Thursday, June 23, 2005

ALL-OUT FINANCIAL WAR LOOMS LARGE: U.S. AND CHINA TRADE BLOWS

Great article on the true unsustainable nature of our current trade deficit with China. In addition, the topic of foreign debt financing is also brought up as a risk to any currency devaluation the Chinese may engage in. We may be caught between a rock and a hard place here. The Yuan's exchange rate being pegged to the dollar is terrible for our trade deficit, but gives the Chinese excess capital to finance our debt. Once that pegging is gone, so too may be their large investment in our debt which could cause a massive currency collapse....
"Financial war is a form of nonmilitary warfare which is just as terribly destructive as bloody war, but in which no blood is actually shed... when people revise the history books... the section on financial warfare will command the reader's utmost attention." -Unrestricted War: China's Master Plan to Destroy America, People's Liberation Army, Colonels Liang & Xiangsui

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In analyzing the precarious predicament that has $1.94 trillion U.S. Treasury debt owned by foreign banks, most notably China, the overloaded U. S. debt burden is already teetering on a fine line. Any hint of a problem in maintaining support of U.S. bonds would create an instantaneous meltdown of the greenback with a simultaneous surge in the price of gold.

However despite this, the Treasury Department warned China last month they have until November to make their exchange rate more flexible or they will be labeled as currency manipulators. This charge would start bilateral talks on the exchange rate and possibly retaliatory action.

Currently the yuan is pegged with the U.S. dollar at 8.3:1 giving China, with its low labor costs, an excellent trade advantage which both Republican and Democratic politicians have been strongly complaining about for the last few years.

I would have to conclude that these bureaucrats are only looking at the trade imbalance with China and ignoring the tenuous nature of the important reliance on foreign debt purchases. As Business Week warned, a revaluation of the yuan could have other serious repercussions for the dollar. "With a stronger currency peg versus the dollar, China would purchase fewer bonds, as would Asian central banks if they were to cut back on currency market intervention. And further weakness in the Treasury market with a resulting bump higher in interest rates, could weigh on the long-gestating US recovery. In that regard, US lawmakers should be very careful what they wish for."