Wednesday, April 04, 2007

U.S. Pockets Aren't Deep Enough to Win Yuan Row

(Very well said!!)
By William Pesek

Almost two years after a modest currency revaluation, China is still thumbing its nose at U.S. demands for big gains in the yuan.

Last week, officials in Beijing seemed to yawn as Charles Schumer, a U.S. senator pushing for tariffs on Chinese imports, predicted that a new measure aimed at forcing China to boost the yuan will pass Congress by next year.

The U.S. also imposed tariffs on imports of Chinese coated paper. China's response was summed up by central bank researcher Tang Xu who said a stronger currency alone won't solve U.S. trade disputes. Traders were equally unmoved by the U.S. action.

In Japan, meanwhile, neither the government nor investors seemed concerned about a U.S. senator's proposal to require Asia's biggest economy to stop holding down the yen. ``It's time for our government to hold Japan accountable for what amounts to illegal trade subsidies,'' Michigan Democratic Senator Debbie Stabenow said last week.

What gives? You would expect the U.S. to have more sway in markets. It does, after all, print the reserve currency. And while China is growing 10 percent, India isn't far behind and Japan is recovering, the $13 trillion U.S. economy is still proving hard to replace.

One explanation for the U.S.'s waning clout in foreign- exchange markets is something that gets little attention: the country's lack of currency reserves.

Short on Reserves

Certain benefits come from printing the most-used currency, having great sway over the International Monetary Fund and being the pre-eminent economic power. It means you can get away with more. In the U.S.'s case, it's massive current-account and budget deficits, negligible household savings and a pricy military quagmire in the Middle East.

Even so, the U.S.'s $41 billion of currency reserves seem puny compared with China's $1.07 trillion, Japan's $884 billion and even Malaysia's $82 billion. At the moment, the U.S. has fewer reserves than Nigeria's $42 billion, Indonesia's $46 billion and Poland's $49 billion.

All this makes the U.S. look (a) highly confident about its financial condition, (b) complacent amid a growing number of global imbalances, or (c) arrogant. There's little doubt that, if asked, U.S. President George W. Bush and his Treasury secretary, Henry Paulson, would say (a) is the right answer.

Bretton Woods II

There's some merit to the view, considering the so-called Bretton Woods II world in which we live. The breakdown of the post-World War II system centered on the gold standard led to a kind of dollar standard. Many nations adopted the dollar as a new anchor, either formally or informally pegging currencies to it. When you're the U.S., who needs reserves?

Yet in a world littered with risks -- from slowing U.S. growth to global imbalances to terrorism to bird flu to the yen- carry trade to overheating in the Chinese economy -- one wonders how wise it is for the U.S. to have so few reserves.

That's especially true when you consider that the U.S. has arguably lost control of the dollar. With its economy facing big challenges, the U.S. probably wants a weaker currency for the same reasons everyone else does. How much control does the U.S. have, though, when overseas investors -- Asian governments among them -- own its bond market?

Perhaps that's why the U.S. tries to influence other currencies; it realizes it has lost control of its currency and interest rates to foreigners. Given that arrangement, the U.S. may want to be careful slapping around China and Japan, its two biggest debt customers.

Reserve Bubble?

One could argue that Asia has created a reserve bubble. There would seem to be better uses for the trillions of dollars on which Asian central banks are sitting. Also, monetary authorities may have reached the point of no return in their ability to reverse course or manage their massive holdings.

Yet the U.S. decision to boost its foreign reserves by just $10 billion in 10 years (they were $31 billion in 1997) was either a shrewd move or a mistake. Only time will tell.

In the meantime, the U.S. should expect more shrugging from officials in Beijing and Tokyo on currency matters. China's need to create millions of jobs to keep the peace trumps the desire to make nice with the U.S. Japan also remains unwilling to try living without a weak exchange rate.

Besides, what is the U.S. going to do about it? Intervene in currency markets to strengthen the yuan or yen with less money than either Bill Gates or Warren Buffett has? It's doubtful.

If there's any positive spin here for the U.S. it's that it now has two potential saviors in the event of a crisis. The credit crunch known as the Panic of 1907 forced the U.S. to turn to one man for financial aid: J.P. Morgan. The White House now has at least two wildly rich men to call if the dollar plunges and reserves run low.

The truth is that when it comes to swaying currency markets, the U.S. has little money to put where its mouth is.

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