China stuck in ‘dollar trap’

– Yes, as I see it, China is in a fatal embrace with the U.S.   Now that the two of them have engaged with each other, neither can let go without a major problem.  The U.S. needs China to keep buying our government debt so we don’t collapse and China has to keep buying our debt or it risks a severe devaluation of what it has already invested in the U.S. dollar.   Moody’s sees the problem here and is beginning to talk about taking the U.S.’s rating down a notch from the current top-tier Triple A rating it has now.

– And I’m not the only one who see this.   Check this quote from an article about Niall Ferguson new book, The Ascent of Money in Vanity Fair:

How badly could the Chinese screw us if they wanted to?

Well, they would have a difficulty in that they would kind of be screwing themselves. This is their dilemma. There’s a sort of “death embrace” quality to this, I think that someone’s talked about mutually assured financial destruction. The Chinese have got, we know, reserves in the region of $1.9 trillion, and 70 percent [of it is] dollar denominated, probably. That’s a huge pile of treasury bonds, not to mention Fannie and Freddie debt that they’ve accumulated over the last decade, when they’ve been intervening to keep their currency weak, and earning these vast amounts of foreign currency by running these trade surpluses. Now, politically, it might be quite tempting for the Chinese to phone up and say, “We really disagree with you about, let’s say, Taiwan and Japan and North Korea. You’d better listen to us, because otherwise, People’s Bank of China starts selling ten-year treasuries, and then you guys are dead.”

But then their investments become worthless.

Then you lose about five percent of China’s GDP, and that’s a hard sell—even for an authoritarian regime. So, they have a dilemma, and they are discovering the ancient truth that, when the debt is big enough, it’s the debtor who has the power, not the creditor.

But, then again, these things aren’t always the result of calculated policy, decisions. There’s a sense in which a catalyst elsewhere could force the hand of People’s Bank of China. It doesn’t need to be the Chinese who start the run of the dollar. It could be Middle Eastern investors.

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By Jamil Anderlini in Beijing

China’s official foreign exchange manager is still buying record amounts of US government bonds, in spite of Beijing’s increasingly vocal fear of a dollar collapse, according to officials and analysts.

Senior Chinese officials, including Wen Jiabao, the premier, have repeatedly signalled concern that US policies could lead to a collapse in the dollar and global inflation.

But Chinese and western officials in Beijing said China was caught in a “dollar trap” and has little choice but to keep pouring the bulk of its growing reserves into the US Treasury, which remains the only market big enough and liquid enough to support its huge purchases.

In March alone, China’s direct holdings of US Treasury securities rose $23.7bn to reach a new record of $768bn, according to preliminary US data, allowing China to retain its title as the biggest creditor of the US government.

“Because of the sheer size of its reserves Safe [China’s State Administration of Foreign Exchange] will immediately disrupt any other market it tries to shift into in a big way and could also collapse the value of its existing reserves if it sold too many dollars,” said a western official, who spoke on condition of anonymity.

The composition of China’s reserves is a state secret but dollar assets are estimated to comprise as much as 70 per cent of the $1,953bn total and China owns nearly a quarter of the US debt held by foreigners, according to US Treasury data.

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2 Responses to “China stuck in ‘dollar trap’”

  1. MD says:

    Grasshopper,

    Read “The Dollar Crisis”. It explains things very clearly.

    M

  2. Dennis says:

    M.,

    So, is it like I suspect – a fatal embrace – or is it different?

    Dennis