Donald Trump will go down in history for many things, including a Justice
Department investigation into U.S.-Russian collusion in the 2016 election, a
guilty verdict for his former campaign chair, Paul Manafort, and a guilty
plea by his personal lawyer, Michael Cohen, in relation to hush-money
payments to women in violation of campaign finance laws. Then there was the
Access Hollywood tape, the ban on Muslims, the implicit condoning of
neo-Nazis, the plans to build a border wall to keep out illegal Mexicans, the
separation of immigrant children from their parents (though some say that law
was drafted under Obama), and Trump's ban on global abortion funding to
please the pro-life portion of his base. Could Trump's legacy though be
something few had ever predicted: The beginning of the end of the dollar?
On the economic front though, it appears that Trump is doing all the right
things. The Dow was at its highest-ever level of 26,616.71 in January, just
over a year after Trump took office. The U.S. dollar is strong, unemployment
is at its lowest level in 20 years, the stock market is booming, and the Fed
thinks things are going so well that it is ready to pass more interest rate
hikes. Why has the U.S. dollar done well? Mostly because of high demand for
U.S. Treasuries.
Read our Gold and the great stage of fools to learn more about why
the dollar is so strong, at the expense of gold, but also why there are
cracks in the U.S. economy.
Foreign investors purchased some $26 billion of T-bills in May, driven by
fear of a trade war and the indecisive result of the Italian election. They
were also attracted by higher bond yields, which hit a seven-year peak in
May. The two largest Treasury holders, China and Japan, both increased their
buying. Germany bought $12 billion more in April compared to March.
However Russia sold off 84% of its U.S. debt holdings between March and
May, leaving just $14.9 billion in its U.S. reserve account. That compares to
$102 billion in December 2017. (See graph below). The sell-off corresponded
with tough U.S. sanctions imposed on Russian President Putin's closest
associates and Rusal, which produces 7% of the world's aluminum.
The dumping of U.S. Treasuries by Russia caused barely a ripple among U.S.
Treasury officials and politicians, who know that the country only holds
about one-tenth of the T-bills owned by China, which has the most of any
country, $1.2 trillion. But it begs the question, what would happen if China
started selling U.S. Treasuries? The trade war with China is not going well
and the evidence shows that China does not need the U.S. as much as it thinks.
China is warming to Russia through energy deals and is buying Iranian oil
despite U.S. sanctions. Its One Belt, One Road initiative is key to its plan
to exert Chinese hegemony and create a trading bloc without the need to trade
with its former enemies: the U.S. and Europe. Eventually China could stop
buying U.S. Treasuries altogether.
How would that affect the U.S. dollar? And more significantly, how would
the U.S. finance its $21.476 trillion debt if the anti-T-bill movement spread
and the market for them dried up? Here we trace the origins of the dollar and
its post-war pinnacle as the world's reserve currency, to its current sickly
state. Does the U.S. dollar deserve to be the reserve currency, or in the
words of former French finance minister and future president Valéry Giscard
d'Estaing, should it continue to enjoy its "exorbitant privilege"?
We think not. This article will explain why.
Birth of the dollar as reserve currency
In July 1944, as Allied troops were racing across Normandy to liberate Paris,
delegates from 44 nations met at Bretton Woods, New Hampshire, and agreed to
"peg" their currencies to the U.S. dollar, the only currency strong
enough to meet the rising demands for international currency transactions.
"At the closing banquet, the assembled delegates rose and sang
'For He's a Jolly Good Fellow.' The fellow in question was John Maynard
Keynes, leader of the British delegation and intellectual inspiration of the
Bretton Woods design." Robert Kuttner, Bretton Woods Revisited
What made the dollar so attractive to use as an international currency,
the world's reserve currency, was each U.S. dollar was based on 1/35th of an
ounce of gold (35.20 U.S. dollars an ounce), and the gold was to be held in
the U.S. Treasury.
There's a lesson not learned that reverberates throughout monetary
history: when government, any government, comes under financial pressure it
cannot resist printing money and debasing its currency to pay for debts.
London Gold Pool
The US began to send larger and larger amounts of dollars overseas to fund
its increasing trade deficits. The glut of U.S. dollars held abroad began to
threaten U.S. gold reserves—remember U.S. dollars were redeemable for
gold—and worldwide demand for gold was soaring. By the late 1950s U.S. gold
reserves had began to dwindle rapidly.
"Nineteen fifty-eight marked the first year in which foreign
central banks exercised their convertibility rights in significant amounts
and returned their dollars for gold. U.S. gold reserves fell 10% from 20,312
metric tons to 18,290 that year, another 5% in 1959, and 9% in 1960." John
Paul Koning, Mises.org, The Losing Battle to Fix Gold at $35
In October of 1960 panic buying caused gold's price to rise to over US$40
per ounce. A night-time emergency call was made by the U.S. Federal Reserve.
