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The nation’s debt clock is ticking faster than ever — and Wall Street is getting worried.
As the Obama administration racks up an unprecedented spending bill for bank bailouts, Detroit rescues, health care overhauls and stimulus plans, the bond market is starting to push up the cost of trillions of dollars in borrowing for the government.
WASHINGTON (AFP) – China, wary of the troubled US economy, has already "canceled America's credit card" by cutting down purchases of debt, a US congressman said Thursday.
China has the world's largest foreign reserves, believed to be mostly in dollars, along with around 800 billion dollars in US Treasury bonds, more than any other country.
Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the US Federal Reserve's policy of expanding the money supply to prop up the banking system and its over-indebted households. Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyperinflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves.
The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have nearly $10,000bn (€7,552bn, £6,721bn) in foreign exchange reserves, mostly in dollar assets. Any other country with America's problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world's dominant reserve currency. The US can disregard its creditors' concerns for now without worrying about a dollar collapse.
The faith of the Chinese in America's power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar's global status. Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets. You have to check the asset allocations of wealthy ethnic Chinese to understand the dollar's unique status.
US policy is pushing China towards developing an alternative financial system. For the past two decades its entry into the global economy rested on providing cheap labour to multinationals and pegging the renminbi to the dollar. The dollar peg allowed it to leverage the US financial system for its international needs, while domestic finance re-mained state-controlled to redistribute prosperity from the coast to the interior. This dual approach has worked well. China could have its cake and eat it. Of course, the global credit bubble was what allowed the approach to be effective; its inefficiency was masked by bubble-generated global demand.
China is aware it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects its anxiety over relying on the dollar system. The US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.