We have seen in Part 1 the profound risks of a dollar crisis being triggered if global demand for US Treasuries remains high and that the debt bubble persistently and destructively sucks all the air out of the global credit markets. However, if global demand for Treasuries is not sustained at a very high level, there exists an entirely different, yet equally destructive set of impending and mounting risks that a dollar crisis might be triggered.
Like it or not, the US dollar still constitutes the de facto central framework of the present global financial order - the dollar is its fundamental support structure, much like the steel framework that supported the Twin Towers in New York. The global crisis is sending shockwaves of ever increasing intensity throughout the present order. Few thought the shaking would reach its present intensity and scope, and no one really knows how powerful and destructive the shaking might get before the crisis is over.
The initial, knee-jerk reaction in this situation has been to reach out and grab tightly onto the framework with both hands (that is, in an exceptionally risk-averse reflex, flee into the dollar for relative safety) and hold on for dear life. This reaction of global investors is motivated partly by logic but also in large part by the strong psychological components of uncertainty, fear and even panic.
As China Banking Regulatory Commission deputy head Luo Ping stated on February 12, in his own reactive-style retort to the unfolding crisis, Treasuries are just about the only safe-haven option in perilous times. However, his clarification on the next day appeared a bit less knee-jerk and more rational, stating that gold and selected government bonds (but not those of the US) look more attractive to China from a risk assessment standpoint, because China rightly fears its dollar-denominated holdings will almost certainly be inflated away over time by the US policy of issuing huge new sums of dollar-denominated debt in the form of Treasuries.
This brings us to the crux of the matter of escalating risks for the dollar. In the current fiscal year alone, the US is expected to issue somewhere between US$2 trillion and $2.5 trillion in new debt. It could conceivably exceed that amount if the crisis worsens and more money than anticipated is required to rescue the financial and economic sectors from ruin, or if virtually the entire financial sector has to be nationalized to prevent a total collapse. That is a prospect that is swiftly becoming more and more likely. A running estimate by Bloomberg News recently put the total so far of all the new sums of dollars the US government has spent, lent and/or committed to spend due to this crisis at about $9.7 trillion and counting!
To deal with a crisis that fundamentally arose, at length, out of the escalating risks of shortsightedly spending in colossal sums of dollar-debasing debt, the US government is attempting to "solve" the crisis by frantically spending gigantic additional sums of new dollar-debasing debt. Before this crisis spending binge was undertaken, the dollar's strength had already been greatly undermined over the past four decades by a combination of shortsighted dollar-debasing government policies and the accumulation of huge sums of debt since the 1980s.
According to official calculations, it required $5.54 in 2008 to equal the purchasing power of just $1.00 in 1970. This comparison illustrates the potency of inflation in undermining the value of a mere fiat currency such as the dollar.
But now, the US government is risking setting in motion inflationary forces that are profoundly more potent and difficult to manage. Virtually every economist on the planet calls this situation one that has the real potential for seriously and permanently damaging the dollar by inflating away too much of its remaining value not very far down the road. They also warn that, specifically due to the extremely risky monetary and budgetary policies now being embarked upon, the timing will be absolutely crucial for future Fed watchfulness and actions aimed at preventing a catastrophic, uncontrolled rise in dollar inflation.
They further warn that the severely weakened US financial and economic systems will be very slow to recover strength and stability and will likely be unable to withstand the tightening measures that will be needed further down the road so as to keep inflation from running out of control. The US may therefore be condemning its own currency to collapse by enacting such shortsighted policies.
In spite of such warnings, extremely potent inflationary, dollar-debasing policies are being enacted anyway. Is this the picture of a fundamentally sound global financial and economic superpower worthy of international respect, confidence and trust, or the picture of an erstwhile global financial and economic empire that is even now falling over the threshold into collapse? This is absolutely a valid question to pose at this juncture. Why?
What's the salient point here? International trust and confidence in the monetary, financial and economic policies of the US government are far more crucial now, right in the midst of this deepening global crisis, than at any previous time in history because these policies will directly and indirectly affect the dollar, either for good or for bad. Since the dollar does still constitute the central framework of the present global financial order, and since the shaking of present order is only intensifying, international confidence and trust in the dollar as a safe store of wealth is absolutely essential.
