Tuesday, December 05, 2006
Financing our cheap credit
The potential distortions of the Greenspan Indian Summer also spill over into globalization. The US has been running an unprecedented trade deficit. In the past such a sizable deficit (approaching $1T per year, or 8% of GDP) would cause the currency to collapse. Instead the Chinese have been providing a form of 'vendor financing' by keeping their currency artificially cheap. They build up US Dollar reserves from all the sales to the US, and then buy US treasuries, which keeps the Dollar bouyant and the US Federal deficit funded. At some level does it hurt us to send over pieces of paper and get back physical goods at low prices? If the pieces of paper become worth less by the Dollar dropping against the Chinese RMB, the Chinese take an enormous paper loss and we get lots of new toys. Sounds clever, but it is too clever. It does cost us. The coming drop in the Dollar will reduce our national net worth relative to China. On the one hand it looks as if China is funding our deficit; but on the other we are funding the growth of their economy. If we had done so as we used to by investment, we would accrue ownership of major parts of the Chinese private sector, and reap the benefits of these investments as we had previously in Europe and other parts of the world. Instead we have reaped our transient toys, and they have reaped a marvelous and robust economy.
The Chinese are beginning to withdraw that vendor funding. The Chinese currency has started to appreciate against the Dollar, and China is diversifying their reserves out of the Dollar into a basket of currencies that reflect their trade flows. The YE$ currency is emerging. The Dollar is still the major currency, and is over-represented in such a basket due to seniorage we receive for the world oil trade being in Dollars.
Of course they are at our mercy in that we could go into depression and stop buying their goods. Somehow that does not seem like much comfort. More like I am going to kill myself to make you feel bad because I'm gone. We can only hope that they and the rest of the world don't decide to start selling US treasuries at the same time.