by gjohnsit, posted with permission
The fact that this announcement came out just one day after the Federal Reserve committed itself to printing money by the trillions, is not a coincidence.
(Reuters) – A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar.
Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.
. . .
“It is a good moment to move to a shared reserve currency,” he said.
If you think this is just some rogue panel, think again. It has the backing of our main Asian rivals.
(Reuters) – China and other emerging nations back Russia’s call for a discussion on how to replace the dollar as the world’s primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.
Calls for a rethink of the dollar’s status as world’s sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.
Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decisionmaking globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed.
“They (China) did not formally put forward their position for the G20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency),” the source told Reuters, speaking on condition of anonymity.
Sounds like the G20 summit next month is going to be interesting.
Meanwhile the Persian Gulf OPEC nations are preparing for their own common currency to be started right around the time we will be pulling our troops out of Iraq.
This brings up the questions of what it all means? To answer that you have to look at what caused this situation to arise.
The End of Bretton Woods II
To quote political economist Daniel Drezner:
“Under this system, the U.S. is running massive current account deficits to be the source of export-led growth for other countries. To fund this deficit, central banks, particularly those on the Pacific Rim, are buying up dollars and dollar-denominated assets.
Critics of this monetary system (such as myself) always assumed that our foreign creditors would one day choke on all those dollar-based debts they were forced to buy with their recycled trade surpluses. It seemed counter-intuitive that countries like China would forever sink nearly all of their profits funding America’s overconsumption while their people lived in poverty.
I was wrong. So were the other critics. Our foreign lenders, with only a couple minor exceptions, have never slackened their appetite for our dollar-based debt. China may complain once in a while, but there was never any serious measures taken to ween themselves off of dollars.
The reason is because dollars are still the premium hard currency in the world. Just like savings in a fractional-reserve banking system, or gold in a central bank vault, foreign nations need our dollars (and dollar-based debts) in order to feed their own internal credit markets. Plus, the very nature of a debt-based currency requires a constantly growing economy in order to service the debts, and a growing economy requires credit.
All those Asian nations intentionally suppressed domestic labor unions and working salaries in order to undercut competition for shares of the American consumer market. This allowed them quick access to dollars, but prevented them from creating domestic demand of their own.
So if our foreign creditors are unable, or unwilling, to stop buying our dollar-based debts, then why should Bretton Woods II ever end?
The reason it is ending is because of the other side of the ledger – the American consumer.
The last couple days have witnessed an epic collapse in the American consumer’s purchasing power. Never before has retail sales fallen so far and so fast.
This is happening because the various asset bubbles have burst (housing and stocks), and the American consumer is no longer able to borrow against those assets to fund a lifestyle that his/her salary couldn’t afford.
Rehashing the troubled American consumer is probably old news to you by now. It’s been done to death.
However, what isn’t talked about much is how this effects our foreign creditors.
Remember, they buy our dollar-based debt from their trade surpluses with us. Thus America must live and consume foreign goods far beyond its means for this dysfunctional system to continue.
So what happens when foreigners can’t sell their cheap goods to America?
Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October.
. . .
“This is no regular cycle slowdown, but a complete collapse in foreign demand,” said Lindsay Coburn, ING’s trade consultant.
Vast naval fleets of empty container ships are anchored in the ports of Singapore and Hong Kong. Almost nothing is moving, and even if it does, it is selling at below cost.
The unsustainable in the long-term is becoming the unsustainable in the short-term.
Shippers can’t afford to ship product “at cost” for long, and producers can’t afford to sell product “at cost” for long.
Meanwhile America’s trade deficit is shrinking fast.
Normally this is not a big deal. The weak go out of business. The strong takes them over. Bad debt is washed out of the system. Capitalism moves on.
However, we don’t have a non-dysfunctional monetary system. We have a very dysfunctional one that requires the American consumer to keep buying things he doesn’t need with money he doesn’t have. Without our wasteful consumption of their goods our foreign creditors have neither the means nor the reason to keep buying our debt. Bretton Woods II breaks.
The Bretton Woods 2 system – where China and then the oil-exporters provided (subsidized) financing to the US to sustain their exports – will come close to ending, at least temporarily. If the US and Europe are not importing much, the rest of the world won’t be exporting much.
And rather than ending with a whimper, Bretton Woods 2 may end with a bang.
The federal government is trying to offset the drop in economic activity with increased borrowing and spending. However, that just puts more strain on the system because a) it doesn’t do much to restore the falling trade deficit, thus not putting many new dollars in the hands of our foreign creditors, while at the same time b) it requires much more borrowing from our foreign creditors.
Where will our foreign creditors get the money to loan us if they don’t have significant trade surpluses? If they don’t loan us the money, where will the federal government get the cash to fund stimulus packages?
Doing the math
Yesterday’s Treasury International Capital (TIC) report was a disaster.