The Bank of England was to immediately flood the gold market with enough
supply to reduce and stabilize the price of gold. The U.S. had just made it
abundantly clear that stopping the drain of its gold reserves, and the
depreciation of its currency against gold, was a huge priority.
The US, the Bank of England and the central banks of West Germany, France,
Switzerland, Italy, Belgium, the Netherlands, and Luxembourg then set up a
gold sales consortium to prevent the market price of gold rising above
US$35.20 per ounce.
This consortium was known as the London Gold Pool. Member banks were to
provide a quota of gold into a central pool; the U.S. Federal Reserve would
match their combined contributions ounce to ounce. This meant that the dollar
would now be backed not only by the gold in Fort Knox but all the other pool
members' gold as well.
By early 1962, the Bank of England, the consortium's buy/sell agent,
through the London Gold Exchange, was buying gold on the dips and selling on
the rise to cap its price. Until 1968 nearly 80% of newly mined gold passed
through the London Gold Exchange, London being the world's premier gold
market. The London Gold Fix had been a daily morning ritual since September
1919—the 3 pm Gold Fix was introduced in 1968 to coincide with the opening of
the U.S. markets.
Despite the Cuban Missile Crisis and escalating tensions between Moscow
and the U.S., gold prices remained fairly stable; the London Gold Pool was a
success.
End of the gold standard
With the Gulf of Tonkin incident in late 1964 and the acceleration of the
Vietnam War in 1965, U.S. military spending exploded. This was compounded by
President Lyndon B. Johnson's Great Society project spending and not raising
taxes.
By 1965 the London Gold Pool was selling more gold, suppressing the rise,
than it was buying back on the increasingly fewer, and shallower, dips.
Britain devalued the pound sterling in late 1967.
The ramping up, in early 1968, of the Vietnam War—because of the Tet
offensive and President Johnson's agreeing to General Westmoreland's proposed
troop surge—brought renewed pressure on the dollar.
Since Johnson refused to raise taxes to pay for the social welfare reforms
undertaken earlier and the war in Vietnam, the U.S. was now running massive
balance of payment deficits with the world.
In a little over a month London sold close to 20 times its usual amount of
gold, over 1,000 tons. France dropped out of the pool to send its dollars
back to the U.S.—for gold rather than Treasury debt.
Gold demand was skyrocketing. London sold 100 tons of gold in one day, 20
times the average. The consortium said "the London Gold Pool re-affirm
their determination to support the pool at a fixed price of $35 per oz."
Fed chairman William McChesney-Martin said the U.S. would defend the US$35
per ounce gold price "down to the last ingot." Several planeloads
of gold were emergency airlifted from the U.S. to London. Gold demand
continued to escalate with the London Gold Pool selling 175 tons one day and
the very next day selling an additional 225 tons.
This broke the back of the London Gold Pool. Members were tired of draining
their countries' gold reserves to pay for the U.S.' Vietnam War and social
reform policies. At the request of London Gold Pool members the Queen of
England declared Friday, March 15 a bank holiday. The London gold market
remained closed for two weeks and the London Gold Pool was disbanded.
Johnson was forced to reverse his decision to send hundreds of thousands
more U.S. troops to crush the Vietnamese resistance—instead he opened up
peace talks.
An official "two-tiered" price for gold was announced to the
world—the official price of US$35.20 would remain for central banks dealings,
the free market could find its own price.
"...there came the March 1968 run on gold, which led to the
collapse of the London Gold Pool. The U.S. government and Federal Reserve
System, seeking to stave off the complete collapse of the dollar-gold
exchange standard, felt obliged to take deflationary measures. The fed funds
rate, which on October 25, 1967, had fallen to as low as 2.00 percent, rose
to 5.13 percent on March 15, 1968, the day the gold pool collapsed.
As the Federal Reserve System's deflationary measures took effect, the
fed funds rate rose to as high as 10.50 percent during the summer of 1969.
Long-term interest rose too, if to a lesser extent. On September 6, 1967, the
rate on U.S. government 10-year bonds fell to 5.20, still well above the
level of around 4 percent that prevailed during the first half of the
1960s...
On December 29, 1969, the yield on the long-term government bond hit
8.05 percent. With interest rates, both long term and short term, at such
high levels, the demand for gold bullion was finally broken, and the dollar
price of gold fell to around $35 an ounce by 1970. For the moment, the
dollar-gold exchange standard had been saved." The Industrial Cycle
and the Collapse of the Gold Pool in March 1968,
critiqueofcrisistheory.wordpress.com
In February 1970 the closing gold price on the London market averaged
US$34.99. On August 15, 1971, U.S. President Nixon ended the convertibility of the dollar into gold. With
gold finally demonetized, the Fed and the world's central banks were now free
from having to defend their gold reserves and a fixed dollar price of gold.
The era of Bretton Woods was over.
For more economic history, read our Demise of London Gold Pool ends Vietnam War.
