Why China Is Fleeing the Dollar

From the April 2010 Trumpet Print Edition

Most Americans have little idea what is happening to the economy. Many people think America is emerging from a vicious little recession and will soon be back on the road to prosperity. America always has, so it always will, is the common reasoning.

Yet this time, things may turn out very different. On January 8, cnbc reported that the U.S. Federal Reserve purchased an unprecedented 80 percent of all U.S. treasury securities issued in 2009.

This is earthshaking, game-changing news with possibly lethal repercussions. Here is why.

How America Went Into Debt

During 2009, the federal government ran a $1.4 trillion deficit—the largest in world history, more than triple the size of the previous year’s record-breaking deficit.

Since Americans save so little money, foreigners have come to provide almost all the federal government’s borrowing needs in recent years. They do this by purchasing U.S. treasury bonds. This was a win-win for them: Not only would they earn interest on their money, but also, since American consumers tend to spend the borrowed money purchasing foreign-made goods, a good proportion of the money cycled right back to them.

From 2006 through November 2009, Beijing lent $527 billion to America through treasury purchases alone. Hong Kong lent an additional $100 billion. Other countries like Japan lent hundreds of billions more. Then there were the hundreds of billions of dollars they lent to government-sponsored entities like mortgage giants Fannie Mae and Freddie Mac.

But now it is as if the foreign nations see the writing on the wall. They realize that America is addicted to debt and that their loans might never get repaid. As a result, America’s most important source of lending is drying up.

Want to Buy Some Treasuries?

On February 17, the Department of the Treasury reported that last December, foreign demand for U.S. treasury securities fell by more than in any month ever recorded.

China led the pack. It reduced its dollar holdings by over $34 billion—about 4 percent of its holdings. For six months in a row, China not only stopped lending money to the federal government, it actually sold treasuries.

China has been America’s most important creditor. Is China just rebalancing its portfolio for the short term, or is this the beginning of a structural move away from the dollar? If China is trying to quietly get out as much of its money as possible while it can, the greenback could be in a lot of trouble. At the very least, it could mean higher interest rates for America—which would really hurt consumers, who are loaded with debt. Not only that, but it would set a dangerous precedent. China holds most of the world’s supply of investable funds. That means that where China invests, and how long it supports the dollar, and what it does with its own internal credit policies, sets the tone for investors all over the world.

Perhaps that is why oil-exporting nations like Saudi Arabia, Qatar, Iraq and Venezuela have been net sellers of treasuries since June too. Thus, two of America’s four most important foreign creditors are awol.

All things being equal, this exodus of foreign money would have caused massive credit contraction capable of smothering America: interest rates skyrocketing into the double digits, zombified Wall Street banks with broken business models, small businesses unable to roll over their debts, a housing market in a renewed free fall, soaring consumer bankruptcies, and unemployment worse than the Great Depression.

So far, this has not happened. Why? Faced with the above list of catastrophes, the Federal Reserve decided to risk the biggest catastrophe of all in a forlorn attempt to avoid the inevitable financial reckoning.

To prop up the economy, the Federal Reserve began doing the one practice anathema to all fiat-currency-based economic systems: creating money out of thin air.

Funny Money

Remember that $1.4 trillion deficit America ran last year? Eighty percent of that—$1.12 trillion worth—was funny money. The U.S. government needed money, and since foreigners were unwilling or unable to provide it, the Federal Reserve simply turned on its digital printing presses and electronically sent over some ones and zer0s.

But the Fed didn’t just print money to give to the government to spend. It also created close to $1 trillion to prop up asset prices in America. It printed money to give to the big banks and to purchase toxic mortgages from Fannie Mae and Freddie Mac.

It was theft and highway robbery on a grand scale because the Fed did nothing to earn this money: It simply said it had the money, and it was so. Consequently, all other money in circulation—yours, your grandma’s and Uncle Fred’s money—became worth less. The Fed now has over $2 trillion worth of assets on its balance sheet—mostly money it willed into existence over the past year.

No wonder foreigners are beginning to flee the dollar. The Fed is doing what every failed fiat currency system in the history of paper money has done. To governing officials under financial pressure, the temptations of the printing press are too great.

The results are always disastrous. Once you start down the money-printing road, it is almost impossible to turn back.

The history of money printing says the dollar is doomed. Maybe that is why the Chinese have dumped their Fannie and Freddie investments. During 2009, they took the Fed’s newly created money and ran while the dollars still had some value remaining. After all, the dollar has lost almost a third of its value over the past decade.

Prettying Ourselves Up

Did you know that this exact scenario in which America finds itself was prophesied thousands of years ago?

Speaking of the modern nations descended from ancient Israel, of which America is currently the most geopolitically prominent, the Prophet Jeremiah warned that a time would come when America’s trade partners would abandon it despite America’s best attempts to pretty itself up. “And when you are plundered, what will you do? Though you clothe yourself with crimson, though you adorn yourself with ornaments of gold, though you enlarge your eyes with paint, in vain you will make yourself fair; your lovers will despise you; they will seek your life” (Jeremiah 4:30; New King James Version).

America has two choices: Raise interest rates to try to attract its economic lovers back to lend more money (which means America’s debt payments would mushroom, potentially derailing the economy), or continue to destroy the dollar to pay the bills. Neither option is attractive. Expect America’s foreign lovers to keep voting with their feet—as they head out the door.