It's all good. It shouldn't worry anyone the 50 to 66 percent of the USD in criculation are being held by foreign entities. No worries, mates. No worries.
China has more than a trillion U.S. dollars held in reserve. They buy up all these dollars so that they can maintain their loose currency peg to the greenback (not technically a peg, because they are allowing the yuan to increase in tiny and controlled increments per day....but the effects are similar to a peg). It is a bit of a game that China is playing in order to artificially prop up their economy at the expense of the rest of the world. Technically, the yuan....if traded openly and freely in the market, would have a much higher value than it does today. Because it is kept artificially low by the government, it makes all goods and services and investments very very attactive. Huge amounts of foreign inflows (capital) go into China. China "subsidizes" these inflows by lending to countries like the U.S. (by buying over a trillion dollars worth of Treasury notes). In essence, China is putting cash into Americans hands so that they can, in turn, buy Chinese goods...
What this whole thing does is weaken the U.S. dollar because of all the investments coming out of America (sell USD) and going into China (buy yuan)....purely due to the fact that the yuan is kept artificially cheap.
But this game China is playing is not without its consequences. You see, China is currently grappling with an inflation problem that can quickly get out of control. If not dealt with effectively, it can bring down their entire economy. The problem stems from the contrasting economies. The Chinese economy is in a boom. A boom is naturally accompanied with lower unemployment, higher capacity utilization and therefore wage pressures. This results in
higher inflation, which can normally be dealt with by raising interest rates to slow growth. On the other hand, we have the U.S. economy which is currently grappling with
contraction. The U.S. Federal Reserve is dead set on an interest rate
decreasing track for the rest of the year and probably into 2009. Every rate decrease weakens the dollar because it makes USD denominated investments less attractive so people don't hold as many USD assets in their portfolios. But because of the yuan/dollar peg, a U.S. interest rate decline will, by default, also weaken the yuan. This makes Chinese goods even cheaper than it already is and foreign investment floods the market. Inflation would be magnified and not under completely under the control of the Chinese government. If the People's government does not act decisively, they will find themselves in an uncontrollable hyperinflationary environment that will bring their great nation down to its knees.
So, in summary, while the Chinese are exporting a huge amount of cheap goods to the U.S., the U.S. is exporting a huge amount of inflation to China. Funny how what goes around, comes around...huh?
China is a big cause of a lot of imbalances in the world marketplace... the balance of trade.....foreign exchange..... inflation. Their government needs to let market forces determine the natural course of economic development....I fear that their blatant government intervention will only lead to future woes for China and the continuing problems for the rest of the world.
WP
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