2004 December 05 Sunday
Japan And China In Economically Dysfunctional Relationship With United States
James Brooke and Keith Bradsher of the New York Times have written a good article on the enormous US bond holdings of China, Japan, Taiwan, and South Korea and on whether the East Asian nations will continue to prop up the US dollar.
As in Japan and China, small groups of civil servants in Taiwan and South Korea are struggling to invest sizable foreign currency reserves of $235 billion and $193 billion, respectively. For years, all four countries have held the bulk of their reserves in the Treasury bills, notes, and bonds that finance the federal budget deficit, leaving American consumers and companies free to spend more on other things and invest their spare cash in more promising ventures.
Together, these Asian institutions are responsible for holding roughly 40 percent of the American government's public debt.
In contrast to Japan, China's money managers, while selling little of their existing Treasury holding, have not been buying much more. China's foreign currency reserves rose by $111.3 billion in the first three quarters of the year, according to official Chinese data. But its Treasury holdings, American filings show, climbed by only $16.4 billion.
Japan holds $720 billion in US Treasuries.
The Japanese are in an especially difficult place. They have to keep buying to protect the value of the dollar in order to protect their dollar holdings. But that costs large amounts of money every year with no way to stop it short of letting the dollar decline against the Yen.
The Chinese and Japanese governments are whispering loudly that the US government should act more fiscally responsible. But that is like a drug dealer telling a junkie that the junkie ought to quit so that the dealer can stop feeding his habit. Except this relationship is more like addicts on both sides feeding each others' addictions. The Japanese and Chinese have addicted themselves to the strong dollar while the US government has addicted itself to deficit spending. The Chinese and Japanese fed the US addiction by allowing the US addict to behave in a fiscally wreckless manner without paying the price of higher interest rates.
What does the U.S. stand to gain by becoming more fiscally responsible so long as foreign debt holders continue to finance its recklessness? Nothing, especially in the short term--the fix is going to have to come from the debt holders. It seems inevitable that funds will continue to dry up, forcing the dollar lower; exactly what the U.S. needs to balance the trade deficit. Less luxurious living conditions are a necessary price to pay for a fundamentally stronger, more sustainable economy in the future. But obviously the government won't make that happen--global market forces will.
One reason China and Japan need a stable dollar is because they use these dollars to buy many raw materials,
including oil, by using the US currency. So far, the main currency for buying raw materials is the US currency.
To get these extra dollars, China and Japan need the Americans to incur a certain amount of foreign trade deficit every year.
This need for raw materials, and the obligation to pay for the raw materials by using US dollars, forces the
foreigners to work for the USA essentially for free, in exchange for the dollars we export in exchange for the
cheap goods we consume. Since the rest of the world, is expanding, as long as the US annual trade deficit is kept
small, this should NOT cause a terrible decline in the value of the US currency. Recall that the US dollar actually
appreciated tremendously before 2000, and it is only natural if it declines even some more than during the last couple of
years. As long as the global money supply does not increase dramatically relative to the size of the world economy,
these foreign-owned dollars should not be a problem. But the trouble is that the world is becoming saturated by US
dollars, every year, by as much as 5 % of the US GDP. Compared to the rest of the world, this IS a large addition to the
foreign money supply every year. If the raw materials finally become impossible to buy due to the devaluation of the US
dollar, then China and Japan will suffer immeasurably, and this is when the US dollar can become totally discredited,
leading to a panic and chaos.
Both sides are locked into a game of deadly double-bluff,real "who blinks first" stuff.
Should be an interesting situation for the exponents of mathematical game theory to analyse.
Quoting from the above article:
"..Over the past 15 years, the overall US deficit with the rest of the world has risen to $2,700bn - an abuse of its privileged currency position. Although about 80% of foreign exchange and half of world trade is in dollars, the euro provides a realistic alternative. Euro countries also have a bigger share of world trade, and of trade with Opec countries, than the US.
