Monday, November 13, 2006


Here's something more than a few people have been wondering for awhile: how long before China recognises how inherently unsustainable the current US economic paradigm actually is? It seems that the recent US economy, built on the hallucinated wealth of an inflating housing market, has finally jarred the Chinese now that that housing market is suffering. The Chinese central bank won't say this, of course, but rather indicate that they simply want to "diversify." Naturally, valuation of the dollar is at risk.
The concerns over dollar assets mounted this week after Zhou Xiaochuan, the Chinese central bank governor, said that China planned to diversify its assets across different currencies and investment instruments, including emerging markets. The dollar, which analysts reckon make up around 70 percent of China's reserves, fell to 2-1/2 month lows against the euro as his comment hit trading.

Analysts noted that China has pointed to such plans before without making any huge shifts, but the news rekindled persistent worries about China diversifying away from the dollar.

In the United States, Zhou's remarks contributed to a growing sentiment that a sound portfolio contains a bigger portion of international assets.
That the Chinese are finally signaling that they will adjust their holdings of $1 trillion US dollars to something more "sound" is telling and Wall Street is taking the hint. A drooping dollar will almost certainly force the Fed to raise interest rates, something that will further hit the housing market. The cooling real estate market has already produced two slow growth quarters in a row this year, with the third quarter of 2006 displaying economic growth with the "weakest pace in more than three years."

If the Chinese central bank moves aggressively to divest itself of US dollars, this will really cause some problems. I doubt this will happen, though, and for the same reason the Japanese can't dump their US dollars: doing so would collapse the rest of the dollar market and loose them billions. The Chinese also know that they can't do this too aggressively either because any US holdings they possess will too suffer enormous losses and they won't likely want to afford that.

Does this sound like the basis of a sound economic position in the world? We are now so indebted to the Chinese that, even if they wanted to get rid of US dollars, they can't because doing so would loose them too much money. We're like the guy who owes the mob so much money, they can't afford to whack him. But they will break a kneecap or two, just to get the message across.


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