Countries Fighting Collapsing Dollar Value

A number of countries around the world are acquiring larger positions in the U.S. dollar in hopes it'll help shore up the plummenting value of the greenback to the detriment of their exports.

The most recent countries snatching up the dollar are Russia, South Korea, the Philippines and Thailand. The 15-month low of the U.S. dollar continues to raise concerns on slowing down any economic recovery because of exports from the countries having strong domestic U.S. competition because of the dollar's weakness.

Countries like Taiwan an Brazil are also concerned about the strength of their currencies against the dollar, and in the case of Taiwan they've now forbidden foreign investors from placing time deposits in the country in hopes of weakening their own currency. Comments from official in Brazil also imply there could be more action on taking steps to weaken the real.

In spite of rhetoric from Washington that they support a strong U.S. dollar, no steps have been taken to make that happen, and so it seems that's a direct nod to U.S. manufactures and unions who had backed Obama's presidential run. Exports from the U.S. increase when the U.S. dollar declines in value.

For now, China doesn't care whether the dollar rises or falls against the yuan because it's pegged to rise or fall against the dollar, keeping it at an even keel. Other countries have been pressuring China to allow the yuan to rise in value as Chinese exports also benefit from a weaker dollar as far as when competing against non-American exports.

With that in mind, there's no incentive for China to change its monetary policy, even though regional competitors complain about it. We might see some carrots thrown out to manage some of the complaints, but other than that, I don't see China making any drastic changes to their current monetary policy any time soon.

China holds all the cards in this economic battle, as if too much pressure is put on them, they could keep the import of goods from those particular nations at a small level, a major concern with the huge population in China and a solid, emerging middle class which will resume spending once the global economy rebounds.

Consequently, individual nations will have to take their own steps to make their currencies competitive, and not mistakenly wait around for some type of move by China.

For the U.S. dollar, it almost assuredly will continue to fall in value, making it even harder for other nations to compete on the international stage and with China for U.S. imports. Other nations as well are concerned, as the Euro continues to strengthen against the dollar, also making it harder for European nations to increase exports to the U.S.

China's Risk with Dollar

China buying U.S. debt dollars Treasurys

Over the short term China will continue to buy up U.S. dollars in order to keep their export business thriving, but over the long term they're definitely taking steps to ensure they're not forced to be put into this position again.

China’s foreign-exchange reserves are growing again, aiding the Obama administration to sell extraordinary amounts of debt as it seeks to pull the world’s largest economy out of a recession.

Stockpiles of currency rose by a record $178 billion in the second quarter to top $2 trillion for the first time, the People’s Bank of China said recently. The numbers are close to two-thirds the size of China’s economy.

The cash holdings are increasing as the central bank sells its currency, the yuan, to try to stop an appreciation that would make the country’s exports more expensive. The yuan sales mean for all the calls by China and other emerging markets for an alternative to the dollar as the world’s reserve currency, it has little choice but to keep buying U.S. government assets.

“People are talking about whether the Chinese may actually one day dump the dollar and Treasuries because of the problem in the U.S., but they are missing the point,” said Stephen Jen, head of macroeconomics and currencies in London at BlueGold Capital LLP. “The reserves are so big because China needs to keep the exchange rate stable for its exports. Therefore, they have to keep buying dollar assets.”

To me, Jen misses the point. Just because over the short term the Chinese are buying U.S. dollar debt doesn't in any way deter the idea that they will have a policy of getting rid of the dollar over the long haul. As the dollar continues to plunge in value and inflation really takes hold, then we'll see what the Chinese will really do.

The need to balance gains in its currency led China, the largest global holder of U.S. Treasuries, to more than double its holdings of U.S. government notes and bonds in three years to $763.5 billion in April, according to U.S. Treasury data. The amount was equal to 38 percent of its reserves at the time.

Stimulus Spending

Barack Obama’s administration is trying to sell a record amount of debt to pay for measures to revive the U.S. economy. New York-based Goldman Sachs Group Inc. projects that government borrowing go as high as $3.25 trillion in the year ending Sept. 30, almost four times the $892 billion in 2008, to finance the budget deficit.

The reluctance to let the yuan appreciate when the world is mired in the deepest recession in six decades means that China will keep accumulating U.S. debt, even if the amount of its purchases declines, according to economists at RGE Monitor, a New York-based research firm headed by economist Nouriel Roubini.

