Some habits are hard to break.
[img]555|left|||no_popup[/img]
It is one thing to stop smoking or biting your nails.
But what if you had to give up the dollar?
That’s precisely what some emerging economies say they plan to do.
Brazil, Russia, India and China – also known as the BRIC countries – flexed their collective muscle when each recently announced plans to shift some foreign reserves from U.S.-backed Treasury bonds into notes issued by the International Monetary Fund (IMF).
Several commentators, including Nouriel Roubini, the New York University economics professor who gained notice by predicting the financial crisis, see this as another sign that the U.S. dollar may soon lose its preeminent status as the world’s leading reserve currency. To others, the move by the BRIC nations may be more a signal of their growing financial clout than a lack of demand for U.S. assets.
Yesterday, Russia and Brazil stated their intention to each purchase $20 billion in IMF bonds. To diversify their reserve holdings, India and China are expected to follow suit by purchasing up to $50 billion in IMF bonds.
These moves couldn’t have come at a worse time for the U.S. and the dollar.
Does China Have Reason to Worry?
To fund our economic recovery, the federal government is running up a massive debt. The tab for this multi-trillion dollar deficit is being underwritten by the sale of U.S. Treasury notes and bonds.
With more than $1 trillion in American bonds, China is by far the U.S. government’s largest creditor. China surpassed Japan last year as the largest foreign holder of Treasury bonds.
[img]556|left|||no_popup[/img]
On several occasions during the last few months, Chinese officials, including Premier Wen Jiabao have publicly expressed their distress over the safety and security of their investment in the U.S. economy.
In a recent statement before the National People’s Congress, Wen voiced his apprehension about his country’s stake in the U.S. economy. “We have lent a huge amount of money to the U.S.,” said Wen. “Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”
Between them, the BRIC countries hold nearly $2.8 trillion in reserves, making them among the largest holders of U.S. Treasuries. Their holdings are rivaled by OPEC countries like Saudi Arabia, because like so many other assets sold in the global marketplace, oil is the U.S. dollar denominated.
Late last year, as the financial crisis began to grip the global economy, oil producing countries like Kuwait and the United Arab Emirates revealed an intention to diversify their reserve assets by exchanging a significant portion of their dollar holdings for Euros and Japanese Yen. Both have yet to disclose the actual dollar amount they have converted.
Chatter About the Dollar
During a press conference last week, Russian President Dmitry Medvedev renewed his call for consideration of a supra-national currency to challenge the dollar. In March, Zhou Xiaochuan, the Governor of the Chinese Central Bank urged the IMF to create a “super-sovereign reserve currency.”
Talk may be cheap. But all this trash-talking about the future status of the dollar is making it more difficult and expensive for the U.S. government to bankroll the recovery.
Treasuries declined yesterday, pushing benchmark 10-year yields to their highest point since October. The yield on the 10-year Treasury bond jumped to 3.9 percent this week from a low of 2.2 percent in January.
This upward trend in yields has increased the cost of borrowing, and threatens to undermine the continuing ability of the U.S. government to use its good credit to stabilize the domestic economy.
In a precursor to joint economic talks between China and the U.S. in late July, Treasury Secretary Tim Geithner recently traveled to Beijing to reassure the Chinese. They listened politely to the pitch, but obviously didn’t trust the pitchman.
Like any shark, the Chinese smell blood in the water. Undoubtedly, they will use their leverage as our No. 1 creditor to fend off renewed U.S. demands for economic reforms.
The U.S. dollar may not be in immediate danger of losing it status as the top dog. In our weakened economic state, however, the dollar will remain anemic, continuing to make it vulnerable to challenges from every quarter.
Fortunately for the United States, even the midst of the worst economic crisis in 60years, the dollar remains the safest bet.
But nothing lasts forever.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
