Wednesday, April 01, 2009

China wants its cake and eat it too

International it’s a mean place out there: The U.S. Dollar is the worlds "reserve currency." That means that most international transactions are conducted directly or indirectly in U.S. Dollars. The price of oil, grains and precious metals are all set in U.S. Dollars. For example if someone in Dubai wants to buy gold from someone in France the transaction is made, directly or indirectly, in dollars. The price of gold is specified in U.S. Dollars but if the actual transaction is conducted in Euros then the price of the commodity reflects the value of the Euro relative to the U.S. Dollar. This really irks the Chinese.

The Chinese are the largest holder of U.S. Dollars, somewhere around $2 trillion, and have an interest in seeing that money retain its value. The U.S. economy dwarfs that of all other countries including China and Russia, only the European Union comes close which is why the Dollar is the world’s primary currency and why other currencies are "pegged" to the Dollar. By pegging the local currency to the U.S. Dollar a country with a smaller economy is able to create external value for its currency. A Walmart coupon may have a $10 face value for anything purchased in a Walmart store but unless it can be exchanged for $10 in U.S. currency it has little value to anyone shopping at K-Mart. The Chinese currency only has value in so far as it can be exchanged for Dollars. This concept has a bruising effect on the egos of totalitarian rulers.

The trouble is that the Chinese have too many Dollars because they have artificially kept the value of their currency low relative to the Dollar. This keeps the price of Chinese goods low and the price of U.S. goods high on the international market. Our economy is large enough to tolerate this up to a point. Eventually the Chinese will have sold us everything we can afford to buy and will have all our money. Not really, of course, but that’s the idea behind an imbalance of trade taken to reductio ad absurdum. The larger a claim the Chinese have on our economy the less our money is worth. A dollar doesn’t buy what it used to. The Chinese don’t like that but one wonders if their totalitarian rulers have bothered to consult with professional economists. Eventually, whether the Chinese like it or not, the value of their currency must rise relative to the U.S. Dollar. The Chinese require payment in Dollars but if the Chinese allowed payment for their goods in Chinese Yuan then someone would have to buy those Yuan with some other currency and each currency would then float to its "natural" level.. This is true regardless of what currency becomes the "reserve currency" of the world. As long as the U.S. economy is the worlds dominant economy the U.S. Dollar will remain the defacto world currency.

Currently 1 Chinese yuan = 0.146323 U.S. dollars.


China Urges New Money Reserve to Replace Dollar
Asia split over China's "war of nerves" with U.S.

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