Saturday, March 24, 2012

$ Going Out With A Whimper, Not A Bang — So Far’s not just euro-bonds that China is accumulating. They’ve been buying gold (only admitting it after the fact), and farmland and mines in Africa and Latin America. So the quality of their portfolio is rising as it shifts towards hard rather than financial assets.

As the article also notes, China’s scaling back of its dollar holdings in relative terms hasn’t caused the dollar to tank because the rest of the world is so troubled that money is flowing into dollars by default. This is probably temporary. Either the rest of the world gets its act together and begins to look safe again or the US is sucked into the maelstrom of a eurozone implosion or Middle East war or whatever. Or our ongoing debt binge finally gets the scrutiny it deserves and even in an unsafe world the US is discovered to be fundamentally unsound.

So for surplus countries the dollar’s recent exchange rate stability is a great chance to sell into strength and accelerate their diversification programs. Next year’s numbers will probably show another big shift out of dollars.

Why does it matter what China or any other country does with dollars the US has already created and spent? Because the foreign exchange markets are where the dollar’s value is determined, and the numbers are now huge. There are maybe $3 trillion in the vaults of just a handful of countries, all of whom want to protect their investment and none of whom trusts the US to do it for them. If China is seen as easing itself out of dollars without adverse consequence, then the other big dollar holders will be tempted to follow suit. The result: a growing number of sellers, which will eventually send the dollar down at an accelerating rate, which will cause the remaining dollar holders to panic and head for the exits. Trillions of dollars being converted to hard assets or euros and yen (or Mexican pesos or Brazilian real) all at once is a currency crisis that the Fed won’t be able to stop.

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