China and the Fed: Partners in Crime?

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The Chinese-negotiated dollar exclusion zones around the world that I have been talking about recently have yet to really become front-page news…

But it's beginning to more and more like the US dollar is under assault by not only the Chinese, but by the Federal Reserve, as well.

What? The dollar is under assault by the Fed?  How can this be?

It makes sense when you look at what’s happening, beginning with the Fed’s continued policy of quantitative easing. The massive expansion of US dollars in the world from quantitative easing has been meant—or so we have been led to believe—to keep US the economy from crashing.

Maybe it has…or at least slowed its descent…

It has certainly kept the stock market afloat, but it has also had other affects that are not so nice and has made more than a few of our trading partners around the world quite angry with us.

What’s been the problem?

Exporting inflation

One of the problems has been that the increase in the supply of dollars in the world has devalued the dollar relative to some of our trading partners’ currencies.

Did the administration want to devalue the dollar?

Well, even though Treasury Secretary Tim Geithner denied that that was the goal, it really was.  And that’s exactly what has happened and for good reason. You see, the Federal Reserve and the administration know that a devalued dollar is good for the American economy…at least it used to be.  The classic currency play of devaluation is what it makes our goods and services cheaper relative to other nations’ goods and services…

Which ought to be a boost to the US economy.

But there’s a fly, or two, in the QE dollar devaluation ointment…

One of those flies is that the “cheaper” dollar has been offset by the worsening situation in Europe.  As my colleague John Frederick Carter has observed, when the Eurozone economy falters and a solution seem further away than ever, money flows out of the Eurozone and into the safety of the US Treasury…

This “flight to safety” keeps the dollar stronger relative to the euro than is desired by the Fed; and so US trade with Europe declines.  That is a real problem, since US exports to the Eurozone are 21% of all US foreign trade.

Another fly in the ointment is that for our other trading partners, the inflationary impact of the Fed printing dollars like they’re going out of style hits them hard. That’s because most international trade transactions are done in dollars.

That means that if, say Brazil, wants to trade with Japan, both would have to do so using dollars as the currency to do so.  With more, cheaper dollars out there, the price of goods rises, in dollars.  That means a Brazilian firm has to buy more dollars with more reals (Brazil’s currency) to do business with Japan, and vice versa.

What does that mean?

It means that we—the US--are actually exporting our inflation, because in a dollar-denominated international financial system, other nations must use the dollar as an intermediary currency.

What happens when prices rise in other countries?

The same thing that happens when they rise in the US: costs rise, people are laid off from their jobs as demand falls due to prices outrunning wage levels...in a nutshell, economic hardship.  Thus, other countries can fall into recessions by the Fed’s efforts to avoid one in this country.

Doesn’t seem like a good way to win friends around the world, does it?

In fact, Brazil’s president has recently declared that a currency war exists between the US and his country.  Now does it make sense that countries like Brazil, Chile, India, Russia, and others are cutting deals with the Chinese?

The QE Effect

As the Chinese yuan goes up in value, those other nations’ goods and services become more competitive.  This is good for China's trading partners, and bad for the US.  Thus, quantitative easing may “feel” good for the stock market for a little while, but the cost to the US is already being seen as China and many others around the globe start to abandon the US dollar.

The “QE Effect” also gives China the opportunity to diversify away from the US market by developing deeper trade relations with other markets around the world.  This not only expands China’s influence at the expense of the US, but it also lowers China’s risk exposure to the US economy.

All of these factors make China’s strategy of creating dollar exclusion zones around the world look pretty smart, don’t they?  At the same time, don’t they make the Fed’s policy of quantitative easing look pretty stupid?

What’s the end game?

Given that China has been given special treatment in buying treasury bills, along with the right to enter the US banking industry, there doesn’t seem to be any other conclusion…

I may be wrong--and I hope I am--but it certainly looks like the Fed is working hand-in-hand with China in leading the dollar down the road to oblivion.

And those are…The Gorrie Details.

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2 Comments

1. 

   Ronald Zond

   July 19, 2012 at 8:16 pm

   Hi

   A day ago, I was reading about a "new currency" for the US. No start date though.
   Wonder if the tale is a prelude to the "new currency?"

   Ron

   Reply
2. 

   James Wallace

   July 19, 2012 at 8:40 pm

   Nice post! Gotta dig through a few layers of flith to get to the root of this. Nice exposé on why nations are choosing/seeking to abandon the use of the dollar in trade with other countries - pretty straightforward, yet completely concealed here in the US. Good work.

   Reply