Recognizing that the U.S. and the rest of the world were going to need and
use a lot of oil, and that Saudi Arabia wanted to sell the world's largest
economy (by far the U.S.) more oil, Nixon and Saudi Arabia came to an
agreement in 1973 whereby Saudi oil could only be purchased in U.S. dollars.
This caused an immediate and strong global demand for the buck.
"Beginning in the mid-1970s the American Century system of global
economic dominance underwent a dramatic change. The oil price shocks of
1973-1974 and 1979 suddenly created enormous demand for the floating dollar.
Oil importing countries from Germany to Argentina to Japan, all were faced
with how to acquire export-based dollars to pay their expensive new oil
import bills. The rise in the price of oil flooded OPEC with dollars that far
exceeded domestic investment needs, and were therefore categorized as
"surplus petrodollars." A major share of these oil dollars came to
London and New York banks where the new process of monetary petrodollar
recycling was initiated.
In 1974 U.S Assistant Treasury Secretary Jack F. Bennett and David
Mulford of the London-based Eurobond firm of White Weld & Co set about
the mechanism to handle the surplus OPEC petrodollars. Kissinger, Bennett and
Mulford helped orchestrate the secret financial arrangement with the Saudi
Arabia Monetary Agency (SAMA) that creatively transformed the high oil prices
of 1973-1974 to the direct benefit of the U.S. Federal Reserve banks and the
Bank of England.
Despite the financial windfall enjoyed by the U.S./U.K banking and
petroleum conglomerates who "managed the recycling of petrodollar
flows," most Americans regard the 1973-74 oil shocks as a particularly
painful time period of high inflation and long lines at every gas station. In
the Third World these high oil prices created huge loans from the
International Monetary Fund—debts to be re-paid entirely in dollars." petrodollarwarfare.com
By 1975 all OPEC members had agreed to sell their oil only in US dollars,
thus ushering in the period of U.S. "petrodollar" dominance that
continues to this day.
What is "exorbitant privilege"?
In the 1960s, French politician Valéry d'Estaing complained that the
United States and its exporters enjoyed an "exorbitant privilege"
due to the dollar's status as the world's reserve currency. He had a point.
Because the dollar was, and is, the world's currency, the U.S. can borrow
more cheaply than it could otherwise (lower interest rates), U.S. banks and
companies can conveniently do cross-border business using their own currency,
and when there is geopolitical tension in the world, central banks and
investors buy U.S. Treasuries, keeping the dollar high and the United States
insulated from the conflict. A government that borrows in a foreign currency
can go bankrupt; not so when it borrows from abroad in its own currency.
The dollar is the most important unit of account for international trade,
the main medium of exchange for settling international transactions and the
store of value for central banks. The Federal Reserve is the lender of last
resort, as in the 2008–09 financial crisis, and is the most common currency
for overseas borrowing by governments and businesses.
Wall Street generates significant income from selling banking services in
USD to the rest of the world, and the U.S. manages the world's most important
settlement systems, allowing it to monitor and limit funds used for illegal
activities.
Barry Eichengreen, author of "Exorbitant Privilege: The Rise and Fall
of the Dollar and the Future of the International Monetary System,"
names three unique attributes to the dollar that no other currency has. As quoted by DW, the attributes are:
- Size: Due to the size of the U.S. and its
economy, there are more dollars available than other currencies.
- Stability: U.S. Treasuries have historically been
valued as a safe financial instrument that is backed by the U.S.
government, which pays its bills on time.
- Liquidity: Treasuries can easily be bought and
sold without them losing much of their value, given the consistent
strength of the dollar. The bond market for U.S. Treasuries is
considered the most liquid financial market in the world.
How the USD is losing its privilege
While the attendees at the Bretton Woods conference in 1944 envisioned the
USD enjoying these advantages in perpetuity, the reality is the greenback has
been in decline for some time.
Since the Federal Reserve was created in 1913, the dollar has lost 95% of
its value. (See graph below). Over a hundred years ago a buck was worth a
buck; in 2013 it was valued at 5 cents, it's worth eroded by inflation.
Then there's the U.S. debt, currently sitting at over $21 trillion and
growing daily. In 2011 Standard & Poor's, a ratings agency, downgraded
U.S. sovereign debt from AAA to a lowly A. What happened to U.S. Treasuries
after this blow to the egos of American central bankers? They went up. As the
Financial Times reported:
The reaction to the news that the US was not a "risk-free"
credit was swift—money poured into U.S. Treasuries. Bond yields fell, and
soon the U.S. stock market also recovered. For years afterwards, U.S. assets
surged forward while Europe and the emerging world stagnated."
Why? Because the U.S. dollar still enjoyed exorbitant privilege.
But as Bob Dylan once sang, "the times they are a changing."
Jeffrey Sachs, writing for Project Syndicate, argues "the dollar
punches far above America's weight in the world economy," producing just
22% of world output, but accounting for 50% or more of cross-border
invoicing, reserves, settlements, liquidity and funding.