Net foreign purchases of long-term securities were negative $43.0 billion.
. . .
Foreign holdings of Treasury bills decreased $15.4 billion.
Monthly net TIC flows were negative $148.9 billion. Of this, net foreign private flows were negative $158.1 billion, and net foreign official flows were $9.2 billion.
To put this into context, America’s savings rate is barely above zero. We need massive amounts of the world’s savings to fund our lifestyle – an estimated $2 Billion a day, 365 days a year.
Therefore, the TIC flows need to be a positive $30 Billion a month just so America can continue to tread water. Negative numbers are something that cause all sorts of problems. And negative numbers are what we’ve been getting on a regular basis recently.
|Domestic Securities Purchased, net|
On the other side of the equation is supply – which is something we have no shortage of.
His budget plan projects a federal deficit of $1.75 trillion for 2009, or 12.3% of the gross domestic product, a level not seen since 1942 as the U.S. plunged into World War II.
All that deficit spending requires someone to buy that debt (in the form of treasury bonds). This tsunami of debt issuance is creating distortions in the bond market.
For instance, premiums on newly-issued treasuries over off-the-run securities have tripled. This is a reflection of increased risk. The credit default swap (insurance against the risk of default on debt payments) on treasuries has increased seven-fold over a year ago.
That increased risk was reflected by the statements of the Chinese Premier just last week.
“We have lent a huge amount of money to the United States,” Wen said at a press briefing in Beijing today after the annual meeting of the legislature. “Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”
. . .
“China is worried that the U.S. may solve its problems with the fiscal deficit and banks by printing money, which will stoke inflation,” said Zhao Qingming, a Beijing-based analyst at China Construction Bank Corp., the country’s second-biggest lender.
And printing money out of thin air is exactly what the Fed promised to do yesterday, to the tune of $1.2 Trillion.
For the moment China is still purchasing treasuries, but 95% them are short-term. That’s why the Fed announcement yesterday was about long-term treasuries – because not enough people were buying them.
Quantitative Easing: refers to the creation of a pre-determined quantity of new money ‘out of thin air’ through open market operations by a central bank as the start of a process to increase the money supply.
Let me refer back to the pie chart above. Even before this latest crisis America was absorbing 75% of the world’s savings just to maintain our lifestyle.
Now our trade deficit has been cut in half, but the federal government has tripled its deficit spending. Thus our borrowing needs have gone up while the amount of dollars the world has to recycle back to America has dropped.
The numbers don’t add up! Or to put it another way:
In the latest data, 90% of the dollars going to foreign countries to pay for the U.S. trade deficit was being reinvested in U.S. government debt. While mathematically that ratio can rise to more than 100%, practicality means it can not. A ratio of more than 100% would mean governments are investing more dollars than they are receiving in U.S. debt. In short, they would have to take dollars away from their citizens in order to help finance the U.S. government. That probably is not going to happen.
Should the U.S. trade deficit continue to shrink, the amount of U.S. debt to be bought by foreign central banks will fall. Unless the U.S. trade deficit rises, the amount of U.S. debt that can be bought by foreign institutions will be capped. In short, the supply of money for the U.S. government from gullible foreign official institutions is being capped at a new, lower level.
That means Obama will need to turn to the Federal Reserve to monetize a goodly portion of the more than $2+ trillion deficit of the U.S. government in the year ahead.
Putting it all together
Let me summarize this for you:
The Federal Reserve didn’t make the move yesterday because it wanted to. It made it because it had to. Our foreign creditors are either unable or unwilling (probably a combination of both) to keep funding our increasingly large and irresponsible deficit spending.
Our foreign creditors are going to take a bath on their dollar-based assets when the Federal Reserve starts monetizing the Treasury and Agency debts. They aren’t happy about that, nor should they be.
If this keeps up then America will lose its position of having the world’s reserve currency. If nothing has changed by 2011 you can bet that this danger will become a reality.
What does that mean? It means that when we want to buy oil from the Persian Gulf we won’t be able to just print dollars. We’ll have to use either another currency (which we don’t presently have), or sell goods that the rest of the world wants (which we don’t presently have an industrial base to create), or simply do without.
Can you imagine what would happen to the American suburbs without cheap energy? Can you imagine what would happen to the northern states if they can’t get heating fuel in the winter at a price that retirees can afford? Or how about the farming states if they can’t afford to run their farming equipment?
We are rapidly approaching the “no bullsh*t moment”. America can either learn to live within its means and suck up the pain, or the rest of the world is going to learn to live without America.
If that happens we are going to discover that we need the rest of the world more than it needs us.
Seriously. Is the rest of the world incapable of eating too much, drinking too much, spending too much, and consuming too much? Because that seems to be America’s role in the world. Don’t you think other nations would rather give it a try being wasteful?