[R-G] [BillTottenWeblog] China's Calculated Currency Rhetoric

[Bill Totten]

by Stratfor (March 25 2009)


One of the more popular conventional wisdoms is that the United States
is in decline and that it is a simple matter to select options that will
edge the United States out of its dominant position in the world. In an
editorial published Tuesday, Chinese central bank governor Zhou
Xiaochuan spoke to one of the more popular financial conspiracy theories
in this vein when he wrote that the time had come to establish a new
scrip to replace the US dollar as the global reserve currency. The issue
is close to Beijing’s heart: The Chinese reserve fund is a significant
holder of US debt, with some $750 billion in US Treasury bills.

China does not purchase US debt out of choice, but out of a lack of
choice. China is a state with serious social stability issues that are
mitigated only by state intervention in the economic structure to
maintain mass employment. Since there isn’t much internal demand for the
goods these employed masses produce - due in part to a high savings rate
and low incomes - China must peddle its goods abroad. The US consumer
market, with annual sales of approximately $10 trillion, is roughly
equivalent in bulk to the next six consumer markets combined. Sales to
the United States and other countries hardwired into the American supply
chain - which includes the bulk of East Asia - are the only reasonable
option. And so the Chinese yuan has a de facto peg to the US dollar.

That is hardly the extent to which the Chinese are bound to the dollar,
however. Because China lacks the financial and industrial infrastructure
needed to metabolize the massive revenues generated by exports, the
income must be stored in some sort of non-Chinese asset. Outstanding US
Treasury bills currently total $11 trillion, which - with the notable
exception of Japanese government debt, which very few foreigners even
touch - is greater than the next five government debt issues combined,
by a ratio of two to one. US debt outsizes combined euro-denominated
government debt by more than three to one.

Corporate debt isn’t much of an option either, even though the combined
global corporate debt market is sufficiently large to absorb China’s
currency reserves. Whenever an investor holds a substantial portion of
any company’s debt, market liquidity is constrained and trading dynamics
are altered. The solution is a highly diversified - and therefore
actively managed - portfolio. But the administrative cost of a
trillion-dollar portfolio so diversified that it does not affect the
value of any particular asset would be staggering. In contrast, US
government debt is a one-stop shop that requires - at most - minimal
management.

That China’s income is primarily in either dollars or dollar-linked
currencies only strengthens the rationale for pouring surplus income
into American assets in general, and US government debt in particular.
Plainly put, China cannot put its income anywhere else because there is
no other option available. There have been some mild attempts to
diversify, but a dearth of options means that "mild" is about as dynamic
as a diversification program for China can get.

As to a world beyond the dollar, the issue is that a reserve currency is
not decided upon; it creates itself. Two things are needed to create a
reserve currency. First, there must be sufficient liquidity to support a
global system. That requires a central bank with an enormous amount of
autonomy from a state government, and the US Federal Reserve is
unparalleled on this count. Not even the European Central Bank can
compete. Second, the economy upon which the currency is based must be
large enough to withstand fluctuations caused by other economies buying
and selling its assets in massive amounts. Again, the United States is
the only economy that potentially could qualify.

Part and parcel of any replacement of the US dollar would be a
large-scale abandonment of US Treasury bills as the core of Chinese
currency reserves, which - as the conventional wisdom holds - would
force intractable economic problems upon the United States. But a closer
look reveals that this is not the case. First, selling US Treasury bills
en masse simply is not possible. Every seller requires a buyer, and the
volumes at hand cannot be exchanged quickly. Second, starting down that
road would cause the value of the securities in question to plummet,
destroying the savings the Chinese have been building up for years. The
so-called "nuclear option" really is not an option at all.

So why are the Chinese bringing this up in the first place? Beijing
clearly has done the math already and knows that this idea - even if it
had broad support - is a nonstarter. There are two reasons. First,
officials in Beijing know that any direct confrontation - whether
military or financial - with the United States would end in disaster for
Chinese national interests. Therefore, they wants to foster anything
they can that would create an international structure to restrain
American power; failing that, something that just gets people thinking
in that direction will have to do. Second, China is more severely
affected by the ongoing financial crisis than it would like the world to
register. The Chinese need sustained international demand to maintain
their export industries and, consequently, their high employment levels.
Espousing rhetoric that makes it appear that you have more options than
you do, while redirecting attention toward a foreign power, always plays
well at home.

A Stratfor Intelligence Report.

http://www.realclearworld.com/articles/2009/03/chinas_calculated_currency_rhe.html


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