"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Tuesday, September 28, 2010

China - US Currency conflict escalates... former adviser to the PBoC says US Dollar "One Step Closer" to a Crisis

From Bloomberg:
Dollar Is `One Step Nearer' to Crisis on Burgeoning Debt Burden, Yu Says

The U.S. dollar is “one step nearer” to a crisis as debt levels in the world’s largest economy increase, said Yu Yongding, a former adviser to China’s central bank.

Any appreciation of the dollar is “really temporary” and a devaluation of the currency is inevitable as U.S. debt rises, Yu said in a speech in Singapore today.

“Such a huge amount of debt is terrible,” Yu said. “The situation will be worsening day by day. I think we are one step nearer to a U.S.-dollar crisis.”

Yu also said China is worried about the safety of its foreign-exchange reserves including those invested in U.S. Treasuries as the U.S. currency weakens, reiterating his earlier views on the dollar assets. The U.S. will record a $1.3 trillion budget deficit for the fiscal year ending Sept. 30, the Congressional Budget Office said Aug. 19.
Article continues:
Reduced U.S. Holdings
China, the biggest foreign investor in U.S. government bonds, cut its holdings by about 10 percent to $846.7 billion in the 12 months ended July, according to the Treasury Department
U.S. Treasuries fail to provide safety or liquidity in managing China’s $2.45 trillion foreign-exchange reserves, Yu said in an e-mail in August. To help cool demand for the securities, China needs to curb the growth of its foreign reserves by intervening less in the currency market, he said.

China should reduce its holdings of U.S.-dollar assets to diversify risks of “sharp depreciation,” Yu said in July. The nation should convert some holdings in U.S. dollars into assets denominated in other currencies, commodities and direct investments overseas, he wrote in a commentary in the China Securities Journal.
My view:

China's purchases of US Treasuries do not fund the US.   Sounds crazy?  It's true.  China DOES NOT FUND THE US.  The US, unlike individual countries in the European Union, controls the issuance of its own currency, and issues debt in its own currency.  What that means is that the US can print as much money as it wants to pay off that "debt."

But that's where the problem lies.  Modern fiat money relies on the myth that nations that issue their debt in their own free floating currency they control, still have to abide by "budgetary constraints."  They don't.  But, if they do flaunt budgetary constraints, and print at will, and allow debt to gdp figures to go through the roof, then they face other issues.

What do they face?  They face the wrath of currency traders, of trading partners, and the wrath of the sovereign bond market participants that actually erroneously believe that the US has a funding problem.  Kind of ironic, is it not?  The myth of fiat money becomes its downfall.

In the end, the US national government will never face a budgetary crisis, unless Congress decides to avoid paying its bills.  Rather, the US faces a currency credibility issue.  Yes, the US can do whatever it wants with its currency.  But that doesn't mean the rest of the world will abide by that.  No one likes a free rider.  And when a fiat money system no longer "looks sustainable" that's when issues arise.  That is, the myth of fiat still needs to resemble a real, sustainable system.  That's why we use terms such as "credit" and "full faith", etc...

In another post, I will describe how the US ended up like this in terms of, trade and budget deficits.  The bottom line is, the US hosts the world reserve currency, the US Dollar.  Hence, it must constantly run deficits in order to facilitate the growing global economy for the rest of the world.  It's called the Triffin Dilemma.  As I said, I will discuss in another post... to be continued...

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