If that trust and confidence in the dollar should be sufficiently undermined anytime soon by risky policy, then the present global crisis will almost certainly turn into a global catastrophe - the perfect storm against the dollar alluded to in the introduction of this article. The importance of international trust and confidence cannot be over-emphasized for the dollar, a mere fiat currency that is backed by no hard assets at all (such as gold), but only by the pledge of the US government to stand by it and not to default on its international debt.
The massive global rush into the dollar as a safe haven would appear to indicate that we don't have much to worry about respecting international trust and confidence in the dollar. That might well be true if it could be clearly established that such a global move has been strategic in nature and well thought-out and as such has come as a result of rationality, logic and reason much more than being merely a tactical move as a result of fear and panic. Some important questions must be posed here:
Are investors such as China, which likely holds 70% of its reserves in dollar-denominated assets, satisfied to remain in the dollar for the foreseeable future, and satisfied to increase exposure to the dollar, or do its central bank governors increasingly find themselves having to hold their noses, as it were, with respect to their exposure to the dollar? Is their concern flaring?
Are global doubts and fears mounting with respect to the appeal of the dollar as a safe store of wealth beyond the short term?
If the answer to the question above is yes, then is the appeal of the dollar being undermined mostly because of fears over the potential effects of the dollar-debasing policies that are now irreversibly being implemented in Washington?
Are key investors like China's central bank increasingly looking for ways to reduce exposure to the dollar?
Is the dollar facing significantly increasing competition from other safe haven stores of wealth, such as gold?
Gold's increasing appeal as a safe haven, demonstrated by its ongoing surge, adequately answers the last question. From the start of January 2009 until mid-February, gold has surged from around $800 per ounce to near $1,000 per ounce and is likely to rise further. This surge coincides with the raft of official data releases since the start of 2009 that demonstrate the US and global financial systems and economies are moving deeper into crisis. Investors increasingly see the value of investing in hard assets, and in times of uncertainty and crisis gold and other precious metals are usually the ultimate investment in that category.
As for the answers to the remaining questions posed above, even before Premier Wen Jiabao last week publicly warned the US of his government's concern about the safety of China's US holdings (see Wen puts US honor on the debt line, Asia Times Online, March 14, 2009) consider the recent comments of Luo Ping, China's Banking Regulatory Commission deputy head, referred to above:
"We hate you guys. Once you start issuing $1 trillion-$2 trillion ... we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do."
Also note the recent comments of Yu Yongding, a prominent former advisor to China's central bank, as reported by Bloomberg News on February 11, 2009:
China should seek guarantees that its $682 billion holdings of US government debt won't be eroded by "reckless policies", said Yu Yongding, a former adviser to the central bank. The US "should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way," said Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences
Also, as reported by Bloomberg News on February 11, 2009:
China may voice its concerns over US government finances and the potential for a weaker dollar when Secretary of State Hillary Clinton visits China on February 20, according to He Zhicheng, an economist at Agricultural Bank of China, the nation's third-largest lender by assets. "In talks with Clinton, China will ask for a guarantee that the US will support the dollar's exchange rate and make sure China's dollar-denominated assets are safe," said He in Beijing. "That would be one of the prerequisites for more purchases."
Now, note the clarification offered by Luo Ping on the next day, as reported by Reuters News Service:
Buying US Treasury bonds is an option - but not the only option - for China, which is aware that huge debt issuance by Washington would reduce the value of China's existing portfolio, a banking regulator said in remarks published on Friday. In an elaboration of his remarks, the China News Service paraphrased Luo as saying: "Compared with gold or bonds issued by other countries and regions, US Treasury bonds are still an option (for China). But if the US government issues a large amount of Treasury bonds amid efforts to deal with the economic crisis, all investors who hold US Treasuries will suffer losses."
