The $7 Trillion Problem That Could Sink Asia

[Sancho Panza]

Bloomberg 5/8/13

'Asia sits on almost $7 trillion in currency reserves, much of it in dollars. Asia’s central banks engaged in a kind of financial arms race after a 1997 crisis, stockpiling dollars as a defense against turmoil. That altered the financial landscape in two ways: One, Asia now has more weapons against market unrest than it knows what to do with. Two, Asia is essentially America’s banker, with China and Japan having the most at stake.

In a perfect world, Washington’s bankers would threaten to call in their loans. Asian nations would sit White House and congressional leaders down and tell them to get their act together. But Connally’s 1971 observation is infinitely truer today than at any time in Asia’s history. We need to stop considering huge reserve holdings as a financial strength. They are a trap that is complicating economic policy making. It’s time Asia devised an escape.

Fiscal Matters

China isn’t without leverage. It’s no coincidence that new Treasury Secretary Jacob Lew’s first overseas visit in March was to his banker-in-chief, Xi Jinping, in Beijing. Nor did it go unnoticed that Lew was the new Chinese president’s first foreign-official meeting. Lew may have been sending Xi a signal this week by calling on Congress to act “in a way that doesn’t create a crisis” on fiscal matters.

But that leverage is limited. Xi and Premier Li Keqiang are engaged in a risky rebalancing act, trying to wean the Chinese economy off exports without fanning social unrest. Another debt-limit tussle would fuel market volatility, strengthen the yuan as the dollar plunges, and result in the loss of tens of billions of dollars in China’s portfolio of U.S. Treasuries.

In Tokyo, Shinzo Abe faces a similar dilemma. An important pillar of the prime minister’s plan to end deflation and restore healthy growth is a weak yen. The currency’s 17 percent drop since mid-November has helped even down-and-out Sony Corp. eke out some profits. Yet the yen would surge anew on another U.S. downgrade: In 2011, a giant flight-to-quality trade drove huge amounts of capital Japan’s way.

The more Asia adds to its holdings of U.S. debt, the harder they become to unload. If traders got even the slightest whiff that China was selling large blocks of its $1.3 trillion in dollar holdings, markets would quake. The same goes for Japan’s $1.1 trillion stockpile. So central banks just keep adding to them. Pyramid scheme, anyone?

Never before has the world seen a greater misallocation of vast resources. Loading up on dollars helps Asia’s exporters by holding down local currencies, but it causes economic control problems. When central banks buy dollars, they need to sell local currency, increasing its availability and boosting the money supply and inflation. So they sell bonds to mop up excess money. It’s an imprecise science made even more complicated by the Federal Reserve’s quantitative-easing policies.

Stealth Selling

At the very least, Asia should stop adding to its dollar holdings and consider ways to bring more of those funds home. They could be used for infrastructure, education, research and development on cleaner energy, or any other vital investments in the future. The question, of course, is how?

There is a clear first-mover advantage for smaller economies. South Korea (with $53 billion in Treasuries), the Philippines ($40 billion) or Malaysia ($18 billion) could try to dump dollars on the sly. Bigger ones couldn’t pull that off in this hyperconnected, 24/7-news-cycle world; news of sizable central-banker sell orders would inspire copycats.

Washington can help, and not just by avoiding another suicidal debt-limit fight. The Treasury should engage with its Asian counterparts in a cooperative, transparent brainstorming process to draw down their reserves without devastating markets. It’s in the U.S.’s best interest to keep more of its debt onshore, Japan-style, by attracting greater purchases from cash-rich U.S. companies. That would make the U.S. less vulnerable to capital flights in the future.

If ever there were a time for a currency summit, it’s now. Perhaps the International Monetary Fund or the Group of 20 can host the debate. Such high-level discussions would help Asia set goals and consider the mechanics and timing of reclaiming more of its savings. Only then will all those dollars start being the solution to Asia’s challenges, not the problem. '

[interestrateripoff]

Should be interesting to see what happens to the US if all this currency heads home.

The dollar has infected the entire global system, which was the plan.

Still on the positive side it's less than 50% of US govt debt.....

[R K]

'Asia sits on almost $7 trillion in currency reserves, much of it in dollars. Asia’s central banks engaged in a kind of financial arms race after a 1997 crisis, stockpiling dollars as a defense against turmoil. That altered the financial landscape in two ways: One, Asia now has more weapons against market unrest than it knows what to do with. Two, Asia is essentially America’s banker, with China and Japan having the most at stake.

This is a complete nonsense article.

For every asset there must be a liability.

Thus it is impossible for a surplus country to 'stockpile' dollars in the manner suggested.

They're simply the result of a pegged currency that has been used to effectively sell below market labour/products and print RMB.

In much the same way Germany has 'stockpiled' iou's from the PIIGS.

