A local TV station ran Shakespeare’s “King Lear” last week. That was a welcome break from the “much ado about nothing” that has dominated economic news of late.
I refer to the silly kerfluffle about the possibility of a “world currency” that started with statements by China’s premier and the head of its central bank.
China now realizes that by buying up $2 trillion of other nations’ money it chose to perch on the end of a very rotten financial branch. It craves a safer position but there really isn’t one. So it has sent signals of its discomfort. That touched off coded exchanges with U.S. officials, ones misunderstood not only by ordinary citizens, but by currency traders who should know better.
China purchased all this foreign money to keep the value of its own currency as cheap as possible. Once China had the money, it needed to hold these funds in some form. Most went into short-term U.S. Treasuries or other dollar-denominated bonds and some into bonds in euros, pounds or yen.
The United States is doing two things that threaten the value of these Chinese-owned assets. First, the Fed is increasing the base of the U.S. money supply dramatically as it lends money freely to keep AIG and other financial firms from going under. Second, the Treasury is borrowing unprecedented sums of money to fund huge budget deficits.
Two weeks ago, Chinese premier Wen Jiabao said these developments worried him. He has good reason for concern. It is always dangerous for one nation to loan money to another nation in the second nation’s currency. No one in their right mind would loan to Paraguay in guaranis or to Nigeria in naira.
The U.S. president and Treasury secretary responded by reminding the premier that U.S. treasury bonds are considered the world’s safest investment. Over 220 years, our government has never failed to make a single interest or principal payment when due.
That is true and it is completely irrelevant, as Obama, Geithner and Wen all know.
The United States can always print Federal Reserve notes to pay principal and interest on its bonds. The question is what those greenbacks will be worth, either in terms of their buying power within the United States or relative to other currencies.
One purpose of this dialogue was for China to signal its citizens that a foreign power, the United States, is responsible for any economic ills that may come down the pike. And Wen reminded the U.S. government that China can create difficulties by simply not continuing to keep vast sums in the United States.
Obama and Geithner’s statements also served a domestic purpose, trying to reassure U.S. citizens that they know what they are doing. They are not willing to tell the public how bad a set of choices we face, between financial sector collapse and depression on one hand and inflation and a doubled national debt on the other.
Anybody who reads the newspapers, including bond and currency traders, should know that is the case. They should realize that events have ratcheted up the dysfunctionality of the symbiotic embrace in which the United States and China have been trapped for most of a decade.
If the United States expands its money supply and national debt to rescue its economy, the dollar will have less value here and around the world. The value of Chinese dollar assets will drop. If the United States does not expand its money supply and debt, the global economy will shrink, harshly punishing China’s export-reliant economy.
If China does not maintain or increase its dollar holdings, then U.S. interest rates will have to rise, further sapping a weak economy, or the Fed will have to increase the money supply even more, increasing eventual inflation and decreasing the exchange value of the dollar. Either one hurts China deeply.
And so Chinese officials voiced wistful fantasies of an international currency that would allow them to have their cake and eat it too. Such a currency, they dream, would allow them to promote their exports with a weak currency but never run the risk of losing the value of their foreign exchange holdings.
They could have saved their energy. It isn’t going to happen.
As the euro has demonstrated, to have a true multinational currency, you need a multinational central bank, and that isn’t easy. It is far from clear that the Europeans have even succeeded yet.
Moreover, for some new currency to displace the U.S. dollar as a reserve currency, you would need huge amounts of bonds denominated in that new currency.
That isn’t likely unless there is a corresponding multinational government to borrow via such bonds. If you have a “world currency” but still want to buy dollar bonds you have just traded one exchange rate dilemma for another.
There have always been fringe groups calling for world government, like the United World Federalists of which Ronald Reagan was an enthusiastic member 60 years ago.
But, except in the nightmares of the congressional Flat Earth Caucus or assorted conspiracy groups, there is no chance of that happening in time to affect either the United States or China in the foreseeable future.
Both are going to have to tough out the next decade, one way or another, with the currency and international exchange system we have right now.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.