Now, note these statements made by Chinese officials, advisors and experts as reported by the official Xinhua News Agency on February 18, 2009:
"To rescue the ailing US economy by increasing government borrowing will create a record-high federal deficit," said Yu Zuyao, economist with the Chinese Academy of Social Sciences, a government think tank. "This can further lead to catastrophic consequences such as serious inflation and US dollar depreciation," he said Tuesday. China faced high depreciation risk to its foreign exchange reserves, US Treasury bonds and other US dollar-denominated assets, Yu said.
With regard to whether Chinese advisors and experts think the US government is creating a dangerous and unstable Treasuries bubble, note this statement:
"Buying US government bonds amid an economic downturn, [a purchase] that is not based on the sound performance of the US economy itself, indicates a huge bubble," said Zuo Xiaolei, chief economist of China Galaxy Securities. [italics added]
Chinese officials express mounting alarm at the likely negative near-to-medium term effects upon the dollar, and upon their huge reserves, of the spend-spend-spend policy emanating from Washington:
The huge deficit would not immediately lead to inflation, since banks were likely to curb lending as the financial system remained weak, Zuo said. "It might be two or three years before the huge deficit leads to serious inflation." Analysts noted that if the stimulus plan didn't accomplish its goal of restarting growth, the US government would have to ease its large fiscal burden by borrowing more and issuing more dollars, instead of relying on economic growth.
Huge Treasury bond issues would exacerbate the depreciation of the US dollar and world wealth. Such developments would be more catastrophic than the global financial crisis, according to Zhang Yansheng, head of the International Economic Research Institute under the National Development and Reform Commission, the chief economic planning body in China.
A weaker US dollar would hurt that currency's international status, he said, which would "not be in the interests of the United States and other countries and would exacerbate the crisis." Said Zuo: "US dollar depreciation is inevitable in the long run. China should prepare and reduce its holdings of US Treasuries to a proper size."
In a strong hint that China's central bank won't be adding to its holdings of Treasuries at anywhere near the rate it did in 2008, that it may already have clandestinely achieved more diversification out of the dollar than is widely known, and may well find ways to further decrease its holdings without explicitly telegraphing its moves, note this statement:
Fang Shangpu, deputy director of the State Administration of Foreign Exchange, noted Wednesday that the report released by the US Treasury of the amount of government bonds held by China included not only the investment from the reserves, but also from other financial institutions. It might be a hint that Chinese government is not holding as much US government bonds. [Italics added.]
China is managing its foreign exchange reserves with a long-term and strategic view, Fang told a press briefing. "Whether China is to purchase, and to buy how much of the US government bonds, will be decided according to China's need," Fang said. "We will make judgment based on the principle of ensuring safety and the value of the reserves," Fang said.
The foregoing quotes beg the following questions:
What about the widely held view, which is even at times recited by Chinese central bank officials themselves, that says China has no choice but to maintain its holdings of Treasuries and to keep buying more, lest any significant slowdown in its rate of purchases risk triggering a global dollar panic?
Is that view correct, or does China's central bank actually have other viable options, as Luo Ping and other officials insist that it does?
What might those other options be, are they really viable, and what might happen to the dollar if China's central bank began to exercise its professed "other options"?
What kind of scenario might prompt China's central bank to attempt to do so?
Could its enactment of "other options" be carried out in a way that would be difficult to trace, so that China would avoid triggering a dollar panic while it steadily reduced its exposure to the dollar over the coming months?
Saying "goodbye!" sooner, not later
With respect to whether China will continue to purchase Treasuries at anywhere near the same rate at which it has in the recent past, a new and fundamental problem is arising. Its significantly slowing economy is causing a rapid slowing of the rate of growth of its reserves, which makes much less new reserve accumulation available, and therefore also undermines the need for the purchase of Treasuries. Experts state that even if China's central bank uses all of its new accumulation of reserves each month to purchase Treasuries, the sums it would purchase would still fall.
Additionally, China must now fund its new $585 billion domestic stimulus package, and that will only further decrease funds available for the purchase of Treasuries. Therefore, its rate of purchase of Treasuries will almost certainly decline significantly from here forward.
This potentially potent new fundamental comes into play at the most inopportune time for the US, when it intends to sell perhaps as much as $2.5 trillion in Treasuries this fiscal year alone. The question that begs an answer, and that is increasingly being asked around the globe, is who's going to buy this huge new supply of debt? Certainly not Japan, for its exports are plunging, as is its new reserve accumulation, as it suffers a severe economic contraction at an annual rate of 12.7% according to the latest figures.