In 1999, Iran mooted pricing its oil in euros, and in late 2000 Saddam made the switch for Iraqi oil. In early 2002 Bush placed Iran and Iraq in the axis of evil. If the other Opec countries had followed Saddam’s move to euros, the consequences for Bush could have been huge. Worldwide switches out of the dollar, on top of the already huge deficit, would have led to a plummeting dollar, a runaway from US markets and dramatic upheavals in the US.."
The author was a key British civil servant involved in North Sea oil planning.
It appears China is not standing still while waiting for the "who blinks first" scenario:
"..By the end of 2010, all Chinese cities will be expected to reduce their buildings’ energy use by 50 percent; by 2020, that figure will be 65 percent. Furthermore, by 2010, 25 percent of existing residential and public buildings in the country’s large cities will be retrofitted to be greener; that number will be 15 percent in medium-sized cities and 10 percent in small cities. Over 80 million square meters of building space will be powered using solar and other renewable energies.."
I would advise all oil-consuming countries to immediately undertake a similar program in a bid to alleviate financial and resource pressures. We cannot afford to continue with the status quo. Those who make the switch will provide a new era of prosperity and security for their fellow citizens.
"In 1999, Iran mooted pricing its oil in euros, and in late 2000 Saddam made the switch for Iraqi oil. In early 2002 Bush placed Iran and Iraq in the axis of evil. If the other Opec countries had followed Saddam’s move to euros, the consequences for Bush could have been huge. Worldwide switches out of the dollar, on top of the already huge deficit, would have led to a plummeting dollar, a runaway from US markets and dramatic upheavals in the US.."
In my opinion, the fear that the Middle Eastern oil will be priced in euro instead of the US currency, was the main
reason Bush invaded Iraq, as a first step to threatening all the Gulf nations .
Note that Saudi Arabia is ALREADY dumping the dollar reserves, at a slow rate, replacing the dollars with other
currencies, especially euros. This is the main reason the US would be in grave danger if Al Qaeda takes over Saudi Arabia, not
only because this would make it very difficult for the US to buy oil, but all the $500 billion per year annual trade deficit
will be impossible to continue if the world does not need dollars in order to buy raw materials, since this is one of the main
reasons they export cheap goods into the US in exchange for printed money.
The Chinese (PRC) currency should go up in value relative to the US dollar.
"Chinese Computer Maker Acquires IBM's PC Biz" is posted here.
Randall, do you think this purchase should be blocked by the US federal government (if that's possible)?
China is becoming a larger market for PCs than the United States. They have huge supplies of engineers. I expect Chinese PC makers to eclipse US makers regardless of whether this sale happens.
If a move out of the dollar were to snowball, this would make it so cheap against the currencies of Japan,SK, Taiwan and China, that their export manufactures would be shut down by 30, 40, even 50% or more. That would be the worst situation economically for them, if it were to happen during the course of a year or so. To these countries, it would seem worthwhile to buy up as many dollars as other countries wanted to get rid of, and hold them as reserves in their central or other banks. To an extent, this is what several of these countries, but Japan more than the others, are doing. They developed their economies by increasing exports however they could, but the market for further expansion is not currently a paying one; these countries, as a group, can today grow by exporting on credit. The danger is that their economic level depends on our irresponsibility; no good can come of that.
John, isn't the PRC's currency "pegged" to the US dollar? I think that the Japanese and South Korean currencies do fluctuate in value relative to the US dollar.
The PRC's currency needs to increase in value.
I meant a move out of the dollar broad enough to include China, and central banks not supporting it. Some of this support is indirect and somewhat hidden. An artificial interventionist approach, which has been used in Asia by several fast-growing, or formerly fast-growing, countries, is coming to its end. It involves making producer fixed investment the all-important central priority, and getting export manufactures to increase by any means, including taxing their economy 10% to support the dollar, as Japan does. China is so late to this method, that they will run up against the fact that there is no paying market for any great increase in their exports. The only open market of any size, has to pay with consols, or whatever you would call the US method of payment.