“Despite China’s concerns about the value of its large stock of U.S. assets, reserve diversification will continue to be difficult."

Cash Surge

China’s reserves have grown by almost 14 times over the last 10 years as exports generated a trade surplus that pumped in cash. Capital Economics Ltd. estimates that exports will generate 30 percent of China’s growth this year.

Investors have also recently pushed cash into emerging markets such as China, amid signs that their economies will recover more quickly than those of developed nations.

Such investment inflows mean that “policy makers bought dollars and sold local currency in order to prevent currency appreciation. China will continue intervening to keep the yuan trading at about 6.83 per dollar through the end of this year.

Yuan’s Stability

The yuan’s value has barely changed in the past year, following a 21 percent appreciation in the three years after China scrapped its dollar peg in July 2005. The demand for dollars conflicts with China’s recent calls for the world to consider drawing away from the greenback as its sole reserve currency.

“As the Chinese were becoming more vocal in regard to the need to move away from the U.S. dollar, they were in actual fact buying more dollars than ever,” said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi UFJ Ltd.

People’s Bank of China Governor Zhou Xiaochuan urged the International Monetary Fund in March to move toward creating a “super-sovereign reserve currency” to eventually replace the dollar. Premier Wen Jiabao said the same month that he was “worried” the dollar would weaken.

Speaking to Al-Arabiya television yesterday, U.S. Treasury Secretary Timothy Geithner expressed confidence that the dollar “will remain the principal reserve currency.”

Dollar Dominance

The dollar’s share of global foreign-exchange reserves increased to 65 percent in the first three months of this year, the most since 2007, according to the International Monetary Fund.

China is trying to reduce its reliance on the U.S. currency in other ways. It signed 650 billion yuan ($95 billion) of currency swaps this year with nations from Argentina to Belarus and is encouraging trading partners to use the yuan to settle cross-border trade.

The country’s top currency regulator this week relaxed curbs on overseas investment by local businesses, allowing more funds to flow abroad starting Aug. 1.

The 21.4 percent drop in net exports in June from a year earlier means “the yuan is stuck in cement until the middle of next year at least."

“The reserves will continue to pile up,” said Zhu Baoliang, chief economist of China’s State Information Center, an affiliate of the National Development and Reform Commission, the nation’s top economic planning agency. “Over the short term, there is not much that China can do but continue to buy U.S. Treasuries while hoping that the U.S. economy can recover as soon as possible so that China’s investment won’t suffer too much loss.”

However you want to communicate this, China over the long term will continue to diversify and not allow its currency and postion to be so dependent on the U.S. dollar. For now they'll continue to buy, but already they're taking steps to eliminate the inherent risks and very real threat of owning U.S. dollars.

China buying U.S. debt dollars Treasury's

Dollar Should be in for a Rough Ride Going Forward

Now the the Chinese have decided to focus on their own infrastructure with the approximate $585 billion stimulus plan, they'll start cutting back on buying U.S. treasuries.

Acquisition of U.S. treasuries worked in China's favor, as it provided money to U.S. consumers who would then buy Chinese products manufactured in the country.

This has worked as the Federal Reserve has been able to keep interest rates low because of the over $1 trillion China has invested in U.S. government securities, which helped prop up the dollar; even though it has struggled until recently.

Consumers were then able to use cheap money to acquire a huge amount of consumer goods; at least until the mortgage bubble broke, and the weakness of those buying habits exposed themselves.

So we're going to see much less Chinese money going to U.S. securities; continued forced liquidation of funds to get access to more cash; printing more money to pay off misguided stimulus plan; and credit continue to be hard to get.

This will end up being "perfect storm" against the greenback, and will eventually put enormous downward pressure on it.

Weakening U.S. Dollar has China Exporters Looking to Other Currencies

Chinese exporters are moving away from the American dollar as rising labor and material costs are cutting into their profits.

The Financial Times cited the CEO of B2B company Web firm Alibaba.com, who said that the vast majority of the 700,000 Chinese suppliers are no longer using U.S. dollars to take care of non-U.S. transactions.

"They are moving to euros, pounds, Australian dollars or even quoting prices in renminbi (yuan)," CEO David Wei told the "Times."

Another drawback is when prices are quoted in U.S. dollars, they are now only valid for a seven day period, in contrast to the former 30-60 day periods.

So far in 2008, the yuan has climbed 3 percent against the dollar, but has declined against most other major currencies.