It certainly appears likely that as new Treasuries flood the market, the point could soon be reached where supply outstrips demand, causing yields to rise. The Fed is trying to keep yields as low as possible so as to attract big buyers that already have large holdings of Treasuries, such as China. For such holders of Treasuries, rising yields would ravage the value of their holdings, making the purchase of yet more Treasuries distinctly unattractive. Yet, lower yields tend to be less attractive for new buyers, except in the case where such a buyer is suffering from strong risk aversion and is looking, not so much for profit, but rather for a safe haven.
Therefore, minus the environment of extreme risk aversion that still plagues the markets, the US is caught between multiple contradictory interests. On the one hand, it wants to keep yields low so as to attract buyers such as China to purchase significantly more Treasuries. On the other hand, it needs higher yields to attract many new buyers because the big buyers are becoming much less able to keep up their purchases, let alone increase them. But those higher yields would almost certainly force investors such as China's central bank to begin to more quickly divest themselves of Treasuries - or risk seeing the value of the dollar-denominated portion of their reserves eaten away.
The biggest factor that has so far prevented a destructive collision of all these conflicting interests is the persistence of extreme risk aversion in the markets, causing a global rush into Treasuries as a safe haven.
If that extreme risk aversion were to subside, then investors holding Treasuries and prospective new buyers of Treasuries would be lured instead to investments that offer greater profit potential. The yields on Treasuries would have to rise in order to attract buyers, but that would undermine the value of investors' holdings of Treasuries, which would in turn drive them to sell out in favor of better safe stores of wealth. As yields rise rapidly, prospective buyers would likely stay on the sidelines to wait for the best deal rather than jump in too soon only to see their holding ravaged by yields that continue to rise.
The yields would rise yet further on the falling demand for Treasuries, and the downward spiral would feed into itself in a stampede out of Treasuries and the dollar. What I am describing here is a bursting of the Treasuries bubble. It would most likely be disorderly and chaotic.
But such a bubble burst for Treasuries could come about even if risk aversion persists, or perhaps intensifies, in this deepening global crisis. What if investors become more worried about the safety of Treasuries, fearing, as China's central bank increasingly does, that the flooding of the market with huge new sums of US debt will inevitably inflate away the value of their Treasury holdings? Or what if the costly new US stimulus package and bank rescue fail, and the US descends into a much deeper recession or a full-blown depression and is forced to nationalize virtually the entire financial sector, stoking fears that the US government may have no choice but to default on at least a portion of its gargantuan debt?
In that case there is a real threat that investors will begin to transfer their risk aversion strategy from focusing on Treasuries and the dollar to focusing on something else that is deemed much safer - perhaps including hard assets like gold and other precious metals and commodities. If US gross domestic product (GDP) deteriorates significantly further than it has already, the dollar will become much more vulnerable and will likely fall as investors begin to value the safe haven currency more in line with the fundamentals of the US economy. Then, the same self-reinforcing downward spiral described above would likely come into play, and the Treasuries bubble would burst in chaotic fashion in an investor stampede to havens safer than the shaky dollar.
One can begin to see how very tentative is the dollar's recent appeal as a safe haven in the mounting storm. In verification of that fact, investors have been piling into short-dated Treasuries for the most part, for two reasons. First, these assets are less vulnerable to the ravages of higher yields, which tend to hit the long-dated Treasuries earliest and hardest. Second, the short-dated assets facilitate a quick exit in the event that it is deemed justified. When taken together, these two factors are not a very solid vote of confidence in Treasuries and the dollar.
