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The Day of the Yuan

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Julian Phillips on the coming Currency Crisis

President Bush’s decision to print $700 Billion, President Obama’s decision to do the same, and Bernake’s recent infusion of an extra $1 Trillion into the economy were met by the public with a collective head scratch. “Well, alright, I suppose…” the thought surely went, “if it’ll fix economy, why not? But I wonder where that money will come from.” The Fed has the power to print money in extreme circumstances, so most have contented themselves with the explanation that the money ‘came out of thin air’.  I believe the technical term is ‘Quantitative easing’. But strictly speaking, this isn’t true. In order for the dollar to have value – for it truly to be money – the rest of the world must perceive it as such. Thus far the world has had no choice but to believe in the dollar’s value.  All the truly valuable things – gold, oil, IMF loans, etc. were primarily priced in dollars, forcing them to do business with the US – usually at a steep disadvantage. Various US military actions, most notably Vietnam, Central America and Iraq, along with covert US support of friendly dictators further ensured the rule of the dollar. However a new day dawns – a new set of circumstances with a growing alternative to dollar hegemony. In light of that, printing money was likely the worst response our leaders could have taken in response to this financial imbroglio.

Up until now the dollar has been the standard reserve currency due largely to a lack of alternative. The US was virtually the last robust economy left after World War II, and shrewdly issued its currency to anyone who would accept it. The dollar was especially attractive then because the US held large stores of gold and promised investors that they could trade $35 for an ounce of it any time they wanted out of the arrangement – the long-forgotten gold standard. More importantly, the US made sure that oil would be priced exclusively in dollars via their interventions in Iran, Saudi Arabia, Egypt, and other countries. This ensured that any nation who wished to have an industrial revolution would necessarily have to go through the US in order to do so.  In 1971, the US reneged on its gold standard obligation, but by then it had ensured the world would be so dependent on the US for economic growth that they had no choice but to remain silent.  Thus the dollar proliferated throughout the world, and the US used all its available military and political influence to ensure that it would be the world’s only reserve currency. So long as that remained true, the US economy would have ultimate insurance – since all other currencies were backed by the dollar, the nations of the world have a strong vested interest in US economic stability.  A dollar collapse would imply their currency’s collapse as well.  When oil inflated in 2008, the rest of the world found themselves obligated to devalue their own currency to bring it in line with the inflating dollar, which they quietly agreed to do during an emergency meeting in September.

Since 2007 the Federal reserve has printed approximately $2.5 Trillion, and has made clear to our financial sector that their mon etarycommitment is essentially unlimited. Many estimates of the total cost of this crisis run into the tens of trillions of dollars. In March, China’s Premier expressed “grave concern” as to China’s investment in US Treasury Bonds, soon after the announcement of another trillion in printed cash. Though the US media gave the Premier’s remarks only perfunctory coverage, these ‘concerns’ have serious implications for US monetary policy. More disheartening are China’s repeated calls for a new global reserve currency. At first such calls were ignored, even laughed at, but as the crisis unfolds they become harder and harder to disregard. At the very least one can say that China is unhappy with its investments in the US Treasury, and it would not be a large stretch to put forth that they may be looking for an alternative, or even to supplant the dollar with their own currency.

But what about the $2 Trillion in US debt of which China is the proud holder? This is the argument commonly put forth by high-level investors with whom I have discussed these issues. They claim that China needs a robust US economy even more than the US needs China to invest in its bonds, that an attempt by China to supersede the US would be tantamount to financial suicide, rendering a bulk of their investments worthless. It is the Mutually-Assured Destruction model for the 21st Century. But it does not hold to scrutiny. Evidently the Chinese leadership does not consider it advantageous to dump their US assets, or they would already have done so. But for how long did my conversation partners think this would remain true?  The time may easily come when China decides to simply cut their losses. Given that the Obama Administration has announced multi-trillion dollar deficits for the next decade, that time is not very difficult to forsee. Depending on the moment and manner in which they dump their US investments,those losses might not turn out to be so great. If, for instance, China can convince the rest of the world to drop their dollar assets at the same time they do, and simultaneously re-invest in the Yuan, the money China loses to US debt will be offset by the influx of new investment from the rest of the world.

This would not be so difficult as it sounds. In fact, with one move, China can simultaneously achieve both of its goals: striking a death blow to US dollar hegemony and installing the Yuan as the new global store of value. All they must do is make two announcements, preferably in one day. First, that they immediately seek to unload their investments in the US government, and second that the Yuan will trade at double its current value in relation to the dollar on a specific day in a few months. Perhaps they’ll read this essay and call it The Day of the Yuan. I admit I am an ordinary, newspaper-reading layman with no special knowledge of macroeconomics, but in my uninformed opinion there would ensue a run on US currency followed by a frenzy for the Yuan, were China to enact such a policy.

Hyper-inflation is a dirty word among business circles. No one I’ve encountered who makes their living by trading money will entertain the notion that the dollar may enter a severe inflationary cycle.  But it is the necessary extension of a collective, immediate disbelief in the value of a currency. Most historical examples of hyperinflation, from Germany in the 20s, to Yugoslavia in the 90s, to Zimbabwe today, were preceded by vast inflationary spending – be it through costly wars or simply printing currency. The US has done the former for decades and has just embarked on a visible demonstration of the latter, but the implications of such actions are widely disregarded. There exists a belief that normal economic rules, even ones learned in high-school, do not apply to the US – a belief of which we are likely about to be disabused.

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Written by pavanvan

July 26, 2009 at 7:39 pm

Posted in Economy

Tagged with , , , , ,

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