Wednesday, August 3, 2011

America narrowly missed being a deadbeat--this time

The last time the world faced a financial tsunami in 2008, smart money looked for safe harbor and that was to buy U.S. treasury bills. Even though it was the American financial market running amuck that led to the financial collapse, everybody remained convinced that the dollar as the safest place to be. So much money piled into the U.S. that, for a while, the dollar actually rose in strength relative to other currencies.

After the latest fiasco from Washington, will the rest of the world continue to have faith and confidence in the value of the dollar? After watching Congress played politics and care not a whit about upholding the honor of United States, can the world assume that America is not about to become a deadbeat to beat all deadbeat nations in history?

Even if the US Treasury honors its obligations this time after undergoing the tortuous exercise between House, Senate and the White House, can any investor feel assured that there would be a certain outcome the next time? Who is to say that some fringe group won’t successfully hijack the government and decide to renege on the government obligations?

China holds more US federal debt than any other foreign country. What has China done about this situation other than wringing the collective hands in Beijing? Actually, quite a lot.

On the one hand, even at the outset of the financial crisis, Beijing asked Washington to keep the value of the dollar from sliding. Members of the Obama administration serially assured China that the US will uphold the integrity of the dollar, maintaining as deadpan a demeanor as possible all the while knowing that printing more money is inevitable.

Of course, no one in Beijing took the U.S. assurance to the bank. Instead, China has been actively investing declining dollars into hard assets, such as oil fields and mineral deposits in Africa, Australia and Latin America. (China would make more investments in the U.S. as well except for Washington's generally frosty reception.)

Since the activity of China’s central bank is not transparent to outsiders, we can only speculate that China has also been diversifying their foreign exchange holdings into other currencies. However, no other currency has large enough circulating volume to allow China to fully divest out of dollars by exchanging into it.

The other means of not depending on the dollar is to conduct bilateral trade based on bilateral currency swap agreements that would allow the use of Chinese yuan rather than the dollar to settle the trades. China has entered such agreements with selected countries such as Brazil, Russia and South Korea. This is considered a step towards internationalizing the Renminbi.

In May, I attended an international conference on global financial security in Beijing. All the speakers from outside of China as well from inside China expressed concern on what action the U.S. will take to stabilize the world financial market. None anticipated that the American politicians would play political chicken and brinksmanship with the U.S. national debt and throwing America’s prestige and image down the sewer.

Since America’s financial collapse that drag the world down, which China side-stepped with its own considerably more effective economic stimulus plan (one that does not require bailing out banks), China has been looking at the U.S. with skepticism. Now that China has seen America’s much touted democracy in action, China is even more certain not to follow the U.S.

China’s economic stimulus meant more superhighways and bridges as well as a high speed rail system becoming the envy of the world, recent accident notwithstanding. In contrast, America’s superhighways need repairing and bridges that threaten to fall down.

Since 2008, China has formulated a national development plan that placed reduced reliance on export, especially away from labor intensive, low cost goods but aimed for higher valued added manufacturing. Recent Wall Street Journal article reported that multinational corporations are placing their high value manufacturing investments near foreign markets where they are making profits, not in the U.S.

China has continued to invest in education and allocated more of the national budget for R&D. Hundreds of thousands of graduates, mostly in technical disciplines, have gone overseas for graduate education. Many have returned to China to found companies that are competing on the global market such as Baidu, Huawei, and Suntech.

These companies compete on their proprietary innovations. With a pipeline of well trained technologists, there will be more coming from China. The U.S. with an increasingly dilapidated education system will need a steady infusion of foreign students to keep pace.

It’s not at all certain that the eventual accord reached by Congress will create jobs and restore the dignity of the millions of Americans seeking employment. The next time the U.S. lectures China about human rights, the spokesperson should be careful lest he/she is accused of wearing no clothes.

The U.S. is mired in two wars it doesn’t know how to win. Now the dysfunction of Washington has been laid open for all to see. While China is too diplomatic to question America’s vulnerability, will the rest of the world continue to see America as the sure footed hegemonic power that can be counted on to step in as the ultimate peacemaker?

There are pundits that still insist that America remains a great power and that eventually the country will pull out of this downward spiral. I would like to know how.
A shorter version ran in New America Media. The New America Media version was also picked up by Xinhuanet and Global Times.

See interview on Russian TV.

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