Next: China Inoculating Itself against a Dollar Collapse
W Joseph Stroupe is a strategic forecasting expert and editor of Global Events Magazine online at www.globaleventsmagazine.com
Dollar Crisis In The Making - Part 2: The Not-So-Safe Haven - By W Joseph Stroupe (17/3/09)
Official and popular analysis of the predicament facing the US dollar has for the most part been distinctly unwilling to come fully to grips with the stark truth about the real nature of this deepening crisis and the escalating risks that are surfacing. Far too much optimism and wishful thinking, and scarce courageous realism, is a recipe for an even worse disaster than the one we're suffering at present.We have seen in Part 1 the profound risks of a dollar crisis being triggered if global demand for US Treasuries remains high and that the debt bubble persistently and destructively sucks all the air out of the global credit markets. However, if global demand for Treasuries is not sustained at a very high level, there exists an entirely different, yet equally destructive set of impending and mounting risks that a dollar crisis might be triggered.
Like it or not, the US dollar still constitutes the de facto central framework of the present global financial order - the dollar is its fundamental support structure, much like the steel framework that supported the Twin Towers in New York. The global crisis is sending shockwaves of ever increasing intensity throughout the present order. Few thought the shaking would reach its present intensity and scope, and no one really knows how powerful and destructive the shaking might get before the crisis is over.
The initial, knee-jerk reaction in this situation has been to reach out and grab tightly onto the framework with both hands (that is, in an exceptionally risk-averse reflex, flee into the dollar for relative safety) and hold on for dear life. This reaction of global investors is motivated partly by logic but also in large part by the strong psychological components of uncertainty, fear and even panic.
As China Banking Regulatory Commission deputy head Luo Ping stated on February 12, in his own reactive-style retort to the unfolding crisis, Treasuries are just about the only safe-haven option in perilous times. However, his clarification on the next day appeared a bit less knee-jerk and more rational, stating that gold and selected government bonds (but not those of the US) look more attractive to China from a risk assessment standpoint, because China rightly fears its dollar-denominated holdings will almost certainly be inflated away over time by the US policy of issuing huge new sums of dollar-denominated debt in the form of Treasuries.
This brings us to the crux of the matter of escalating risks for the dollar. In the current fiscal year alone, the US is expected to issue somewhere between US$2 trillion and $2.5 trillion in new debt. It could conceivably exceed that amount if the crisis worsens and more money than anticipated is required to rescue the financial and economic sectors from ruin, or if virtually the entire financial sector has to be nationalized to prevent a total collapse. That is a prospect that is swiftly becoming more and more likely. A running estimate by Bloomberg News recently put the total so far of all the new sums of dollars the US government has spent, lent and/or committed to spend due to this crisis at about $9.7 trillion and counting!
To deal with a crisis that fundamentally arose, at length, out of the escalating risks of shortsightedly spending in colossal sums of dollar-debasing debt, the US government is attempting to "solve" the crisis by frantically spending gigantic additional sums of new dollar-debasing debt. Before this crisis spending binge was undertaken, the dollar's strength had already been greatly undermined over the past four decades by a combination of shortsighted dollar-debasing government policies and the accumulation of huge sums of debt since the 1980s.
According to official calculations, it required $5.54 in 2008 to equal the purchasing power of just $1.00 in 1970. This comparison illustrates the potency of inflation in undermining the value of a mere fiat currency such as the dollar.
But now, the US government is risking setting in motion inflationary forces that are profoundly more potent and difficult to manage. Virtually every economist on the planet calls this situation one that has the real potential for seriously and permanently damaging the dollar by inflating away too much of its remaining value not very far down the road. They also warn that, specifically due to the extremely risky monetary and budgetary policies now being embarked upon, the timing will be absolutely crucial for future Fed watchfulness and actions aimed at preventing a catastrophic, uncontrolled rise in dollar inflation.
They further warn that the severely weakened US financial and economic systems will be very slow to recover strength and stability and will likely be unable to withstand the tightening measures that will be needed further down the road so as to keep inflation from running out of control. The US may therefore be condemning its own currency to collapse by enacting such shortsighted policies.
In spite of such warnings, extremely potent inflationary, dollar-debasing policies are being enacted anyway. Is this the picture of a fundamentally sound global financial and economic superpower worthy of international respect, confidence and trust, or the picture of an erstwhile global financial and economic empire that is even now falling over the threshold into collapse? This is absolutely a valid question to pose at this juncture. Why?