Due to U.S. fiscal and monetary mismanagement, as described above, the
Bretton Woods financial system set up in 1944 collapsed. The breakdown of a
gold-backed dollar led to high inflation in the U.S. and Europe, then a fall
in inflation in the early 1980s. Sachs argues the turmoil of the dollar was a
key factor in motivating Europe to embark on monetary union, resulting in the
euro's launch in 1999.
Same with America's mishandling of the 1997 Asian debt crisis, which led
to China wanting to internationalize the renminbi, or Chinese yuan. The
2008–09 financial crisis that started in the U.S. through the sub-prime
mortgage debacle, was another flag to the rest of the world, signaling a move
away from the dollar toward other currencies, notes Sachs.
"America's monetary stewardship has stumbled badly over the years,
and Trump's misrule could hasten the end of the dollar's predominance."
The quantitative easing program that saw the Fed's assets skyrocket from $900 billion to $4.5 trillion
between 2019 and 2015 (through the buying up of Treasuries, paid for by printing
money), made it inexpensive for the U.S. government to continue to borrow and
spend—with rates close to zero.
However, what that did was show other countries that no longer was the
United States following a sound fiscal policy; all they were doing was
printing money. Countries started to diversify their foreign exchange
reserves and reduce their dependence on the dollar. According to the IMF, USD
foreign exchange reserves have dropped from 72% of the world's forex in 2001
to 62% today.
Of course, none of this matters to the two main buyers of U.S. Treasuries,
China and Japan (then Ireland and Brazil)—see table below—who have, up to
recently, kept on buying. T-bills are still the best defense against
financial, political and military turmoil (like trade wars). Not because of
all the exorbitant privilege reasons outlined above, but because there are no
other good alternatives. The euro isn't stable because of problems within the
European Union, the yuan isn't yet ready, and the Japanese yen continues to
lose value, DW points out. The dollar still accounts for 85% of all forex
transactions despite only making up 25% of the world economy.
Trade wars: U.S. loses, China wins
So for years, the U.S. dollar has been losing its exorbitant privilege.
Only now, that loss of status is being exacerbated by the United States under
the Trump administration, which has engaged in harmful trade disputes that
will actually weaken the dollar, the evidence suggests.
Starting in March, Trump through the U.S. Commerce Department levied
import duties on steel and aluminum, implicitly targeting China for overproducing
these metals, causing prices to decline and hurting U.S. steel plants. As we
all know, trade tensions between the two economic superpowers have escalated.
The latest round involves more tariffs on a proposed $200 billion worth of
Chinese goods plus another $267 billion. There are currently 25% tariffs on
$50 billion in Chinese-made goods coming into the U.S.
For its part, China has promised to retaliate by subjecting 85% of $110
billion worth of American imports to tariffs.
Jeffrey Sachs, of Project Syndicate, argues that the combination of
Trump's trade battle with China and his insistence on re-imposing sanctions
on Iran despite the nuclear deal signed under President Obama "will
weaken the dollar's role and that of New York's role as the global financial
hub," just as Brexit has undermined London's financial district—and will
backfire, big time:
The most consequential and ill-conceived of Trump's international
economic policies are the growing trade war with China and the reimposition
of sanctions vis-à-vis Iran. The trade war is a ham-fisted and nearly
incoherent attempt by the Trump administration to stall China's economic
ascent by trying to stifle the country's exports and access to Western
technology. But while U.S. tariffs and non-tariff trade barriers may dent
China's growth in the short term, they will not decisively change its
long-term upward trajectory. More likely, they will bolster China's
determination to escape from its continued partial dependency on U.S.
finances and trade, and lead the Chinese authorities to double down on a
military build-up, heavy investments in cutting-edge technologies, and the
creation of a renminbi-based global payments system as an alternative to the
dollar system.
And it's not just China that is distancing itself from the U.S. as it
becomes more protectionist and isolationist. The European Union is looking at
ways to circumvent U.S. sanctions on Iran, by working around the dollar
payments systems—in effect setting up its own SWIFT (Trump said in May that
"any nation that helps Iran in its quest for nuclear weapons could be
strongly sanctioned" and signed an executive order re-imposing sanctions
on any foreign company that continues to do business with Iran).
"It is absurd that Europe pays for 80 per cent of its energy
import bill—worth €300 billion a year—in U.S. dollars when only roughly two
per cent of our energy imports come from the United States. It is absurd that
European companies buy European planes in dollars instead of euro." European
Commission President Jean-Claude Juncker
SWIFT, the Society for Worldwide Interbank Financial Telecommunications,
is the communications system used for transferring money between countries.
Before SWIFT, the only way to transfer money overseas between banks was through
telex.
"How long will it be before the world's businesses and governments
are running to Shanghai rather than Wall Street to float their renminbi
bonds?" asks Sachs.
