The Coming Confrontation Over the Dollar
By Jacek Popiel
An interesting article was published in the Financial Times on May 5th. Titled If China Loses Faith the Dollar will Collapse, written by Mr. Andy Xie, an economist in Shanghai, the article clearly points to the next phase of the global financial crisis.
In many ways the US and China are the main actors in the developing financial crunch. The US, through its trade and budget deficits, has pumped huge amounts of dollars into the global system. China, on the other hand, has soaked up these dollars through its large trade surpluses, accumulating over a trillion and a half in foreign currency reserves, most of which are dollar-denominated.
In the recent past this arrangement has served both countries well, allowing them to pursue their chosen economic and fiscal policies. But it has also created the huge financial imbalance which is at the root of the current crisis. And because of the crisis the collaboration between the two powers is quickly morphing into confrontation.
On the Chinese side, the accumulated dollar reserves are critical to the country’’s further development. As the Chinese economy grows it needs increasing amounts of foreign currency to purchase the raw materials, such as oil and industrial metals, it no longer produces in sufficient quantities.
It also needs the money to acquire the technologies, equipment and armaments it is not yet capable of developing on its own. To pursue its industrial growth and its strategic expansion China therefore needs its monetary reserves to keep their current value. In practice, this means a strong and stable dollar.
The US, on the other hand, is in the grip of a financial meltdown and a severe recession. The Federal Reserve has chosen to cure the financial problems by vastly increasing the amount of liquidity in the financial system, printing or creating money by fiat if necessary. The Obama administration is fighting the recession by the same methods: huge budget deficits and stimulus programs to jump start the economy and revive private consumption.
To put it simply, the US is attempting to inflate itself out of the crisis. As this is rapidly increasing the amount of money in circulation, the dollar will inevitably lose value.
The economic and fiscal policies of China and the US are thus incompatible: if the US policy is maintained, Chinese dollar reserves will decline in value with respect to the goods China needs; but the only way for the dollar to remain stable is for the US government to abandon or sharply curtail its anti-recession policies. At this point neither side is giving in. In fact they do not appear to even be talking about this major issue.
The Chinese government has, for the last six months, attempted to draw American attention to the problem, through official statements as well as large purchases of gold and strategic materials. Mr. Xie’’s article has no overt tie to Chinese government policy, but its publication in the world premier financial newspaper gives food for thought.
As written, it is a clear warning to the United States. It is doubtful the Chinese government would let such a statement go by unless they at least tacitly approved of it.
It is unlikely that the US government will pay attention, being preoccupied with the domestic situation and believing the Chinese do not really have a choice but to continue buying dollar-denominated US government debt.
But the Chinese have already made their position clear: they will not tolerate a devaluation of the US currency and of the dollar reserves they already hold. They are thus likely to ratchet up both rhetoric and action, with the intensity of the dispute quickly escalating.
The danger here is not an overt confrontation or an economic war. More likely, in the absence of mutual understanding and compromise, one of the parties will try to make its point through a move the consequences of which have not been foreseen. Such a move could roil the markets sufficiently to initiate a run on the dollar, potentially crashing the entire world financial system.
The world financial situation is still extremely unstable. It could take only a minor miscalculation to start another major panic, with consequences far more severe than anything that has happened so far.
About The Author
Jacek Popiel was born in Poland and educated in Africa, Canada, and the US. His career spanned military service and international business development. He is a writer and first book Viable Energy Now will be published in the coming weeks. http://voyons-potsdemiel.blogspot.com/