What's the salient point here? International trust and confidence in the monetary, financial and economic policies of the US government are far more crucial now, right in the midst of this deepening global crisis, than at any previous time in history because these policies will directly and indirectly affect the dollar, either for good or for bad. Since the dollar does still constitute the central framework of the present global financial order, and since the shaking of present order is only intensifying, international confidence and trust in the dollar as a safe store of wealth is absolutely essential.
If that trust and confidence in the dollar should be sufficiently undermined anytime soon by risky policy, then the present global crisis will almost certainly turn into a global catastrophe - the perfect storm against the dollar alluded to in the introduction of this article. The importance of international trust and confidence cannot be over-emphasized for the dollar, a mere fiat currency that is backed by no hard assets at all (such as gold), but only by the pledge of the US government to stand by it and not to default on its international debt.
The massive global rush into the dollar as a safe haven would appear to indicate that we don't have much to worry about respecting international trust and confidence in the dollar. That might well be true if it could be clearly established that such a global move has been strategic in nature and well thought-out and as such has come as a result of rationality, logic and reason much more than being merely a tactical move as a result of fear and panic. Some important questions must be posed here:
Are investors such as China, which likely holds 70% of its reserves in dollar-denominated assets, satisfied to remain in the dollar for the foreseeable future, and satisfied to increase exposure to the dollar, or do its central bank governors increasingly find themselves having to hold their noses, as it were, with respect to their exposure to the dollar? Is their concern flaring?
Are global doubts and fears mounting with respect to the appeal of the dollar as a safe store of wealth beyond the short term?
If the answer to the question above is yes, then is the appeal of the dollar being undermined mostly because of fears over the potential effects of the dollar-debasing policies that are now irreversibly being implemented in Washington?
Are key investors like China's central bank increasingly looking for ways to reduce exposure to the dollar?
Is the dollar facing significantly increasing competition from other safe haven stores of wealth, such as gold?
Gold's increasing appeal as a safe haven, demonstrated by its ongoing surge, adequately answers the last question. From the start of January 2009 until mid-February, gold has surged from around $800 per ounce to near $1,000 per ounce and is likely to rise further. This surge coincides with the raft of official data releases since the start of 2009 that demonstrate the US and global financial systems and economies are moving deeper into crisis. Investors increasingly see the value of investing in hard assets, and in times of uncertainty and crisis gold and other precious metals are usually the ultimate investment in that category.
As for the answers to the remaining questions posed above, even before Premier Wen Jiabao last week publicly warned the US of his government's concern about the safety of China's US holdings (see Wen puts US honor on the debt line, Asia Times Online, March 14, 2009) consider the recent comments of Luo Ping, China's Banking Regulatory Commission deputy head, referred to above:
"We hate you guys. Once you start issuing $1 trillion-$2 trillion ... we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do."
Also note the recent comments of Yu Yongding, a prominent former advisor to China's central bank, as reported by Bloomberg News on February 11, 2009:
China should seek guarantees that its $682 billion holdings of US government debt won't be eroded by "reckless policies", said Yu Yongding, a former adviser to the central bank. The US "should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way," said Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences
Also, as reported by Bloomberg News on February 11, 2009:
China may voice its concerns over US government finances and the potential for a weaker dollar when Secretary of State Hillary Clinton visits China on February 20, according to He Zhicheng, an economist at Agricultural Bank of China, the nation's third-largest lender by assets. "In talks with Clinton, China will ask for a guarantee that the US will support the dollar's exchange rate and make sure China's dollar-denominated assets are safe," said He in Beijing. "That would be one of the prerequisites for more purchases."
Now, note the clarification offered by Luo Ping on the next day, as reported by Reuters News Service:
Buying US Treasury bonds is an option - but not the only option - for China, which is aware that huge debt issuance by Washington would reduce the value of China's existing portfolio, a banking regulator said in remarks published on Friday. In an elaboration of his remarks, the China News Service paraphrased Luo as saying: "Compared with gold or bonds issued by other countries and regions, US Treasury bonds are still an option (for China). But if the US government issues a large amount of Treasury bonds amid efforts to deal with the economic crisis, all investors who hold US Treasuries will suffer losses."
