Thread: If China loses faith, the dollar will collapse

If China loses faith, the dollar will collapse

By Andy Xie

Published: May 5 2009 03:00 | Last updated: May 5 2009 03:00

Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the US Federal Reserve's policy of expanding the money supply to prop up the 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 hyperinflation 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 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 now 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 of the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. The renminbi remains a closed currency and is not yet a credible vehicle for wealth storage.

The US could repair its balance sheet through asset sales and fiscal transfers rather than printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts instead of dubious spending to prop up the economy. When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. America's vast and unexplored natural resource holdings could be auctioned off.

The global environment is extremely negative for savers. The prices of property and shares are not yet good value and may decline further. Interest rates are near zero. The Fed is printing money, which will 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 failing US banks and bankrupt households will eventually destroy the dollar's status. Ethnic Chinese demand for it is waning already. China's bulging foreign exchange reserves reflect the lack of private demand for the US currency.

US policy is pushing China towards developing an alternative financial system. For the past two decades its entry into the global economy rested on providing cheap labour to multinationals and pegging the renminbi to the dollar. The dollar peg allowed it to leverage the US financial system for its international needs, while domestic finance re-mained state-controlled to redistribute prosperity from the coast to the interior. This dual approach has worked well. China could have its cake and eat it. Of course, the global credit bubble was what allowed the approach to be effective; its inefficiency was masked by bubble-generated global demand.

China is aware it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects its anxiety over relying on the dollar system. 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 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

http://www.ft.com/cms/s/0/46db5314-390d ... ck_check=1

US Dollar Decline is Accelerating

By Bob Kirtley
May 5 2009 1:58PM



The banks are currently undergoing various forms of stress testing, which, good, bad or indifferent are having the effect of reassuring the investment community that all is well as evidenced by the improvement in the stock prices of the banking sector, however, the decline of the US Dollar appears to be accelerating.

As an example we can see that today the banking sector led the charge with some banks putting on double digit gains as the whole sector rose on a renewed optimism that they just might be profitable.

Considering just how much money they need to stay afloat it is mind boggling that are worth anything at all. Still with government cash to shore up their decimated balance sheets they present an investment opportunity to both investors and speculators. Stocks this volatile are magnets for day traders and options players looking to be on the right side of the next dramatic move.

Standing quietly in the background so as not to attract attention is the US Dollar which has fallen back since the 20th April 2009 when it topped ‘89 on the Index and is currently heading south as we can see from the above chart. The technical indicators are drifting lower so it will be interesting to see if it can bounce once the RSI hits ‘30. Failure to stabilize shortly could mean that it is about to re-test last summers low of ‘72 as confidence ebbs away.

In the mean time this demise of the dollar has had a positive effect on gold as we see it trading $17.40 higher in New York, of all places, to close just above the $900/oz parapet at $903.20.

The move by the Chinese to almost double their gold reserves gives us a clue as to how they feel about the dollar as a store of wealth. We expect their acquisition programme to continue at a steady pace and as secretly as it has begun providing gold with a little more in the way of support.

Hang on to your core positions despite the volatile nature of the markets as gold is coiled for a big move north sometime this year. That's about as accurate as we dare to say at the moment given the myriad of unknown variables, however as the situation evolves we will be looking to increase our exposure to the precious metals sector as this bull market gains the recognition it deserves. Come Christmas Eve we expect to see gold at a new all time high putting a smile on the faces of gold bugs everywhere.

Have a good one.

Bob Kirtley
bob@silver-prices.net

http://www.kitco.com/ind/Kirtley/may052009.html

If China does not participate in any upcoming Treasury obligation auctions, it will be the beginning of the end of the dollar. And, if at the same time they decide to dump all the Treasury securities they own onto the market, we will be totally bankrupt. A nice fat million dollars will be able to get us a loaf of moldy bread.