”

Tuesday, January 15th, 2008

BCA Research: Global economy – the oil tax
“The surge in oil prices toward the US$100 threshold adds to growth risks for many of the world’s economies. At US$100 per barrel of WTI, the world’s oil bill will approach US$3 trillion, equivalent to roughly 5% of GDP. That would mark a 1% increase compared with last year and comes at a time when growth in the advanced economies is already moderating in response to the US housing collapse and tightening credit conditions. US consumers in particular will feel the pinch, increasing downside risks for the American economy.

“While strong oil demand – especially in China and the Middle East – is contributing to the surge in crude prices, the rising world oil bill is bearish for global growth. This ‘tax’ on growth adds to pressure for major central banks to ease monetary policy. While rising oil prices have temporarily push up headline inflation, the impact of crude on price pressures may already be peaking. Bottom line: High oil prices will require more aggressive stimulus from policymakers in order to support economic growth.”

Source: BCA Research, January 7, 2008.

Tags: American Economy, Banks, Central Banks, China, Collapse, Commodities, Credit, Crude Prices, Downside Risks, Economic Growth, Economy, Emerging Markets, energy, GDP, Global Economy, Global Growth, Headline Inflation, inflation, Investment, Miscellaneous, Monetary Policy, oil, Oil Bill, Oil Demand, Oil Prices, Oil Tax, Policymakers, Price Pressures, Rising Oil Prices, Stimulus, Trillion, World Oil, Wti
Posted in Commodities, Markets, Oil and Gas | No Comments »