Now, note these statements made by Chinese officials, advisors and experts as reported by the official Xinhua News Agency on February 18, 2009:
"To rescue the ailing US economy by increasing government borrowing will create a record-high federal deficit," said Yu Zuyao, economist with the Chinese Academy of Social Sciences, a government think tank. "This can further lead to catastrophic consequences such as serious inflation and US dollar depreciation," he said Tuesday. China faced high depreciation risk to its foreign exchange reserves, US Treasury bonds and other US dollar-denominated assets, Yu said.
With regard to whether Chinese advisors and experts think the US government is creating a dangerous and unstable Treasuries bubble, note this statement:
"Buying US government bonds amid an economic downturn, [a purchase] that is not based on the sound performance of the US economy itself, indicates a huge bubble," said Zuo Xiaolei, chief economist of China Galaxy Securities. [italics added]
Chinese officials express mounting alarm at the likely negative near-to-medium term effects upon the dollar, and upon their huge reserves, of the spend-spend-spend policy emanating from Washington:
The huge deficit would not immediately lead to inflation, since banks were likely to curb lending as the financial system remained weak, Zuo said. "It might be two or three years before the huge deficit leads to serious inflation." Analysts noted that if the stimulus plan didn't accomplish its goal of restarting growth, the US government would have to ease its large fiscal burden by borrowing more and issuing more dollars, instead of relying on economic growth.
Huge Treasury bond issues would exacerbate the depreciation of the US dollar and world wealth. Such developments would be more catastrophic than the global financial crisis, according to Zhang Yansheng, head of the International Economic Research Institute under the National Development and Reform Commission, the chief economic planning body in China.
A weaker US dollar would hurt that currency's international status, he said, which would "not be in the interests of the United States and other countries and would exacerbate the crisis." Said Zuo: "US dollar depreciation is inevitable in the long run. China should prepare and reduce its holdings of US Treasuries to a proper size."
In a strong hint that China's central bank won't be adding to its holdings of Treasuries at anywhere near the rate it did in 2008, that it may already have clandestinely achieved more diversification out of the dollar than is widely known, and may well find ways to further decrease its holdings without explicitly telegraphing its moves, note this statement:
Fang Shangpu, deputy director of the State Administration of Foreign Exchange, noted Wednesday that the report released by the US Treasury of the amount of government bonds held by China included not only the investment from the reserves, but also from other financial institutions. It might be a hint that Chinese government is not holding as much US government bonds. [Italics added.]
China is managing its foreign exchange reserves with a long-term and strategic view, Fang told a press briefing. "Whether China is to purchase, and to buy how much of the US government bonds, will be decided according to China's need," Fang said. "We will make judgment based on the principle of ensuring safety and the value of the reserves," Fang said.
The foregoing quotes beg the following questions:
What about the widely held view, which is even at times recited by Chinese central bank officials themselves, that says China has no choice but to maintain its holdings of Treasuries and to keep buying more, lest any significant slowdown in its rate of purchases risk triggering a global dollar panic?
Is that view correct, or does China's central bank actually have other viable options, as Luo Ping and other officials insist that it does?
What might those other options be, are they really viable, and what might happen to the dollar if China's central bank began to exercise its professed "other options"?
What kind of scenario might prompt China's central bank to attempt to do so?
Could its enactment of "other options" be carried out in a way that would be difficult to trace, so that China would avoid triggering a dollar panic while it steadily reduced its exposure to the dollar over the coming months?
Saying "goodbye!" sooner, not later
With respect to whether China will continue to purchase Treasuries at anywhere near the same rate at which it has in the recent past, a new and fundamental problem is arising. Its significantly slowing economy is causing a rapid slowing of the rate of growth of its reserves, which makes much less new reserve accumulation available, and therefore also undermines the need for the purchase of Treasuries. Experts state that even if China's central bank uses all of its new accumulation of reserves each month to purchase Treasuries, the sums it would purchase would still fall.
Additionally, China must now fund its new $585 billion domestic stimulus package, and that will only further decrease funds available for the purchase of Treasuries. Therefore, its rate of purchase of Treasuries will almost certainly decline significantly from here forward.
