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Editorial See other Editorial Articles Title: Could China Crash the US Dollar on a Whim? Could China Crash the US Dollar on a Whim? posted on: October 23, 2007 | about stocks: FXI / PGJ / CAF Over the last 30 years, Chinas economy has grown at an average annualized rate of nearly 10%. While this statistic alone is jaw-dropping, what is more impressive is the extent to which the nominally Communist countrys economy has become intertwined in the global economy. China now exerts enormous influence over the economies of virtually every country in the world, and a slight change in its domestic economic policy has the potential to send shockwaves rippling throughout the world. Nowhere is this more apparent-and frightening-then in Chinas economic relationship with the United States, which is very much at the mercy of China when it comes to prices, wages, interest rates, most importantly, the value of the Dollar. The precariousness of this relationship is already the subject of significant publicity, redolent of the Japanaphobia of the 1980s that saw American economists scare-mongering about Japanese control of the US economy. [Of course this later turned out to be unfounded, but that is beyond the scope of our discussion.] With regard to China, most of the analysis is focused on its growing foreign exchange reserves, the majority of which are held in Dollar-denominated assets. This article will go beyond forex reserves and discuss several other facets of Chinas economy. From US house prices to global commodity prices, from interest rates to inflation rates, we will explore how China could cripple the US economy, both willfully and unintentionally, if so desired. Forex Reserve Diversification Lets begin with an examination of Chinas forex reserves, which is probably Chinas biggest bargaining chip in its economic relationship with the US. Up until two years ago, Chinas currency, the RMB or Yuan, was pegged to the Dollar. As with any peg, there often develops a discrepancy between the fixed value of the currency and the value that the market would assign if the currency were permitted to float. As Chinas economy surged ahead, especially over the last five to ten years, tremendous pressure began to build under the RMB. In order to maintain the peg and hold down the value of the RMB, China began accumulating foreign exchange reserves by withdrawing foreign currency from circulation. Today, Chinas foreign exchange reserves are massive, at $1.4 trillion as of September 2007. In the eyes of American policy-makers, this presents a problem because the majority of these reserves are held in Dollar-denominated assets, namely in the form of US Treasury securities. The US government theoretically could not be happier that foreign Central Banks are willing to finance its perennial budget deficits. However, this borrowing has reached a point where foreigners now control over 40% of the US national debt. Moreover, long-term US interest rates are market-driven, based on the buying and selling of US government bonds. In other words, the US has gradually ceded control of its long-term interest rates to foreign Central Banks, namely China and Japan. As the Dollar has depreciated over the last five years, many Central Banks have begun diversifying their forex reserves, by switching from Dollar assets to assets denominated in other currencies. This is problematic for the Dollar for two reasons. First, switching from US assets to European assets, for example, directly causes the Dollar to depreciate. Second, the bulk sale of US treasury securities (whether or not they are replaced with other US-assets) causes US bond prices to decline and hence, yields to increase. Thus, if China suddenly decided to diversify its reserves, for economic and/or political reasons, it could potentially crash the Dollar and send US long-term interest rates skyward. Since mortgage rates are tied directly to government bond yields, a rise in interest rates would probably also affect US real estate prices. Higher interest rates would make borrowing for a home more difficult, which would lower the demand for houses and thus, the value of American real estate. In fact, China recently created the China Investment Co. Ltd., capitalized with almost $300 Billion, charged with investing its vast forex reserves in higher-yielding assets. However, the companys inaugural investment was a stock purchase in the Blackstone group, an American private equity firm. Thus, while it seems likely that China will gradually discard some of its stock of US Treasury Securities, the affect on the value of the Dollar will be minimal. Besides, while China would certainly punish US businesses and consumers by unloading US Treasuries on the market, it would punish itself even more, since the value of the government bonds that it didnt sell would decline. In short, it seems China will probably hold off on exercising its nuclear option for the time being. Currency Manipulation The second aspect of the China-US economic relationship which China could wield to its advantage is the RMB itself. American public officials enjoy criticizing China for failing to allow its currency to appreciate more quickly. In fact, there is a bill that has been lying dormant in the US Congress which threatens to slap a massive across-the-board tariff on all Chinese imports if China fails to allow the RMB to appreciate adequately against the Dollar. What policymakers dont realize is that a rapid appreciation in the RMB would actually harm the US economy. Coupled with its growing role as the worlds factory, Chinas cheap currency has made Americans wealthier, by increasing their purchasing power. As production of labor-intensive goods was outsourced to China over the last decade, prices for finished products began to fall both in real terms and in nominal terms. While the effect on US employment trends is debatable, its effect on prices has been unambiguous. Thus, even while the American economy boomed, inflation remained relatively modest by historical standards. This allowed the Federal Reserve Board to hold interest rates down and foment economic growth. As the RMB appreciates, Chinese producers will become ever-more forced to pass along some of the price increase to consumers. Now, if China was to suddenly revalue its currency by the 25%-30% that western policy-makers are demanding, prices on a whole host of Chinese products would jump up overnight. This would adversely affect American purchasing power and limit consumption to such an extent that the US would be in danger of slipping into recession. While the trade deficit that is the bane of American politicians existence might decrease in the long-term, it would skyrocket in the short-term. Besides, as many analysts have been quick to point out, there is not much overlap between Chinese and American production. Thus, a more expensive Yuan would send production to other parts of Asia, rather than back to America. While the US-China trade deficit might narrow, it would be offset by increased imbalance with the rest of Asia. Just like with the case of its foreign exchange reserves, however, China is unlikely to exercise this option because it would deal equal harm to itself. Chinas ruling Communist party derives most of its