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The Coming Currency Shock
PostPosted: Wed Nov 17, 2004 11:19 pm Reply with quote
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November 16, 2004
The Coming Currency Shock

Declining Superpower Act


China's currency peg to the US dollar prevents correction of the US trade imbalace and imperils the US dollar's role as reserve currency.

In the post World War II period, the dollar took over the reserve currency role from the British pound, because the supremacy of US manufacturing guaranteed US trade surpluses. The British pound lost its role due to debts of two world wars, loss of empire, a run down industrial base, and socialist attack on UK business.

The reserve currency conveys unique advantages on the favored country. As the reserve currency, the US dollar is guaranteed a high level of demand. Foreign central banks hold their reserves in dollars, and countries are billed in dollars for their oil imports, which requires other countries to buy dollars with their currencies.

As a reserve currency fulfills world needs in addition to the functions of a domestic currency, the favored country can hemorrhage debt for a protracted period on a scale that would promptly wreck any other country's currency.

This advantage is a two-edged sword, because it permits the reserve country to behave irresponsibly by running large trade and budget deficits. When the tide turns against the reserve currency, its exchange value collapses.

The reason for the collapse is the huge stock of reserve currency held by foreigners. When other countries conclude that their hoards of dollars represent claims that the US cannot meet, dollar dumping begins. Financing for US debt dries up; interest rates rise; imported goods become unaffordable and living standards fall.

Flight from the dollar is already underway. During the past two years, the US dollar has declined 52% against the new European currency, the Euro. This decline is striking in view of the sluggish European economy and the fact that many analysts regard the Euro as merely a political currency.

Indeed, the dollar is declining against all currencies that have any international standing: the British pound, the Canadian dollar, the Australian dollar, and even against the Japanese yen despite Tokyo's intervention to support the dollar.

Overcome by hubris and superpower delusion, US policymakers are unaware of America's peril. Economists and pundits are equally in the dark.

Economists believe that decline in the dollar's exchange value will correct the US trade deficit by reducing imports and increasing exports. Once upon a time a case could be argued for this logic. But that was a time before US corporations took to outsourcing jobs and locating production for US markets offshore.

US imports of goods and services rise each time a US factory moves offshore or a US job is outsourced. Goods and services produced offshore by US corporations for US customers count as imports and worsen the trade deficit. The US cannot reduce its trade deficit by increasing sales to China of goods made by US firms in China. As Charles McMillion, president of MBG Information Services, concisely summarizes: "Outsourcing is export substitution."

It is amazing that US policymakers and economists do not understand that dollar devaluation is meaningless as long as China keeps its currency pegged to the dollar.

America's greatest trade imbalance is with China. In 2000 the US merchandise trade deficit with China became larger than the chronic US trade deficit with Japan. By 2003 the US trade deficit with China was almost twice as large as the US deficit with Japan: $124 billion versus $66 billion. This year the US trade deficit with China is expected to be $160, a 29% increase from last year.

This imbalance cannot be corrected as long as China maintains the peg. As the dollar falls against the Euro and other currencies, the Chinese currency falls with it, thus maintaining China's advantage over US goods in world markets.

Both the Clinton and Bush administrations are guilty of permitting China to maintain a grossly undervalued currency that sucks productive capacity out of the US. The combination of cheap Chinese labor and an undervalued currency are destroying US middle class living standards.

As America's industrial base erodes, so does its competitiveness and ability to close its trade deficit through exports.

Currency markets cannot correct the undervalued Chinese currency, because China does not permit its currency to be traded and there are insufficient stocks of Chinese currency in foreign hands with which to form a currency market.

Sooner or later the peg will come to an end--perhaps when China fulfills its WTO obligation to let its currency float. When the peg ends, it will deliver a severe shock to US living standards. Suddenly, Chinese manufactured goods--including advanced technology products--on which the US is now dependent will cost much more. Overnight, shopping at Wal-Mart will be like shopping in high-end department stores.

China accounts for a quarter of the US trade deficit and for one-third of the US deficit in manufactured goods, is the second largest source of US imports after Canada, and is America's third largest trading partner as conventionally measured. Despite these facts, the US government does not publish full current account data for China, instead lumping China in with "Other Countries in Asia and Africa." This keeps the magnitude of the problem out of sight.

Canada and Mexico rank as the US's two largest "trading partners" because of double counting in the measure of imports and exports. For example, the full value of auto bodies shipped across the borders to Canada and Mexico for assembly operations are counted as "exports" when they leave the US and as "imports" when they return.

In contrast US "trade" with China involves almost no double counting of component parts.

Recently, Goodyear Tire and Rubber Company declared its intention to close all US plants and to manufacture offshore for US markets. Each time the US loses an industry, America's export potential declines and America's imports rise. This scenario guarantees a rising trade deficit and the end of the dollar's reserve currency role.

Dr. Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy during 1981-82.

~ If not us, who? If not now, when? ~
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PostPosted: Thu Nov 18, 2004 10:14 pm Reply with quote
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Dollar continues record declines

The dollar has continued its record-breaking slide against many of the world's major currencies, with analysts predicting it could fall further.

Investors are no longer willing to ignore the US economy's problems

Comments by the US administration that it favours a strong dollar failed to stem losses as analysts say little is being done to match words with actions.

They point out that a weaker dollar can help drive export demand, as well as narrow the current account deficit.

Also, higher Asian interest rates are likely to lure investors from the US.

Heading on down

The dollar fell to a record low of $1.3074 against the euro in London trading before bouncing back to $1.2989.

It also slid against the yen and hit a seven-year low against the South Korean won.

"The US dollar will remain under pressure," Merrill Lynch said in a note to investors, citing China's attempts to rein in its booming economy as a main contributing factor.

Many analysts are predicting that borrowing costs will have to increase if China's economy is to avoid overheating.

Should interest rates rise, it will increase capital inflows into the country, having a positive knock-on effect for other currencies in Asia and countries such as Australia and New Zealand, Merrill Lynch said.

"China's economy is slowing, but it has not slowed enough," the investment firm said, adding that last month's interest rate hike "is not enough, it is merely the first of many such measures to come".

Left alone

There also seems to be less risk of intervention in the market by countries such as Japan because the region's currencies have been strengthening together - meaning they are still as competitive as each other, analysts said.

South Korea's Finance Minister Lee Hun-jai said the government would allow the market to set the won's level and that it did not have a target value to defend.

Should traders try to shift the market, however, then its stance will change, he said.

"The government hopes everything goes on appropriately based on supply and demand in the market," said Mr Lee.

"But government won't leave it unchecked when the foreign exchange market shows rapid fluctuations due to speculative forces."

Accounting hole

At the heart of the dollar's problems, however, are imbalances in the US economy that analysts are less and less willing to ignore.

The budget deficit and current account deficit have ballooned to record levels

On Wednesday, US Treasury Secretary John Snow told the Royal Institute of International Affairs in London that US policy "is for a strong dollar".

But his pledges to curb the US budget deficit did little to reassure an already sceptical market.

"Because the market's selling the dollar now on worries over the US deficit, it's hard think it will stop soon," said Junya Tanase, a strategist at JPMorgan Chase. "It's a deep-rooted problem."

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PostPosted: Mon Nov 29, 2004 12:49 am Reply with quote
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cheer-up ... law of nature what goes up must come down Smile

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The Coming Currency Shock
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