The End of the Dollar
In January, Chinese President Hu Jintao was wined and dined with a lavish state banquet at the White House and other official ceremonies usually reserved for America’s closest friends and allies. Why? One must be very polite when entertaining your banker—even if you don’t like him and he doesn’t like you.
Yet there is another more ominous but closely related reason.
For years, China has warned America that its support for the dollar was not unconditional. The warnings fell on deaf ears. Confident that China was virtually forced to lend money to America, Washington embraced a borrow-and-spend policy that would have destroyed any other currency.
Then last year, when it became clear that America could not borrow enough money to pay the bills—it crossed the Rubicon, declaring that the laws of paper money no longer applied to the mighty dollar: America would just print whatever money it needed to pay the bills. Federal Reserve Chairman Benjamin Bernanke declared he would start by conjuring $900 billion—75 percent of America’s borrowing needs—out of thin air.
The world was shocked that America would so abuse the world’s reserve currency. France, Germany, Russia and China were outraged. But Americans wagered that the world is too caught in the dollar trap to do anything about it.
So far, this strategy has worked out pretty well for America. With several European countries falling apart, the dollar has firmed up, and safe-haven money has continued to flow into America. But signs are, that is beginning to change.
Europe’s Sugar Daddy
As the Washington Post wrote, “[S]trange things are happening in Europe—none stranger than the emergence of China as the Continent’s sugar daddy” (January 16).
Wait—wasn’t China America’s “sugar daddy”? Well, just follow the yen. In July 2009, China held $939 billion worth of U.S. treasury debt. More than a year later China’s holdings have fallen to $895 billion. This is big news—and surely isn’t lost on Washington. For more than a year, America’s most important creditor has stopped lending new money to America. Instead, China is investing its money, and its confidence, in Europe.
Today, Europe matters more to China than any place in the world. With 400 million First World consumers and the world’s largest economy, the European Union is by far China’s biggest export market.
It is a reciprocal relationship, too. China now directly holds over $900 billion worth of eurozone national debt. In Greece, China is investing billions more as it attempts to build the Mediterranean port city of Piraeus into the “Rotterdam of the south,” and create a modern-day silk road linking Chinese factories with consumers across Europe and North Africa.
Most importantly, China has thrown its weight behind the euro.
In a recent trip to Europe, Vice Premier Li Keqiang did nothing less than transform Europe’s economic picture. Just as commentators were predicting the collapse of the eurozone, Li—a favorite to become China’s next prime minister—appeared to throw China’s $2.85 trillion worth of foreign exchange reserves into Europe’s breach, promising to be a committed and responsible long-term investor in Europe. icbc bank, China’s largest lender, quickly followed suit, announcing its intention to move full force into the eurozone. It will open its first-ever branches in France, Spain, Italy, Belgium and the Netherlands. It has already opened offices in Frankfurt and Luxembourg.
Li’s support is already paying dividends in Europe. With interest rates coming down from recent highs and successful debt auctions, Spain and Portugal got a welcome taste of what several billion euros’ worth of Chinese “sugar” can do.
Of course, it doesn’t come free. Li publicized China’s desire that the EU relax restrictions on high-tech exports to China and develop trade relations. In addition, China wants access to Europe’s defense companies.
Europe seems all too willing to do business. The EU’s Foreign Minister Catherine Ashton called for abolishing Europe’s arms embargo with China. Reportedly, American officials, who have to deal with a rapidly growing Chinese military presence in the Pacific, are furious.
What Will Replace the Dollar?
It was what Hu Jintao told the Wall Street Journal just prior to his arrival in Washington, however, that should have all Americans preparing for one massive sugar crash. He said the dollar should no longer be the world’s reserve currency. It is a “product of the past,” he said. It is time for a more fair and balanced system.
What does China think should replace the dollar? Hu himself said it wouldn’t be the yuan. What does that leave? Follow the sugar.
“The euro will overcome the region’s deficit crisis,” assured Song Zhe, China’s ambassador to Europe, back in December. The cementing of the euro’s status will “promote the building of a diversified global currency system,” he said.
Remember: When anyone talks about “diversifying” the global currency system, by definition it means ditching the current system—which is the dollar.
And China isn’t alone in shifting support to the eurozone. Japan has also announced that it will step up its efforts to back Europe by purchasing eurozone debt. According to Reuters, Japan will purchase 20 percent of soon-to-be-issued Eurobonds. The Eurobonds would be jointly issued and backed by all members of the eurozone—creating a new debt market that will directly compete with U.S. treasuries. Where will Japan get the money? As America’s second most important lender, it has a whole stack of treasuries it would probably love to “diversify” out of.
If the world wants out of the U.S. dollar, there is only one viable paper alternative: Europe.
According to Li Daokui, an academic member of the Chinese central bank’s monetary policy committee, Americans only have months to prepare—while Europe works to get its act together. “For now, market attention is still on Europe and for the coming 6 to 12 months, it will not shift to the United States,” said Li on December 8. “But we should be clear in our minds that the fiscal situation in the United States is much worse than in Europe. In one or two years, when the European debt situation stabilizes, attention of financial markets will definitely shift to the United States. At that time, U.S. treasury bonds and the dollar will experience considerable declines.”
Strange things are happening in Europe. Now you know why. The international monetary system set up at Bretton Woods in 1944 is on the verge of breaking down, and the dollar will soon be fighting for its survival as the world’s reserve currency.