The Financial Times chimed in that there are limits to
the dollar's exorbitant privilege, namely that money currently moving into
U.S. Treasuries is going into longer-dated bonds (i.e., 10 years or more),
helping to push down yields on shorter-dated bonds. This "flattening of
the yield curve" makes it harder for banks to make money and
"implies growing concern for the strength of the economy," notes
the FT, adding that higher U.S. yields are pushing up the dollar, making it harder
for U.S. exporters. A flattening yield curve also historically has signaled
the beginning of a recession.
Back to the trade war with China, while Beijing has tried to placate
foreign companies like Exxon Mobil, which is planning on spending $10 billion
on an LNG terminal in Guangdong province, due to fears of losing foreign
investment (Read our The road to war: China's kryptonite - Part 2 for more on
China's vulnerabilities), the other side of the coin is that as the trade war
with China continues, the U.S. is likely to feel more of the pain.
Why? As Bloomberg argues, that's because so far, the import
tariffs have avoided consumer goods, but that will change if the planned
(total) $467 billion in tariffs come into effect.
"As the scope of tariffs extends to more Chinese exports, the
marginal side effects will likely rise for the U.S., and the marginal damage
to China will likely decline," Bloomberg quotes Deutsche Bank AG
economists Zhiwei Zhang and Yi Xiong. They estimate the $200 billion list has
$78 billion worth of consumer goods versus only $3.7 billion in the $50
billion list.
These import tariffs are no different from the GST we pay in Canada. They
are a tax that has to be paid by the company, that is being directly passed
onto consumers. So much for Trump helping the average Joe and Jane, as he
campaigned on.
In fact some of Americans' most basic essentials are all going up. Who
cares if the economy is growing at 4% if your six-pack of Miller is going to
take a bigger bite out of your paycheck?
The price of Coca-Cola and other carbonated drinks is going up due to the
higher price of aluminum to make cans. Other products including beer,
furniture, boats, motorcycles and campers are all going to cost more.
Overall, consumer prices have increased 2.9% in the last 12 months through
June.
Companies too are getting ticked off with Trump's trade war. While the
rationale was to lessen the overall trade deficit and particularly the trade
deficit with China—and bring jobs back to the United States—none of that has
happened.
Ford, Apple and Intel are among the big U.S. firms that have pushed back against Trump's monkeying with their systems of
supply-chain management through tariffs that make foreign parts more
expensive. Ford, for example, cancelled plans to import its Focus Active
crossover vehicle into the U.S. from China. When Trump tweeted that the car
"can now be BUILT IN THE USA," Ford shot back that it isn't
profitable to manufacture it in the States.
Apple had a similar response when Trump suggested the tech giant should
build U.S. plants when Apple complained about getting hit with tariffs, even
though its parts are American-made but assembled in China.
"[T]he burden of the proposed tariffs will fall much more heavily on
the United States than on China," the company said in a letter to U.S.
Trade Representative Robert Lighthizer.
Indeed the trade deficit Trump is so anxious about is actually getting
worse. In July it widened by the most in three years and the goods-trade
deficit with China hit a record $36.8 billion. The widening gap with China
was partly due to exports to China falling by 1%, driven by steep drops in
shipments of aircraft and soybeans, both subject to Chinese countervailing duties.
The yawning trade deficit is sure to weigh on growth in the third quarter;
recall that Trump gloated about U.S. GDP growing by 4.1% in Q2, but that was
due to a boost in consumer spending driven by the tax cuts last December and
a burst of soybean exports to China in an effort to avoid import tariffs.
As for whether China will bend on deeper issues raised by Washington
including removal of subsidies to state-owned enterprises, thus leveling the
playing field with US companies, that seems unlikely. Chinese officials have
indicated at least 20% of more than 100 demands from the U.S. laid out in May
aren't open to negotiation.
Why China doesn't need the U.S.
Underlying the Trump administration's failure to bring the Chinese to the
negotiating table is the fact that China actually doesn't need the United
States as much as America thinks it does. Trump and co think that all the
U.S. needs to do is keep piling on the tariffs and Chinese President Xi
Jinping will bend to its will. The reality is quite different. China's
long-term objective is not to tie itself more closely to the U.S., but rather
to become more economically independent. We see this through its One Belt, One Road initiative.
One Belt, One Road
Promising over a trillion dollars in infrastructure spending in 60
countries, including a 260-mile railway spanning eight countries, power
plants in Pakistan, and a Chinese-owned port in Greece to give it an artery
for goods flowing to Europe, One Belt, One Road is China's "great pivot
east." As the Independent described it in 2017:
It is global commerce on China's terms. Xi is aiming to use China's
wealth and industrial know-how to create a new kind of globalisation that
will dispense with the rules of the ageing Western-dominated institutions.
The goal is to refashion the global economic order, drawing countries and
companies more tightly into China's orbit.