legitimacy from the strength of its economy, and especially exports. If a more expensive Yuan forced producers to relocate to other parts of Asia, it would certainly spell trouble for the CCP! Direct Competition with US Exporters A more potent (and plausible) weapon would be to compete more directly with US exporters, by expanding into high-technology products. Currently, China specializes in manufacturing labor-intensive products, which have long since been manufactured outside of the United States. As previously stated, a revaluation of the Chinese Yuan would surely not return production to the US. However, if China were to expand into capital-intensive and/or high-technology products, it could easily steal marketshare and jobs from the US. Limiting the Importation of US Products Of course, there is also the imports side of the trade equation. China is quickly becoming one of the United States largest export markets; limiting the importation of US goods and services would certainly be felt in the US. In fact, China already requires multinational companies in many industries to form joint ventures with Chinese companies in order to produce and/or sell their wares in China. Other anti-competitive measures include tariffs, import taxes, quotas, or a simple ban on the importation of certain types of products. Each would have a devastating impact on the US trade deficit with China and would probably result in retaliatory sanctions by the US. Wage Pressure Next, there is the impact that China has exerted on global wages. When Deng XiaoPings famous tour of the South in 1979 ignited three decades of dizzying growth, hundreds of millions of Chinese were added to the global labor pool overnight. Yet, the majority of Chinas population remains concentrated in rural areas. In fact, there are perhaps 500 million Chinese peasants that have yet to join the modern labor force, which means the full effect of Chinas economic explosion has yet to be fully realized by the rest of the world. Already, there is no hope of unskilled work that has already been outsourced returning to the US. If/when China begins to expand into the production of high-technology goods and more complex services, it will encroach on the territory of American businesses. Unfortunately for the US, China will likely make these undercapitalized sectors of its economy more of a priority in its next five year plan. One popular method for estimating GDP is the income approach, which, as its name suggests, represents a summation of the reported incomes of a given countrys domestic population. Logic dictates that downward pressure on the wages of skilled American workers would negatively impact US GDP, and at the very least, would curtail the purchasing power of American consumers. This would also limit US exports to China, since Chinese would have homegrown alternatives to choose from. Raw Material Pricing In addition, there is the impact that Chinas economic growth has exerted on global raw material prices. It has been said that 25% of the worlds construction cranes are currently located in China, to support the countrys building boom. These massive development and infrastructure projects require proportionally massive quantities of raw materials, namely cement and steel. Unfortunately, China is especially inefficient at converting raw materials into finished products. Combined with the CCPs emphasis on the near-term (which inherently prioritizes low cost over efficiency), this is placing a tremendous strain on global energy supplies, driving prices skyward. Competition for Energy The global prices for oil and coal are already at record highs and China only consumes 1/15 the amount of per-capita energy as the US! Chinese energy companies are becoming increasingly visible, scouring the globe for stable supplies of energy and often coming head-to-head with American energy companies. Conveniently, China does not recognize the ethical issues which arise from purchasing energy from dictatorships and corrupt regimes, whereas US companies are limited from doing business in these places. From Sudan to Myanmar to Kazakhstan, Chinese companies have set up join ventures where US companies could not. While energy prices have certainly risen in the US, they have not kept pace with global energy prices. In this way, China is able to ensure that its citizens and its businesses have the oil, coal, and natural gas that they require, while their American counterparts may be forced to conserve. Two years ago, the Chinese National Offshore Oil Company [CNOOC] (CEO) attempted to purchase an American energy company, Unocal, for over $18 Billion. However, the deal was blocked by the US Congress, which feared Unocals energy reserves would be supplied to China at the expense of Americans. It did not help CNOOCs case that 70% of the Company was effectively owned by the CCP. Needless to say, Chinese government officials were not happy with the outcome; (Unocal was ultimately sold to Chevron for a lower price). China has already shown its willingness to use extreme tactics to secure an adequate energy supply. It seems reasonable to expect its energy policy will continue to oppose and inconvenience the US. Conclusion In short, China has several economic weapons at its disposal for countering the US, ranging from the manipulation of its currency to the diversification of its burgeoning stock of forex reserves. It also has several less blunt options to choose from, such as enabling Chinese companies to compete more directly and effectively with US companies, and opposing the US in securing a domestic energy supply. On all of these fronts, the US is essentially being held hostage, since it has become so dependent on China as the worlds factory. Ultimately, it seems unlikely that China will deliberately butt heads with the US unless it is first provoked, but America should nonetheless be on its guard since its economy hangs in the balance. Adam Kritzer About this author: * Bio & more articles * Visit author's site
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#1. To: tom007 (#0)
Giving credit to one of our smart members, they could, and can, but they'll wait until after the '08 Olympics to do it. If they do it at all. It would, imo, kinda be like killing the GoldenGoose.
Yeah, but when all the goose does for you is shit all over your back yard and honk at all hours of the day and night, you start looking for plum sauce recipes. But I think they will hold off on that unless we get in their way over Formosa or start smart-bombing one of their key energy suppliers.
I've been trying to figure out why we're screwing around in Burma right now. We're also moving into Africa militarily to challenge to challenge them there. So maybe they let us get away with it until next Sept., but after that who knows. Turn out the lights if they start selling treasury bonds. We'll probably be forced into a NAU merger with Canada and Mexico and have to institute a new currency . . . oh wait, I think that's the CFR plan, isn't it. Geez, and China will get all the blame.
That's the only thing I can take away from some of these moves lately. It's like a smart ass kid acting up while company is there because he knows he won't get his ass beat while guests are in the house.
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