Saturday, November 10, 2007

China and the Euro

The dollar has been declining steadily in recent months. A declining dollar is a sign that the world markets sense problems in the U.S. economy. These problems, rather then being fleeting, are far from over and are more then likely to get worse. That is why the dollar is trading at all time lows. More worrying though is a recent comment by Cheng Siwei, vice chairmen of China's National Peoples Congress, that China might consider switching from the dollar as their reserve currency to stronger currencies like the Euro. At the moment, China's trade with the outside world is conducted in dollars, so if someone wants to buy Chinese products they more often than not must have dollars in hand. In this way China has been sucking up dollars and placing them as reserves in their national banks as a backing for the Chinese Yuan and a bulwark against a currency crisis. But with the U.S. economy teetering, the greenback is looking pretty insecure and so China is considering a switch. 

What does this mean for China? If China were to sell off dollars the dollar would fall even further, hurting the remaining Chinese reserve dollars in the process. But, as the economist Dean Baker pointed out on his website, the Chinese main reason for buying dollars in the first place was to stimulate trade with the U.S. If they can keep their economy chugging - and because of their state run set up they have more leverage to do this- and selling their goods to Europe in the process, their state run banks might loose out in the short-term, but they might not even care so long as everything else is going smoothly. As Dean Baker also points out, another big incentive for China to switch to a stronger currency is to stem inflation caused by a white-hot economy growing at 11% a-year. 
But a major sell-off of U.S. dollars poses a significant problem for the U.S., a country increasingly in debt and reliant on foreign energy. A falling dollar means less oil, and less ability to pay off debt - and sell debt. Conversely, a weak dollar could help stimulate manufacturing, only, of course, if the economy as a whole does not take a real dive. In such a scenario even the most feeble dollar would have a hard time bringing U.S. manufacturing back to life. 
The British ran into a problem quite similar to this back in 1839. China only excepted silver for all trade, limiting Britain's ability to trade British goods for the coveted items produced in China. Britain eventual found an addictive product produced in excess in their Indian colonies which they forced upon the Chinese. The product was opium. Opium is illegal today, but maybe the U.S. might be able to trade Zoloft for a holiday shipment of Tickle Me Elmo's and Celebrex for some Hot Wheels. We're going to need to think of something soon before Santa begins accepting Euros exclusively. €:)

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