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An International Reserve Super Currency? Bretton Woods the Third

Currencies / Global Financial System Mar 29, 2009 - 03:05 PM GMT

By: Oxbury_Research

Currencies Best Financial Markets Analysis ArticleMarch 24 (Bloomberg) -- China 's call for a new international reserve currency may signal its concern at the dollar's weakness and ambitions for a leadership role at next week's Group of 20 summit, economists said. Central bank Governor Zhou Xiaochuan yesterday urged the International Monetary Fund to create a “super-sovereign reserve currency.” The dollar weakened after the Federal Reserve said it would buy Treasuries and the U.S. government outlined plans to buy illiquid bank assets.

You can surely expect China , the largest foreign holder of dollar and dollar denominated assets, to increase its influence and make its presence felt on global economic issues. This is the natural progression of things given the massive paradigm shift of power away from the G-20 nations (debtors) to the emerging powerhouses in SE Asia and other resource rich countries (creditors). It's very interesting/pathetic to watch the likes of the U.S. and Western Europe both pretend like this isn't even happening, and act as if they are the ones still holding the means to dictate the monetary/fiscal policy of other nations.

This is exactly what we saw today in response to the Chinese call for a new global currency. Tim Geithner and Bernanke both spoke in front of the House Finance Committee and each one responded to the idea in the Bloomberg article of whether or not this was a plausible situations with an emphatic and almost stubborn NO. That was followed up by the President's response to a new global currency in which he responded with claims regarding the U.S. political system and strong domestic economy as dollar bullish factors…right.

I digress. Think of it as a sort of poker game. The G-20 economies are holding the losing hand and the emerging economies have the winner and the chips to boot. As with each groups' economic climate, the player in this game know what the others are holding. The G-20 talking tough and pretending like they can force the hand of the emerging economies is like bluffing in the poker game with the losing hand already flipped over. Unfortunately for the G-20 nations, the emerging countries aren't going to fold the cards that they already know to be the best hand. The question becomes: how long will the U.S. bluff, or how long will the Chinese let the U.S. bluff?

Ace Up Their Sleeve

Economically speaking, the Chinese aren't brilliant, but they have been fairly smart and very strategic. They do an especially good job with keeping their sizeable financial transaction very discrete and limiting the psychological market impacts that would otherwise occur. This was prevalent in both their massive commodities purchases in the grains, metals and energy markets; as well as the brief periods when the Chinese were net sellers of U.S. Treasuries. The disconnect of the financial media to these events can't 100% be attributed to the subtleness of the Chinese. The lack of reporting was done so intentionally by the likes of CNBC and MSNBC in order to minimize market volatility and market worries, but these half truths or forms of propaganda for lack of a better word, would not have been possible had the Chinese desired their actions to fall in the public media sphere.

This is a very important notion that really stems from the Chinese' patience and the diligent way in which they approach this transition of global superpowers. As previously mentioned, they already know they have the winning hand; it's just a matter of maximizing their economic potential, or minimizing the losses associated with the Chinese taking the reigns from the U.S. The most destructive part of this transition will be the separation of the dollar as the reserve currency in the world and the absolute implosion of U.S. government and private debt markets. In the prior statement, the former is only beginning to show signs of stress. The Chinese realize that they really have the ace up their sleeves and when they play it FOREX markets will tremble. This will be painful for China , but they will employ their discrete financial methods and attempt to minimize the associated losses. As far as private debt markets go, they have jumped into the public spotlight, but don't let that deceive you; ALL PRIVATE DEBT MARKETS IN THE U.S. STILL HAVE NEGATIVE REAL YIELDS.

All In

Growth in the monetary base is running at triple digit levels, while curtain interest rates, such as mortgage rates, are at or near historic lows. This creates an unbelievable amount of economic imbalance. For example, if you are looking to buy a house or take out a student loan, it is in your best interest to assume as much debt over the longest period as possible. By simply holding the loans, you gain in purchasing power. For something that doesn't have an asset value associated with it like the student loans, this is a no brainer. For a home loan, if the difference between interest rates and inflation is greater than the decline in home value over the same period, than you gain in purchasing power. On the flip side of the trade, the money the borrower collects plus the interest is worth less than the initial value of the lent money. In other words, when interest rates are negative real, the borrower wins and the lender loses.

THIS ECONOMIC CLIMATE IS BOTH EXTREMELY DESTRUCTIVE AND FINITE. You have to look at who actually incurs these losses. In order for lenders to keep lending at negative real rates, they need loans with negative real rates from the U.S. government. In order for distressed borrowers to keep borrowing, they need these negative real rates implemented by the Federal Reserve and Treasury Department. Through the process of implementing financial socialism and transitioning a semi-capitalist economy into a social welfare state; the U.S. government and Federal Reserve have become both the lenders and borrowers of last resort as they try and bail out both sides of the debt markets. That is an extremely expensive task to undertake with the costs sustained by the U.S. dollar, and the Chinese are the largest holders of dollars and dollar denominated assets.

I've been sort of a tease, in the sense that I can't really say how long the Chinese will let this go on and watch the value of their assets in holding decline. There are some signs that the stresses are growing like this rhetoric of a new reserve currency and the recent $300 billion commitment by the Federal Reserve to monetize long dated U.S. Treasuries. Remember that when the Chinese really begin to mitigate their dollar risks, they will do so subtly. The signs won't be extremely prevalent, things like TIC data, debt monetization, Fed/Treasury lending facilities and money supply growth figures will be the first to show signs. If you wait for this to become a big story in the financial media it will be too late. Creditor nations are getting ready to rake in the pot.

By Nicholas Jones
Analyst, Oxbury Research

Nick has spent several years researching and preparing for the ripsaws in today's commodities markets.  Through independent research on commodities markets and free-market macroeconomics, he brings a worldy understanding to all who participate in this particular financial climate.

Oxbury Research originally formed as an underground investment club, Oxbury Publishing is comprised of a wide variety of Wall Street professionals - from equity analysts to futures floor traders – all independent thinkers and all capital market veterans.

© 2009 Copyright Nicholas Jones / Oxbury Research - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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