China (and Germany) are the bag carriers. Not a place you want to be.

[Executive Sadman]

Koreans should Dump them and buy what? Crappily built US cars. Warzone homes in detroit.

For that 'debt' to be repatriated, something needs to be given in return.

[wherebee]

Koreans should Dump them and buy what? Crappily built US cars. Warzone homes in detroit.

For that 'debt' to be repatriated, something needs to be given in return.

well I know that China has been buying real estate, farmland, and mining rights in africa, australia, new zealand, canada, and the USA. smart bunnies.

[Butthead]

well I know that China has been buying real estate, farmland, and mining rights in africa, australia, new zealand, canada, and the USA. smart bunnies.

Not really. What is the chance that in a time of crisis or even economic stress the USA would uphold China's "right" to farmland or minerals or whatever? Zero, they'd nationalise it and/or give it to their cronies in an instant.

The smart thing to do would be to stop accumulating worthless peices of paper for productive work. Let their currency appreciate, make themselves wealthier and imported goods/materials cheaper, open up the market to free enterprise etc etc.

[Executive Sadman]

well I know that China has been buying real estate, farmland, and mining rights in africa, australia, new zealand, canada, and the USA. smart bunnies.

Depends if they're getting value. The japs did this in the late 80s eager to swap dollars for hard assets, overpaid, and had to liquidate much of it in the early 90s to cover bad loans at home. In many instances valuations were a lot lower in the early 90s than the late 80s and the japs made significant losses. Of course, its not like China has any soon to be bad loans of its own.

London property doesnt look particularly good value to me, if they are buying in pounds acquired long ago, it looks especially bad value.

[Executive Sadman]

Not really. What is the chance that in a time of crisis or even economic stress the USA would uphold China's "right" to farmland or minerals or whatever? Zero, they'd nationalise it and/or give it to their cronies in an instant.

The smart thing to do would be to stop accumulating worthless peices of paper for productive work. Let their currency appreciate, make themselves wealthier and imported goods/materials cheaper, open up the market to free enterprise etc etc.

Perhaps if the US government had patriots or nationalists in charge....Id disagree. The chinese will lobby corrupt yank politicians just like other yanks have been doing for decades, and they'll get their way. Their 'cronies' arent set in stone, their cronies are whoever pays best, which is likely to be non-americans.

[Sour Mash]

Koreans should Dump them and buy what? Crappily built US cars. Warzone homes in detroit.

For that 'debt' to be repatriated, something needs to be given in return.

More than that, the unique status of the US Dollar as reserve/ petro/ commodity currency gives it some real advantages in that US$ do not necessarily have to 'return home' any time soon. Their holders can and do use them to buy all sorts of non-US sourced resources on the global markets rather than having to spend them on US assets.

Hence the Fed can print away with abandon and export much of the resulting inflation to foreign markets. That's the real problem for anyone stupid enough to build up large dollar reserves - the fact that ultimately their asset is being debased on an ongoing basis.

[MarkG]

The chinese will lobby corrupt yank politicians just like other yanks have been doing for decades, and they'll get their way.

Indeed. Buying the government is much, much cheaper than buying the country.

[sombreroloco]

Don't Rule Out an Asia Banking Crisis, S&P Says

http://blogs.wsj.com...says/tab/print/

Asia came through the global financial crisis relatively unscathed and has been pacing world growth for the last decade. But it could be the next world hot spot for a banking crisis.

Standard & Poor's Ratings Services warned Thursday of a threat to the region's financial stability from a credit and debt bubble in China. In a downbeat look at Asia's banking system, the ratings firm said slower economic growth in China could fuel a spike in bad loans even as the shadow banking sector continues to expand.

"A regional banking crisis isn't out of the question," S&P said in its report.

Much of S&P's concern stems from the off-balance sheet lending by China's banks—known as shadow banking—that goes unmonitored by regulators.

"Years of very rapid credit expansion on- and off-balance-sheet, along with a strong increase in housing prices, is set to backfire on banks' asset quality, profitability, and possibly liquidity," S&P said.

Warnings on China's banking system aren't new. Ratings firms, analysts and the International Monetary Fund have previously flagged the same risks. And S&P itself acknowledges that its base case remains that Beijing would bail out the finance sector in an emergency.

But the direct language used by S&P is a reminder of the threat that China's banking sector, the world's largest, poses to the region.

S&P also sees significant risks in India, where lenders face a triple threat from slower economic growth, a weakening rupee and rising interest rates. That combination likely means an increase in non-performing loans, S&P said.

"We believe that deteriorating asset quality and earnings will constrain the credit profiles of Indian banks as adverse economic developments hurt the corporate sector–the chief recipient of banking credit," S&P said.

