Recent mutterings at the highest level in the Chinese Government about the monetary policy of the United States should send cold shivers down the spine of world leaders.
It signals the arrival of the new economic order. The inevitable Chinese sale of its US denominated assets. The Chinese simply cannot afford to allow the value of its reserve holdings to be stripped away by loose monetary policy in the United States.
If the European or British economies weren’t in the doldrums we could have seen the Chinese diversify into the Euro or pound sterling but these are not realistic options.
China only has to look across the sea to view its future. In the 1970s and 1980s Japan underwrote the spending splurge of the US consumers. The United States repaid that favour by letting the market devalue the $US against the yen, triggering a decade of deflation in Japan.
China thought they’d sidestep that outcome by pegging their currency against their trading partners, however, the US strategy of quantative easing leading to the monetising of their foreign debt will lead to the same outcome of a deflation spiral for China unless they take bold action.
Thus the decision of China, India and Brazil to buy IMF bonds is of great significance. It is the first step in moving away from the US$ as a reserve currency.
The question is will they go the full way of creating the Bancor as advocated by Maynard Keynes? Or will they substitute another currency as the world’s reserve?
Conventional wisdom in the West is that a Chinese move away from the $US as the reserve currency would hurt China and thus they will keep on propping up the $US and hence the US economy.
The thinking is that the Chinese economy depends on the US consumer purchasing Chinese exports and the symbiotic relationship is so interlinked that the separation will be fatal to both. This view is short sighted and ignores the economic realities of the unfolding 21st century.
According to The Economist $US170 billion in hot money entered China in the first five months of 2008 this could reach $US504 billion a year.
Chinese policymakers would be very nervous about the implication of asset bubbles emerging in either the immature Chinese stockmarkets or in the commercial property sector.
The bursting of such an asset bubble could undermine the political structure of China and threaten to destabilise the internal power relationships. It is this very reason that the Chinese authorities will act rather than wait to be engulfed by the fate of the Japanese.
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