The projects inherently serve China's economic interests. With growth
slowing at home, China is producing more steel, cement and machinery than the
country needs. So Xi is looking to the rest of the world, particularly
developing countries, to keep its economic engine going.
In other words, One Belt, One Road is the means for creating a trading
block that can function independent of its traditional Western trading
partners.
The "Belt" refers to a network of overland road and rail routes and oil and natural gas pipelines planned to
run along the major Eurasian land bridges—China-Mongolia-Russia,
China-Central and West Asia, China-Indochina Peninsula, China-Pakistan,
Bangladesh-China-India-Myanmar. They'll stretch from Xi'an in central China
through Central Asia reaching as far as Moscow, Rotterdam and Venice.
The "Road" is a network of ports and other coastal
infrastructure projects from South and Southeast Asia to East Africa and the
northern Mediterranean Sea.
"A network of new "South-South" trading routes
connecting Asia, the Middle East, Africa and Latin America are set to
revolutionize the global economy. Trade and capital flows between emerging
areas of the world could increase tenfold in the next forty years. In the
same way that trade between the developed nations exploded in the 1950s and
1960s, we expect the 21st Century to see turbocharged trade growth between
the emerging nations." HSBC Global Research
"In all trade corridors in which China participates, strong growth
is anticipated. So strong in fact that it is no exaggeration to highlight
this as the emergence of a new world trade order; by 2030, China will
effectively be fulfilling the central trade role occupied by the U.S. and the
EU today." The Super-Cycle Report, Standard Chartered Research 2010
The China Global Investment Tracker is a comprehensive data
set covering China's well over $1 trillion in energy, mining, real estate and
high-tech global investment and construction activity.
An article published by the New York Times, 'The World According to
China,' by Gregor Aisch, Josh Keller and K.K.Rebecca Lai says China has
displaced the United States and Europe as the leading financial power in
large parts of the developing world. Here's where China has the most influence, based on its
share of foreign investment since 2005.
Where Chinese companies once struggled to win orders in a competitive
global market, that is starting to change, thanks to, ironically, the Chinese
countervailing duties, which are making locally made goods cheaper than their
American-made counterparts. When Chinese citizens buy Chinese goods, the
government is happy—the opposite of what Trump intended by his tariffs.
The miscalculation is laid thread-bare in an interesting recent article:
In real life, Trump's tariffs are unlikely to inflict enough pain on
China to compel Xi to make concessions. Its huge domestic market is becoming
more important to Chinese growth. But beyond even that, Beijing's entire
economic strategy is designed to replace critical foreign technology and
products with homegrown alternatives it can control. Simply, the Communist
Party prefers Chinese to buy Xiaomi phones and Geely cars, not iPhones and
Buicks.
That's exactly what the much-feared "Made in China 2025"
program is all about. The plan is to develop new, high-tech industries to
compete with and eventually replace foreign rivals, at home and abroad. In
that sense, it's official policy to limit overseas involvement in the
economy.
The trade war, therefore, comes as a "blessing in disguise,"
as the China Daily put it. Trump's trade sanctions have given Beijing another
excuse to drag its feet on free-market reforms, to support local companies
and to harass and exclude foreign business—all things Chinese leaders are inclined
to do anyway. - Bloomberg
One can see this in "The Made in China 2025 Technical Roadmap,"
better known as "The Green Book" after its original cover. The book
is full of ambitious targets "that if met would virtually lock foreign
companies out of many industrial segments in China and threaten market
disruption for businesses across the globe," another article states:
The Green Book breaks down targets for dozens of industries that supply
the 10 key sectors prioritized by Made in China 2025, which also include
biotechnology, advanced rail equipment, and agricultural machinery. It sees
Chinese companies taking a 56 percent share of the global market and 80
percent of the domestic market for integrated circuits by 2030. By 2025,
they're seen controlling 90 percent of the domestic market for new-energy
vehicles including hybrid and pure electric cars, domestic mobile
communication equipment, key parts of industrial robots, new energy,
renewable energy equipment and energy storage equipment.
In part because of the targets, foreign companies in industries
including medical devices and advanced agricultural equipment—both priority
industries in the Made in China 2025 plan—may already be losing business,
says the U.S.-China Business Council. - Bloomberg
See below for a table of which industries are targeted.
China-Russian cooperation
In another example of China's pivot east, the country has recently turned
to Russia to help solve its soybean problem. Soybeans are used in animal feed
and Chinese citizens consume a lot of pork and beef. China currently import
soybeans mostly from Brazil and the U.S. but shipments have dropped
significantly from the U.S. since duties on American soybean imports were
imposed.
A joint venture between Chinese and Russian companies will
invest $100 million over three years to build a soybean crusher and grain
port in Russia, and lease 247,000 acres of farmland to grow wheat, corn and
soybeans. The country is also reportedly building a new port in the northeast
that will ship grain harvested in Russia by Chinese companies, as part of One
Belt, One Road.
