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Global Dollar Decline Imminent?

1.06.2006

I have been harping on about China off and on for a while. I have lived there for a number of years and find their current rise to power, seemingly inexorable to be both disturbing (for its lack of democratisation) and fascinating (for its zeal and organisation). It is well known that the Chinese are major holders of US debt and reserves. They have managed to finance alongside Japan and some others, a very large US deficit which shows no sign of shrinking.

The majority of the market has kept true to its original and founding wisdom, follow the money, so the last year so now sign of an appreciable adjustment of US Dollar value against other currencies to account for growing defecits because these defecits were being underwritten by foreign central banks.

A prescient article in last weeks Business Post highlighted in very digestible detail the issues at stake for the US dollar at the moment. The reason I am bringing up the issue is that yesterday the Chinese Central Bank issued a statement which put the jitters up the FT. The seemingly innocuous statement about ensuring reserves of foreign exchange support a national strategy of development has got the FT egg-heads wondering if this means China is about to pull some of its support for the US deficit and dollar situations.

There are some who would see such a switch as suicidal since the US Dollar is the 'gold standard' in foreign exchange and it stands to reason to hold it as part of ones reserves. However, the Chinese central bank, like all other institutions in the state are not free from political control and completely in line with the Politburo strategy, whatever it may be.



From the FT:
"However, according to Stephen Green, economist for Standard Chartered in Shanghai, although the language was 'vague', Thursday's statement was the first time Safe has publicly indicated a shift away from dollar assets.

'It is a subtle but clear signal that they are interested in moving away from the US dollar into other currencies, and are interested in setting up some kind of strategic commodity fund, maybe just for oil, but maybe for other commodities,'he said."

While the latter are only options and the Chinese committed themselves to nothing, there are serious geo-political as well as economic implications of this move. The fact that economists around the globe can get so worked up about what it is the Chinese choose to do with their dollars is a clear signal of how important a player China is becoming in the Market psyche. While figures might suggest it is still a moderate-albeit growing-influence, the reality is that the world listens when China moves.

So, even the very idea that China will sell dollars looks like bad news for the US treasury. Of course the US economy actually needs to have its exchange rate cut in order to increase competitiveness. The Business Post article above suggests that the US dollar needs to lose between 20%-40% of its values to bring the economy back into competitiveness. This is the power that the Chinese are perceived as holding over the head of the US.

The US itself has been calling for a long time for China to get its exchange rate in order and let it float against the dollar or at least revalue it to some realistic level. The danger for such an event cannot be undrestimated.

The problem is that the US is one of the few major economies which on paper is doing well. A decline in Dollar values and knock on decline in US economy will have implications for Europe and Asia. China will cope through the pegging of its currency and its massive reserves of cash (estimated at $800 Billion). The EU countries look less formidable. It seems unlikely that the Germans, French or UK willl be able to sustain growth if the US starts to falter.

Geo-politically this makes China king-maker for the time being until the US can takes control of its own fate, a prospect which at this time looks unlikely. There has been talk of the Chinese embarking on an imperial project similar to that pursues by the US (using the term imperial in a loose sense for lack of any other term). The movement to undermine US dominance is at its most embryonic. There is still a very long way ahead and it is not a very positive thing to consider in many ways.

If a major dollar decline ensues, then there should well be major knock on effects to Irish jobs with over 300,000 employed by FDI (corporations). We could lose 8% of GNP in our exports should the US start to readjust. We are certainly positioned very close to the risk in all this. Our proximity of exposure to US dominated investment and our reliance indirectly for a major part of our growth on FDI related activity should give pause for thought.

The Chinese statement also freed up the way for large Chinese multinationals to engage in increasing numbers of merger and acquisition activity. With a domestic growth rate somewhere around 9%-10% it seems likely that the corporations will have a great deal of money sloshing about with which to being purchasing overseas. This begins the process of branding and cultural expansion so familiar to us all now in the current wave of globalisation.

I do not write this with the relish of some foaming at the mouth lefty who desires for all the US stands for to just shrivel away and die. I am seriously concerned at the level of power it is possible for the Chinese to wield without engaging in serious democratic reforms or moving toward serious consideration of human rights. These are most certainly off the agenda in the country, while growth and development are not. China may be the most dangerous exception to the 'golden rule' that increasing levels of capitalism correspond to increasing levels of freedom in a state.

The rise of China can be seen in its increasing role in central Asian energy politics and close relations with Russia and other former Soviet and non-democratic regimes in the region. The wheels of history turn in only one direction and it is clear that we must live with the oncoming reality of a bi-polar order and perhaps ultimately a new superpower.

To my mind todays move underlines the increasing hold that China has on the psyche of the market makers and, by extension, its capacity to have an enormous effect on the US economy. It seems history is reverting to a mass exporting hub as the major player in global affairs.

The fact is that in the demise of the US, or at least its return to bi-polar geo-politics we may lose any manner of success for human rights and democracy. The emerging powers hold little interest in their promotion, the US and her allies ostensibly do. Some on the left will delight at the re-emergence of a Marxist option to US dominance. This sets back the global debate on progress by 50 years.

The US Senate is populated with members who believe that Iraq should be abandoned tomorrow and the focus on conflict with China. Such a feeling of inevitablility is only reenforced by dangerous and loose talk by the most dangerous and loosest Taiwanese President yet. It may be a small island but it seems the most likely candidate to force the Chinese to arms. The Taiwanese are staunchly backed up by a massive US military presense on the island and numerous US commitments to support the island if attacked.

There are larger knock on effects from a Chinese removal of the support for the US dollar than many of us will comfortably contemplate. There is, however, an onus on governments and people alike to ensure that the West can be prepared to engage with the Chinese but on our terms and in a manner which safeguards the principles we have achieved and those we aspire to achieve.

The policy onus closer to home is summed up by Ahearn in his Post article;


"Budgetary policy can cushion some of the shock to total demand that will accompany adjustment. To enable this, European governments should now be striving to improve their budgetary positions. Inmost cases, this means cutting back on borrowings.

In this regard, Ireland might be well advised to aim for sizeable budget surpluses, not the moderate deficit projected in December's budget. Spending could then be boosted or taxes cut to boost economic activity, if necessary.

Irish policymakers should also be more proactive in managing the risks associated with the property market."


The Irish need to cushion a fall that looks more and more likely to take place. We all know how exposed we are to the global economy and how any down-turn can have adverse effects on us. We do not need to shut ourselves off but adopt a more prudent policy stance than the simplistic Boston-Berlin dichotomy. Genuine expansion can be achieved while squirelling away something for a rainy day.

The rise of China is by no means inevitable, however of all outcomes it is the most likely, China is industrialising its economy in Geographical stages, it seems. The sea-board first and then slowly moving inland in large swathes of development. This is all on the agenda and the long term plan, this means that there is a huge pool of people to be added to the growth story over time which can sustain the growth in some shape or form for years. Its a scary proposition.

Incidentally, there are two somewhat colloqial perspectives I'd like to pass on, both picked up in conversation with people whom I would consider as knowing a thing or two;
1) That the dollars decline may see the Euro-Dollar rate hit E1.80 at worst before coming back in to E1.60. When the run starts it will run big, is the thesis.
2)France and Germany will not be hit so hard by Chinese expansion as many of their firms enjoy preferable exposure to the Chinese growth story.

RR


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  1. Anonymous anirudh joshi | 3:26 a.m. |  

    Hello .
    This was a great article.

    What do you think about it now.

    when we are in 2007

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