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3 Careful what you wish for, China may grant
it By Julian Delasantellis
markets for domestically traded
goods would cause a dramatic spike in inflation.
Therefore, the Chinese have decided to let
most of their export proceeds rest comfortably as
reserves, currently at a world-topping $1.2
trillion (growing at a rate of a billion dollars a
day), at the central People's Bank of China.
When, as World War II drew to a close, it
became obvious that a new international financial
architecture would be needed to fund
the
postwar world, allied financial chiefs gathered at
Bretton Woods, New Hampshire, to hammer out what
became known as the Bretton Woods accords.
These replaced the gold-centered prewar
international financial structure with fixed
exchange rates focused around the US dollar. When
this system collapsed in the early 1970s, it led
to the introduction of the current system of
variable, market-derived exchange rates. In this
system, the currencies of countries that run large
trade surpluses, such as the China, were supposed
to appreciate in value, thus making it cheaper for
their citizens to purchase imports; countries that
ran big trade deficits, such as the US, would see
their currencies fall in value so that,
eventually, they would not be able to afford so
many imports.
Like the water levels in the
opened locks of a canal, eventually, the system
intended that the countries with trade surpluses
and deficits would see their numbers equalize, and
the system would eventually balance itself without
any government intervention.
This has not
happened with the Chinese/US trading relationship
of this decade. The Chinese currency, the yuan,
does not "float" in value, as do such currencies
as the euro or pound. For many years it was fixed
at a rate of about 8 yuan to the dollar (meaning
that each individual yuan was worth 12.5 cents).
Over the past year or so, it has been allowed to
rise to 7.62 yuan per dollar, meaning that each
individual yuan has gone up all the way to be now
worth 13.1 US cents.
This meager yuan
appreciation is not nearly enough to reverse
Chinese trade surpluses, which are still growing.
Instead, a new international financial
architecture seems to have developed, one that
economists Nouriel Roubini and Brad Setser, on
their weblog RGE Monitor, call Bretton Woods 2.
Here's how Bretton Woods 2 works. China
(or the other, lesser players in this game, Japan,
Taiwan and South Korea) does not sell its
export-earned dollars. Rather, it banks them.
Without this excess selling pressure, the dollar
does not fall in value against the yuan; it
remains stable, which allows American consumers to
continue their monthly billion-dollar overseas
spending spree. Chinese factories keep humming,
employment is strong, the Chinese people are far
too content buying new stuff to come out to
protest again at Tiananmen Square, and China's
Communist Party rulers are very happy about that.
This is much like what happened with the
billions of petrodollars that were raised by
oil-exporting countries after the oil-price rises
of the 1970s. The billions of dollars of China's
current export earnings get sent back to the US,
mostly to be invested in Treasury securities. This
keeps dollar interest rates, including mortgage
rates, lower than they would have been, and this
keeps the US economy humming and the consumer,
still fat, dumb and happy, flush with cash and
plastic to keep the cycle going for at least one
more round.
But no human agency or
endeavor lasts forever. The internal
contradictions of Bretton Woods 1 caused it to
fall, and the same seems to be happening with
Bretton Woods 2. Specifically, what if China
doesn't want 1.2 trillion in US dollar reserves?
Bretton Woods 2 greatly benefited Bush
administration officials, by both pressuring wage
rates to help out their business buddies and
spurring the economic growth that got them
re-elected in 2004. Still, it is somewhat
embarrassing to be the president of the nation
with the most massive trade deficits in history.
Like spoiled rich kids since time immemorial, the
Bush administration is blaming somebody else.
The administration, along with its
mouthpieces in the corporate conservative media
machine, is arguing that, even with a huge budget
deficit and virtually non-existent national
savings, the trade deficit is not America's fault.
It's not that the US is spending too much and
saving too little, it's that the surplus
countries, especially China, are saving too much
and spending too little.
This
interpretation of savings as bad is certainly new
in the working theory of capitalist economies; in
classical economics, savings are a very good
thing, since the market can direct them to future
investments that will maintain economic growth. A
rough parallel would be an inebriate claiming that
he doesn't have a problem, it's the rest of the
world that suffers from inadequate alcohol
consumption syndrome.
But in business, the
customer is right even when he's not, and the
United States is now far and away China's biggest
customer. For example, it is now estimated that up
to 70% of Wal-Mart's inventory is of Chinese
origin; a remarkable turnaround for a company that
until this decade broadcast advertisements that
trumpeted the red, white and blue all-American
manufacture of its products. Wal-Mart's current
trade with China alone, estimated at more than $25
billion a year, surpasses the GDP of the smallest
112 national economies of the world.
In
letting the yuan appreciate, although maddeningly
slowly, China is responding to demands for action
from US officials, especially in Congress. Another
demand is that China stop just letting its huge
stash of foreign-currency reserves sit around
earning interest. They should go out and buy
American stuff, preferably goods and services, so
that the trade balance can start to equalize.
But as the Greek gods warned, be very
careful what you wish for.
In my July 6,
2006, article Hedge funds: Playing dice with the
universe, I explained how hedge funds,
very lightly regulated pools of private capital
used as high-octane investment vehicles to the
world's supranational moneyed elite, were having
more and more impact on events in the world's
financial markets. I postulated that hedge funds
acting in unison may have been a prime cause of
the May 2006 cross-border equity-market meltdown.
It was estimated then that, collectively, the
thousands of the world's hedge funds had more than
$1 trillion in assets under management.
That's just about what the single
personage of Zhou Xiaochuan, the governor of the
People's Bank of China, has at his disposal for
investment from foreign-exchange reserves.
Last year, the big chatter in the world's
financial markets was over the growing power of
hedge funds, and how their huge concentrated
financial resources had the possibility of
dwarfing any or all governments' ability to
regulate national markets. This year, a new
specter haunts the markets, one whose potential
impact on markets far exceeds the puny $1
trillion-plus that the hedge funds have at their
disposal.
They're called sovereign wealth
funds (SWFs). Basically, it seems that many of the
countries that lately have accumulated huge
foreign-exchange reserves exporting to the United
States are getting bored with just having their
money sit around earning interest at US Treasury
rates. China and the other big exporters, which
until recently were seemingly happy at lending
back to the US the dollars to continue to buy
their stuff, now see the need to earn greater
rates of return than the 5% that US Treasuries
currently earn.
Many of them are facing
demographic time-bombs consisting of their growing
elderly populations needing eventual pension
support, and, for all the glamour and glitz of
today's Shanghai, going beyond China's big cities
still reveals grinding rural poverty that the
central government knows it must address.
SWFs will act as super-hedge funds, in
that they will look for opportunities all across
the investment spectrum. China is in the
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