Russia and China have been cozying up in other ways over the past few
years. In 2014 Russian state-owned Gazprom signed an eye-popping $456 billion
gas deal with China. The year previously, Rosneft agreed to double oil
supplies to China in a deal valued at $270 billion, and in 2009 Russian oil
giant Rosneft secured a $25 billion oil swap agreement with Beijing.
2014 was also the year that China really started to move away from the
dollar. China agreed with Brazil on a $29 billion currency swap in an effort
to promote the Chinese yuan as a reserve currency, and the Chinese and
Russian central banks signed an agreement on yuan-ruble swaps to double trade
between the two countries. The $150 billion deal, one of 38 accords inked in Moscow,
is a way for Russia to move away from U.S. dollar-dominated settlements.
China and Russia have been allies since the 1950s when they agreed to
defend one another against an attack from U.S.-backed Japan or its allies
(China backed North Vietnam and North Korea) so continued cooperation is
unsurprising. In 2001 Vladimir Putin and then-Chinese President Jiang Zemin
signed a 20-year agreement to "increase trust between their militaries." The two
countries now regularly participate in joint maneuvers including joint naval
exercises to counter U.S. influence in the Asia Pacific region. Economic ties
are also growing closer. On New Year's Day a second Sino-Russian oil pipeline
began operating, doubling the amount of Russian crude being shipped to China.
Last summer Xi Jinping and Vladimir Putin met in Russia to sign a deal
whereby two Russian banks and a Chinese bank created a $10-billion investment
fund that will finance infrastructure and development projects, and an $850
million innovation fund. The Russian banks are subject to U.S. sanctions so
the deal allows Russia to access non-Western capital, and to conduct
transactions in yuan or rubles.
The latest evidence of Chinese-Russian business ties involves a new crude
oil futures contract, priced in yuan and convertible into gold. The
Shanghai-based contract will allow oil exporters like Russia and Iran to
dodge U.S. sanctions against them by trading oil in yuan rather than U.S.
dollars.
In early March the Russian State Space Corporation, Roscosmos, and the
China National Space Administration agreed to cooperate in exploring the moon
and outer space, and to create a Joint Data Center on lunar projects. This
could include a Russian mission to launch a spacecraft in 2022 and a Chinese
lunar mission in 2023, a statement said.
Chinese aggression
Of course we can't forget that China's path to claiming global economic
dominance has come with increased military aggression, particularly in the
South China Sea that it claims as its own.
Obama's pivot to Asia, to be realized through increased trade like the
Trans Pacific Partnership (TPP) and increasing its regional military profile,
was a failure. The U.S. could not prevent China from annexing 80% of the
South China Sea, defend freedom of navigation through the $5-trillion annual
maritime trade corridor, or stop China-backed North Korea from conducting
nuclear tests. On assuming power Trump pulled the U.S. out of the TPP and
began a dangerous war of words with North Korea's Kim Jong-un as the
reclusive nation successfully tested its first intercontinental ballistic
missile capable of hitting the U.S. mainland. China is a close ally of North
Korea.
Meanwhile China continues to expand its military. In early March it was
reported that China plans to boost military spending by 8.1% in 2018,
compared to a 7% increase in 2017. Maneuvers in the South China Sea demonstrate that Beijing
is willing to flex its muscles in a region it sees as strategically and
economically important.
Why the South China Sea? China is energy-starved and the areas off the
coast of the Philippine province of Palawan are oil rich. Despite being
rejected by the UN in 2016, China maintains it has control over the entire
China South Sea Basin including crucial shipping lanes. China's territorial
claims over the waters are disputed by its neighbors—the Philippines,
Vietnam, Malaysia, Indonesia and Brunei. China's growing dominance includes
building military bases on new, reclaimed islands constructed from tiny rock
outcrops jutting from the ocean surface.
The United States has responded by sending U.S. warships, refusing to
register with air and maritime "identification zones" set up by the
Chinese. There is also conflict in the East China Sea between China and
Japan. At issue are disputed islands (Senkaku to the Japanese, Diaoyu to China)
and the fishing rights and natural resources those islands would deliver to
their owner. In the Middle China Sea, there is China versus Taiwan, which
China has claimed as its own ever since former Chinese President Chiang
Kai-shek and his Kuomintang followers fled to the island in 1949. Beijing
under the leadership of increasingly authoritarian President Xi Jinping's
(reappointed with no term limits) at the 19th Communist Party Congress said
China must take control of Taiwan by 2050 at the latest, or as early as 2020
according to an article in the South China Morning Post.