This potentially potent new fundamental comes into play at the most inopportune time for the US, when it intends to sell perhaps as much as $2.5 trillion in Treasuries this fiscal year alone. The question that begs an answer, and that is increasingly being asked around the globe, is who's going to buy this huge new supply of debt? Certainly not Japan, for its exports are plunging, as is its new reserve accumulation, as it suffers a severe economic contraction at an annual rate of 12.7% according to the latest figures.
It certainly appears likely that as new Treasuries flood the market, the point could soon be reached where supply outstrips demand, causing yields to rise. The Fed is trying to keep yields as low as possible so as to attract big buyers that already have large holdings of Treasuries, such as China. For such holders of Treasuries, rising yields would ravage the value of their holdings, making the purchase of yet more Treasuries distinctly unattractive. Yet, lower yields tend to be less attractive for new buyers, except in the case where such a buyer is suffering from strong risk aversion and is looking, not so much for profit, but rather for a safe haven.
Therefore, minus the environment of extreme risk aversion that still plagues the markets, the US is caught between multiple contradictory interests. On the one hand, it wants to keep yields low so as to attract buyers such as China to purchase significantly more Treasuries. On the other hand, it needs higher yields to attract many new buyers because the big buyers are becoming much less able to keep up their purchases, let alone increase them. But those higher yields would almost certainly force investors such as China's central bank to begin to more quickly divest themselves of Treasuries - or risk seeing the value of the dollar-denominated portion of their reserves eaten away.
The biggest factor that has so far prevented a destructive collision of all these conflicting interests is the persistence of extreme risk aversion in the markets, causing a global rush into Treasuries as a safe haven.
If that extreme risk aversion were to subside, then investors holding Treasuries and prospective new buyers of Treasuries would be lured instead to investments that offer greater profit potential. The yields on Treasuries would have to rise in order to attract buyers, but that would undermine the value of investors' holdings of Treasuries, which would in turn drive them to sell out in favor of better safe stores of wealth. As yields rise rapidly, prospective buyers would likely stay on the sidelines to wait for the best deal rather than jump in too soon only to see their holding ravaged by yields that continue to rise.
The yields would rise yet further on the falling demand for Treasuries, and the downward spiral would feed into itself in a stampede out of Treasuries and the dollar. What I am describing here is a bursting of the Treasuries bubble. It would most likely be disorderly and chaotic.
But such a bubble burst for Treasuries could come about even if risk aversion persists, or perhaps intensifies, in this deepening global crisis. What if investors become more worried about the safety of Treasuries, fearing, as China's central bank increasingly does, that the flooding of the market with huge new sums of US debt will inevitably inflate away the value of their Treasury holdings? Or what if the costly new US stimulus package and bank rescue fail, and the US descends into a much deeper recession or a full-blown depression and is forced to nationalize virtually the entire financial sector, stoking fears that the US government may have no choice but to default on at least a portion of its gargantuan debt?
In that case there is a real threat that investors will begin to transfer their risk aversion strategy from focusing on Treasuries and the dollar to focusing on something else that is deemed much safer - perhaps including hard assets like gold and other precious metals and commodities. If US gross domestic product (GDP) deteriorates significantly further than it has already, the dollar will become much more vulnerable and will likely fall as investors begin to value the safe haven currency more in line with the fundamentals of the US economy. Then, the same self-reinforcing downward spiral described above would likely come into play, and the Treasuries bubble would burst in chaotic fashion in an investor stampede to havens safer than the shaky dollar.
One can begin to see how very tentative is the dollar's recent appeal as a safe haven in the mounting storm. In verification of that fact, investors have been piling into short-dated Treasuries for the most part, for two reasons. First, these assets are less vulnerable to the ravages of higher yields, which tend to hit the long-dated Treasuries earliest and hardest. Second, the short-dated assets facilitate a quick exit in the event that it is deemed justified. When taken together, these two factors are not a very solid vote of confidence in Treasuries and the dollar.
Next: China Inoculating Itself against a Dollar Collapse
W Joseph Stroupe is a strategic forecasting expert and editor of Global Events Magazine online at www.globaleventsmagazine.com
Di pos oleh Arbain Muhayat pada 23 March 2009