Saturday, September 12, 2009

Systemic instability

Cheap dollars are sowing the seeds of the next world crisis

This is hugely significant. China is now more worried about America inflating away its debts than about those debts being exposed to currency risk. Economists at Western banks making money from QE still say deflation is more likely than inflation.

Posted by devo @ 11:48 PM (1008 views)
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2 thoughts on “Systemic instability

  • I should think its more technically accurate to say that central banks have been sowing the seeds of the next financial crisis. Just like they did the last one. And the one before that.

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  • The Chinese have a reputation for taking a long term view, but on the matter of their trade surplus and forex they have got themselves into a bit of a fix.

    I believe their original justification for allowing such a surplus to develop, was not that the export work would boost their domestic economy, but that they wanted to get Uncle Sam over a barrel. If the US became dependant on Chinese made goods while China could live happily without anything made in America, then China would be in a very strong position, diplomatically.

    – Mission accomplished.

    As with many military campaigns however, the real difficulties arise after the primary objective has been delivered.

    The dollar assets owned by the Chinese are only worth what the USA can ultimately exchange them for in the form of exportable goods.

    As the Chinese can make most of those goods for less themsleves, there is a fundamental problem. It means that the collective real value of those dollar assets is much less than might appear to be the case.

    China needs to secure its place as the global top dog with a fully convertible currency, which must be allowed to rise in value against the dollar, and the other western currencies. Although that will reduce the book value of their forex, it is already an illusory value, so they will not actually be sacrificing anything. However, they will avoid further losses going forward.

    This leads to the question: “by how much does the Yuan need to rise?”

    This is a diffiuclt calculation, but if you consider a scenario where the Yuan had doubled in value against the dollar; it still seems very unlikely that their trade balance would reach equilibrium, indeed it might even be worse, in dollar terms, as the dollar price of their exports would have doubled, while the dollar price of imports remained the same.

    Although the Chinese don’t seem to be in a hurry to do anything dramatic, low risk Yuan denominated assets should be a sound investment now. However, the difficulty of trading them (so far) and the slightly anarchic nature of Chinese investments deters me.

    Investing in companies that would prosper from a Yuan rise seems a safer, smarter approach.

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