Vol. 12, No. 3,009 - The American Reporter - October 19, 2006

Blue Money

by Paul Petillo
American Reporter Correspondent
Portland, Ore.

Printable version of this story

PORTLAND -- Wen Jiabo is not impressed. The prime minister of China, one of the largest customers of United States Treasuries said it best when he asked, "shouldn't the relevant authorities be doing something about this?" He was speaking to the decline of the dollar, a perilous three year slip that has cost Jiabo's government billions in lost profits on their currency investments while adding billions to their surpluses.

John Snow, the in-again, possibly out-soon Secretary of the Treasury has been spreading a message of understanding to anyone willing to suffer the repetition that a falling dollar is not what the United States wants. His acknowledgment that deficits do matter and that the White house has promised not only him but the American people, that they will do something about it, has done little to reassure the world that anything will happen. Questions are beginning to surface about this self proclaimed deficit hawk and the largely powerless agency he heads.

Mr. Snow has his eye on the current account, a burgeoning figure that forces us to offer $600 billion in IOU's every year just to cover the gap created by trade imbalances and the flow of money into and out of the country. As Mr. Snow watches, the dollar continues to fall.

President Bush took his town hall meetings to the Europeans this past week. (He was, it is speculated, going to need to convince the world's financial institutions that his idea for reforming Social Security is prudent. He will be asking these countries to finance his plan to allow Americans to invest in the stock market, a request that will be valued in trillions of dollars. He will also need to portray his free spending administration as economically responsible enough to undertake such an overhaul.)

Much anticipation preceded his arrival as many wondered how the world stage would embrace, if at all, the second term president who was traveling well outside of his political comfort zone. Mr. Bush was seeking several things, among which was an economic handout for his agenda of liberty and freedom, largely perceived across Europe as terms that indicate possible further military action.

South Korea decided on Monday, in the midst of the European tour, that now was as good a time as any to an announce a shift in their rate of currency purchases. While South Korea is not the largest customer of U.S. debt, it is a player of significant repute. The suggestion that they needed to diversify their holdings to include other currencies sent the dollar tumbling. With almost 80% of the world's savings fueling our voracious stateside consumption, it was little surprise that such news was not met with enthusiasm in the currency pits.

A quick reversal of intention the following day had the ring of hollowness to it. The currency traders, mistakenly assumed by both Mr. Bush and Mr. Snow to be rational, even orderly investors, showed their concern over the lack of interest by both men and panicked at the news. They worried that the South Koreans could be at the front of a possible shift in international sentiment.

European leaders, as well as the largest Asian investors were hoping for some sort of announcement from the President to have a currency summit, a meeting that would stabilize of the dollar while the international community discussed what could be done. Instead there was no offer of talks and the dollar reacted in kind, falling further.

Analysts were quick to tell the markets that South Korea was a non-player in the currency world, holding only $69 billion in U.S. debt. Any suggestion that they might not be as interested in their continued purchase of U.S. debt is important for three reasons: The world is worries that the economy of the United States will not be able to keep up the current pace of borrowing.

It is hard to imagine how we would react if we were forced into a reversal of policy. The United States is in need of $2 billion a day in foreign inflows just to stay afloat. Cutting that flow off would not be in the best interest of the world. Money needs to keep coming in to prop up our anemic growth or the economy will head into a tailspin. South Korea could have upset that cart and that would have created problems for China and Japan.

A change in foreign fund inflows from China would be devastating. If there was a sudden (or even gradual, for that matter) lack of interest in the dollar, it would affect the Chinese in numerous ways.

Their Yuan is pegged to the dollar. The further the dollar falls, the further the value of the Yuan falls. No one is quite sure that a change in that policy by the Chinese would help our deficits. Historically, such pegs to the dollar are done to lift the value of a currency, lend credibility to policy efforts and otherwise bail struggling economies out of a deepening malaise on the international markets.

China suffers none of those problems and the United States wants the Yuan to stand on its own. Could China be attempting to blur the economic borders between the United States much the way the Europeans have done with the Euro? While that is possible, other financial centers would be put under pressure to transfer their peg to the dollar. Hong Kong and Taiwan would be forced to go along if the pressure for a common world currency increases. As much as the Americans want to believe the strength of their dollar, even as it weakens, most world economist can see the inevitable shift to a common denominator other than the U.S. currency.

In case you may not have noticed, China has a interest in keeping the American economy growing, or at least giving the appearance of stability. A stable dollar only deepens the perception of growth as Americans finance almost $180 billion of goods from the Asian giant. I do not, however, believe the intentions of the Chinese.

Allowing the American dollar to exist as the pegged currency does not give the United States any real advantage over the Europeans in terms of trade. Nor does it force any real changes in how the Chinese run their government. What it does accomplish will be done under their communist regime, despite the President's wishes for a world democratic order. China has been keeping the income level for all of its citizens on the rise displacing any disparaging talk of dissent. Even the specter of inflation, a possibility that would rein in the low valuation of the Chinese currency seems, at this point in time, a non-event.

Hideo Kumano sees only chaos should the dollar fall further. The economist from the Dai-Ichi-Life Research Institute in Japan suggested that Mr. Bush did not have the ideological ability to step in and assume the mantle of economic leadership of the world. The world's leading economy, does not by default give the President automatic authority to assume the position.

The ensuing economic chaos that a continued decline in the dollar would cause would raise interest rates here at home, effectively grinding to a halt what was poised to be a lackluster year in terms of growth. Not only would an increase in interest rates, the first effect of a slowing of international interest catch most of America with little savings to speak of, it would unravel much of the perceived wealth in their homes.

In doing so, it would have the ripple effect of removing a major customer from the world markets, one whose willingness to borrow to not only money to buy what they want, but to also purchase what they need without a care for the consequence or even a nod toward the cost of serving the debt. That day of reckoning, many international bankers feel, is close at hand.

A further diminished dollar would lay bare the poor economic policies that have put this country in this precarious spot. Mr. Jiabo has good reason to be unimpressed - and maybe even worried. China, while still too young to assume the leadership role of the world's strongest economy, could find enough support in the marketplace to do just that.

Paul Petillo's latest book is "Building Wealth in a Paycheck-to-Paycheck World" (McGraw-Hill). He is the managing editor of BlueCollarDollar.com, a common sense approach to money.

Copyright 2006 Joe Shea The American Reporter. All Rights Reserved.

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