The report is also cautious on the optimism surrounding Japanese Prime Minister Shinzo Abe's economic program.

"Unless structural reforms succeed, we think Abenomics is unlikely to heal the economy or banks in the longer run."

Even S&P sees the bubble now, unlike in 2007/8 when it still gave AAA to just about everyone.

[wonderpup]

Much of S&P's concern stems from the off-balance sheet lending by China's banks—known as shadow banking—that goes unmonitored by regulators.

Funny how a democratic America and a centrally governed China seem to have arrived at exactly the same point- an out of control financial sector that is eating them alive while their respective 'regulators' seem oblivious to the danger.

[Si1]

<br />More than that, the unique status of the US Dollar as reserve/ petro/ commodity currency gives it some real advantages in that US$ do not necessarily have to 'return home' any time soon.  Their holders can and do use them to buy all sorts of non-US sourced resources on the global markets rather than having to spend them on US assets.<br /><br />Hence the Fed can print away with abandon and export much of the resulting inflation to foreign markets.  That's the real problem for anyone stupid enough to build up large dollar reserves - the fact that ultimately their asset is being debased on an ongoing basis.<br />

<br /><br /><br />

fine, except America and China have guns missiles etc pointing at each other

does that have implications for default by inflation? Is Weimar at all relevant?

[zugzwang]

More than that, the unique status of the US Dollar as reserve/ petro/ commodity currency gives it some real advantages in that US$ do not necessarily have to 'return home' any time soon. Their holders can and do use them to buy all sorts of non-US sourced resources on the global markets rather than having to spend them on US assets.

Hence the Fed can print away with abandon and export much of the resulting inflation to foreign markets. That's the real problem for anyone stupid enough to build up large dollar reserves - the fact that ultimately their asset is being debased on an ongoing basis.

Your first point is very important and generally overlooked. As a consequence of its reserve currency status the US is the only country in the world that can run permanent trade and current account deficits. To all intents 'everything' is priced in dollars. Quasi-reserve currencies like sterling and the yen may behave like the dollar but are still vulnerable to crises and collapse, as we're about to discover. Your second point follows on from the first, is broadly accepted as the truth, but false. Set against the volume of world trade and foreign exchange ($2-3 trn traded daily) the Fed's expansion of base money is at best marginal. Which is why despite Bernanke's unprecedented QE Infinity the dollar has risen sharply against a basket of currencies in the last two years and is essentially unchanged since the US recession officially ended in 2009.

[happy_renting]

Your first point is very important and generally overlooked. As a consequence of its reserve currency status the US is the only country in the world that can run permanent trade and current account deficits. To all intents 'everything' is priced in dollars. Quasi-reserve currencies like sterling and the yen may behave like the dollar but are still vulnerable to crises and collapse, as we're about to discover. Your second point follows on from the first, is broadly accepted as the truth, but false. Set against the volume of world trade and foreign exchange ($2-3 trn traded daily) the Fed's expansion of base money is at best marginal. Which is why despite Bernanke's unprecedented QE Infinity the dollar has risen sharply against a basket of currencies in the last two years and is essentially unchanged since the US recession officially ended in 2009.

If some of the TFHers on ZH are to be believed, the US will actually hit it's fiscal cliff in a couple of weeks and default.

Would that trigger selling of dollar holdings world-wide? I don't really understand these things, but i wonder if it could snowball....

[oracle]

<br /><br /><br />

fine, except America and China have guns missiles etc pointing at each other

does that have implications for default by inflation? Is Weimar at all relevant?

yes but the chinese also have missiles aimed at the russians.....for all their talk on solidarity.

...neither trust each other....they both know the long game and they both have very different agendas.

ie middle east:

as i've said before,this little conflict is basically between mad mullahs, holy roman empire 2.0 and soviet union 2.0

all of the above are trying to stitch each other up, and each of the above knows if they commit too many troops into the "crunch zone" in the middle east, and lose...they will be savaged by the other.

the china-russia situation is no different.

russia has massive amounts of oil and gas------china needs them to feed and fuel 1.5 billion people.they would like nothing better than to "act business-like" whila all of the other above parties blow each other to bits...they know they have the manpower to mop up afterwards.....and russia knows it, and germany knows it.

they might give lip-service to the anti-syria stuff,but rest assured, when crunch time happens they will turn on russia on a sixpence if they see opportunity for resource grab.

....they would like to see russsia go all guns blazing in there and take a hiding...then they will pounce.

the russians are doing the same to the mad mullahs with regard to all of that middle eastern oil.

the holy roman empire 2.0 are using the US/UK as their proxies, while agents encourage mass immigration to internally subvert/destroy target populations.

they really can't trust each other one iota....and they know it.

.......oh,what a tangled web we weave.......

Edited October 3, 2013 by oracle