Conclusion
The Trump administration thought it could back China into a corner by
hitting it with hundreds of billions worth of tariffs, but what it has found
instead is that China has options. It can pivot to Europe (China is already
Germany's biggest trading partner), or it can continue to do what it's doing,
carving a huge sphere of influence in the East through its ties with Russia
and 60-odd countries through One Belt, One Road. Perhaps a combination of
both. In doing this, the United States will also find that its U.S. dollar
exorbitant privilege will continue to wane. This brings up some interesting
questions. If China is at war with the U.S. economically, and maybe even
militarily if things get out of hand in the South China Sea (or even North
Korea), why would it buy its Treasury bills? If China slows or stops buying
U.S. T-bills, how will Washington be able to finance its $21 trillion debt?
Not likely, you say? Well, in March China actually sold $2.5 billion worth
of U.S. Treasuries. And it wasn't the only country to do so, notes Peter Schiff in a blog post. Quoting the Financial
Times:
China, the largest foreign holder of U.S. Treasuries, joined other
countries in selling long-term U.S. government debt with a maturity over one
year, having been a net buyer in January and February, according to data from
the U.S. Treasury. Japan, the second-largest holder, sold $8 billion, adding
to sales in January and February of $2.1 billion and $14 billion, respectively.
The largest sales came from the Cayman Islands, where many investment funds
are domiciled, which shed $26.6 billion."
As Schiff states, "If China starts aggressively dumping all of the
debt on the market, interest rates will likely soar and the dollar would
plunge. This is not good news when the U.S. government is trying to sell more
than a trillion dollars of new Treasuries to finance the massive spending
bill along with tax cuts passed by the Republican Congress earlier this year…
The U.S. government depends heavily on three major buyers to finance its
debt—China, Japan and the Federal Reserve. The Fed is trying to shrink its
balance sheet, so it's ostensibly not buying. If the Chinese and Japanese are
getting out of the U.S. debt market—and it sure looks like they are—how is
Trump going to finance his bloated government?"
We go through this exercise almost every year. The government doesn't have
enough money to fund its expenditures so it asks Congress to raise the debt
ceiling. After much hand-wringing and weeks of sharp-pointed debate, the
politicians, wary of being turfed from office for shutting down the
government, relent. More Treasuries are sold to pay for the higher debt and
the ball just keep rolling.
But what if the U.S. can't find buyers for its debt? What if it had to
suddenly raise taxes instead? The call of revolution would be back in the air
and the U.S. military, dependent on funding from government contracts sourced
from Congressional districts, would implode. Within weeks its hundreds of
foreign bases would fold up like cheap tents.
Could this happen? Maybe not right away, but the end of the U.S. dollar is
like a snowball at the top of a hill and starting to roll down, becoming
larger and faster along the way. We already see moves underway to diversify
away from the dollar. It's happening in Europe, which is trying to create its
own SWIFT system on inter-bank transfers, and it's happening with all the
cooperation between Russia and China, which are signing agreements
denominated in their own currencies, thus bypassing the US dollar.
Think about this. China could pay for its entire Belt and Road initiative
out of its USD account, which holds about a trillion dollars. Once that is
done and dusted, why do they need U.S. dollars to buy U.S. goods and other
commodities? They can get what they need from Russia, Iran, or whomever else
the U.S. doesn't want to do business with, and the countries they sign up to
One Belt One Road. Russia has virtually no U.S. dollar reserves. It sold them
all. Is this not an indication that the world is turning away from the U.S.
dollar and towards inter-country currency transactions instead?
China would be more than happy to see the U.S. dollar lose its reserve
currency status and have everybody trade in their own currency and let the
IMF set the rates. The yuan joined the Special Drawing Rights (SDR) club in
2015 so the structure is already set up for this to happen. (To understand
how SDR works, watch this video). And China is working to gradually make
the yuan more international by opening up its financial markets, according to the head of the People's Bank of China
Governor Zhou Xiaochuan:
"In the process of internationalization of the yuan we have taken
sufficient measures that from now on will allow the yuan to be used in trade
and investment. Moreover, the yuan has been included in the SDR currency
basket. The key procedures have already been carried out… As for the future
role of the government or the Central Bank in the internationalization of the
yuan, to my mind, it is still possible to do something to establish
communication between domestic and international capital markets," Zhou
Xiaochuan said at a press conference [last] Friday.
The bottom line is this: No currency lasts forever. The British pound
sterling was top of the currency heap for most of the 19th century and the
start of the 20th, but it eventually gave way to the dollar. The greenback
has enjoyed exorbitant privilege for over 100 years, if you go by the
establishment of the Federal Reserve in 1913. It may be time to move over and
let natural economic forces take over.
Let's face it, America cannot win a trade war right now. They are running
"tremendous" (in Trump language) deficits, an unfathomably large
debt, and rely on the printing of money and the largesse of other countries
to buy its debt in the form of U.S. Treasuries. The government is almost
entirely beholden to foreign entities for it to be able to function. This is
no way to run a country.
Have you considered what the end of the U.S. dollar could mean for the
global economy? If not, perhaps you should.
Richard (Rick) Mills
aheadoftheherd.com
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