It now appears that the United States has
finally succeeded in its efforts to destroy
confidence in the US dollar. Given the currency's
reserve status, its ubiquity in financial markets,
and the economic power and political position of
the United States, this was no easy task.
However, to get the job done Washington
chose the right man: Federal Reserve chairman Ben
Bernanke. Thanks to Bernanke's Herculean efforts,
investors across the globe have now been fully
weaned from their infantile belief that the US
dollar will remain the ultimate safe haven
currency.
The proof of Ben's success can
be seen in comparing how the foreign exchange
markets reacted to the recent crisis in the Middle
East with how they reacted to the financial crisis
of 2008. Three years ago, investors looking for
safety abandoned their
foreign currency positions
and piled into the US dollar (the market for US
Treasury bonds in particular). As a result of
these fund flows, the US dollar surged 20% from
August to November 2008.
However, during
this latest round of global destabilization the
dollar experienced no such rally. In fact, the
greenback has shed about 5% of its value since the
Tunisia revolution began in December of 2010.
The reason should be clear; the Fed has
placed international investors on notice that it
will unleash even greater doses of dollar
debasement at the first whiff of additional
economic weakness, deflation threat, or dollar
appreciation.
Just this week, Bernanke
once again made clear that despite what he
considers to be a better growth outlook at home
and abroad, and spreading global inflation, the
United States will not pull back from monetary
accommodation, even as other nations conspicuously
do so. The architect of US monetary policy has
stated explicitly that dollar debasement will
continue for the indefinite future.
Knowing this, why would any international
investor seeking a "safe haven" choose to park
assets in US sovereign debt? If Bernanke is to be
believed, continued economic weakness in the US
will cause low-yielding Treasurys to lose value
due to inflation while the weakening dollar erodes
the underlying value of the bond in real terms.
This is a one-two punch that sane
investors will seek to avoid. It is no coincidence
that a record percentage of US Treasury auctions
are now being bought by central banks, for whom
sanity is a lowly consideration.
But in
reality, the Fed has much less influence over the
dollar's value than do central bankers in Beijing.
There is little disagreement among economists that
without Chinese support, the dollar would be a
dead duck. But for the last 20 years or so the
monetary arrangement that pegged the yuan against
the dollar served the interests of both countries.
The US enjoyed a flood of cheap imports, the
benefits of ultra-low interest rates, and a strong
currency. The Chinese received a booming export
economy, which accounted for about a third of the
country's GDP, and the ownership of a significant
portion of the future of the United States.
To maintain this peg, the People's Bank of
China has had to print trillions of yuan and
perpetually hold more than $1 trillion in US
dollars in reserve.
But recently, having
led to rampant money supply growth and inflation
in China, the peg has become more trouble than
it's worth, particularly from the Chinese
perspective. The latest reading on year-on-year
money supply growth has China's M2 increasing by
17.2%; which has helped send their reported
Consumer Price Index up 4.9% year on year.
Inflation in China is pushing up the
prices of its exports. According to the latest
survey released on February 14 from Global Sources
(a facilitator of trade with Greater China),
export prices of various Chinese products are
likely to increase in the months ahead, especially
if the cost of major materials and components
continues to soar.
The survey of 232
Chinese exporters revealed that 74% of respondents
said they raised export prices in 2010. The US
Bureau of Labor Statistics reported in early
January that its China import price index rose
0.9% in the fourth quarter after holding steady
for the previous 18 months. And Guangdong, the
biggest exporting province, said recently that it
would increase minimum wages by around 19% this
March.
Here is the rub; China maintains
its peg in order to keep export prices from rising
in dollar terms, but the peg is now causing export
prices to rise anyway. As a result, the policy is
a dead letter. The simple fact is that the threat
to China's exports will exist whether they let
their currency appreciate or not. But a strong
currency offers the benefit of greater domestic
consumption, while a weaker currency offers
nothing.
The Chinese government will take
the path that preserves and balances their economy
while enriching their entire population, rather
than go down the road to never ending inflation.
For China the realistic hope is that the greater
purchasing power of a strong currency will enable
their growing middle class to supplant US
consumers as the end market for China's own
manufacturing efforts.
However, for the US
the challenge will be to develop a diversified
manufacturing base in an expeditious manner before
surging interest rates, a plummeting dollar and
soaring inflation overwhelm the economy.
The dollar's recent reaction to the
turmoil in the Middle East and China's inflation
problem illustrate that we have come to a
watershed moment in American history.
The
decade beginning in 2010 should prove to be the
decade in which the US dollar loses its status as
the world's reserve currency. As bad as that blow
may be, the loss may provide the shock needed to
get its economy back on a sustainable path. The
real danger lies in refusing to adapt to the
changing environment. The country's current
economic stewards are acting as if the dollar's
status is written in stone, when in fact it's
hanging by a thread.
Michael
Pento is senior economist and vice president
of Managed Products, Euro Pacific Capital. For
in-depth analysis of this and other investment
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Schiff's free newsletter. Click here
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commentary and market news is available at http://www.europac.net.
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