De-Americanization! Bonfire of the Straw Men

[This is a modified version of a piece that appeared at Asia Times Online on October 18, 2013.  It can be reposted if China Matters is credited and a link provided.]

 Per my personal transcript of the October 17 NPR Marketplace, the popular, liberal-leaning US radio business show, an exchange between anchor David Brancaccio and Shanghai correspondent Rob Schmitz took as its point of departure the temerity of a Chinese rating agency, Dagong, in downgrading US debt:

Lead in: ... While it doesn’t have the stature of Moody’s or Fitch, a credit ratings agency in China has downgraded the US even with President Obama’s signature on the budget deal last night ...

DB: [in a tone of polite disbelief]: So this Chinese credit agency downgrades the United States despite the fact that there was the big deal in Washington?

RS: It’s a vulnerable time right now for the US economy, and China and its rating agencies are in attack mode. Before the Dagong downgrade, we saw a pretty vicious attack on America‘s role in the world in an editorial written in Xinhua ... which declared an [airquotes] end to the age of Pax Americana [close airquotes].

DB: We saw in fact this full on pitch this week via Xinhua for making the Chinese currency the world’s reserve currency ...

RD: Of course, that is a dream world. The US dollar will remain the reserve currency of the global economy for the time being ... Third-quarter figures showed that China now has US$3.7 trillion in foreign exchange reserves. This figure represented the highest quarterly growth of Chinese investment in US debt in two years. While China’s rating agency that few people have heard of and some in Beijing are using this moment to go after the US economy, China remains more committed than ever in investing in the US economy and it’s certainly not putting its money where its mouth is in this instance. [1]

Wow. Defensive much?

A few things:

The offending piece in Xinhua was not an editorial, and not an op-ed; it was a signed commentary by one "Xinhua writer Liu Chang". It seems that Liu (if that’s his/her real name) has written occasionally on US finance and represents Xinhua’s contribution to the near universal trend to inject bloggy goodness into mainstream journalism. This article is probably the most recent sign of the apocalypse: not the Gotterdammerung of the US-debt fueled fiscal firestorm, but the Global Times-ization of the Xinhua web presence.

Even so, the "viciousness" of the "attack" was somewhat oversold.

Liu did not declare an end to "Pax Americana". He simply stated that "Pax Americana" was not delivering the goods - that is, the peaceful world it promised:

[T]he US government has gone to all lengths to appear before the world as the one that claims the moral high ground, yet covertly doing things that are as audacious as torturing prisoners of war, slaying civilians in drone attacks, and spying on world leaders.

Under what is known as the Pax Americana, we fail to see a world where the United States is helping to defuse violence and conflicts, reduce poor and displaced population, and bring about real, lasting peace.Moreover, instead of honoring its duties as a responsible leading power, a self-serving Washington has abused its superpower status and introduced even more chaos into the world by shifting financial risks overseas, instigating regional tensions amid territorial disputes, and fighting unwarranted wars under the cover of outright lies. [2]

Liu’s proposed solution to the problem, while presented under the infuriating label of "de-Americanization", was little more than the traditional PRC remedy for the ills of the world: respect for sovereignty, multipolarity, strengthened multilateral institutions, etc.

Second, the Marketplace team’s mockery of the Dagong downgrade contained a certain amount of whistling past the graveyard.

Certainly, some propaganda grandstanding is going on, but consider that the budget deal only kicks the can down the road to next year. The Tea Party is not sitting around criticizing its own ignorant presumption; it is selling a dolchstoss ("stabbed in the back" for you non-German speakers) myth to fuel its fundraising and, if it desires, schedule a re-run of the whole mess next February.

In order to forestall another cave-in by the Republican leadership to the Obama administration in the next confrontation, a right-wing radio stalwart took the position that Treasury default would be a nothingburger for holders of T-bonds and T-bills; according to this self-serving narrative, bondholders could get paid off on time and in full with tax proceeds, thus preserving government creditworthiness in the financial markets.

Presumably, no one would mind if government contractors get paid in scrip and social security and medicare beneficiaries just sucked it up for a few weeks without benefits.

Third, has anybody seen a call by the PRC to establish the yuan as the world’s reserve currency? Despite David Brancoccio’s observation, I haven’t.

The Liu Chang piece concludes:

Apart from that, the world's financial system also has to embrace some substantial reforms. The developing and emerging market economies need to have more say in major international financial institutions including the World Bank and the International Monetary Fund, so that they could better reflect the transformations of the global economic and political landscape.

What may also be included as a key part of an effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant US dollar, so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil in the United States.

Of course, the purpose of promoting these changes is not to completely toss the United States aside, which is also impossible. Rather, it is to encourage Washington to play a much more constructive role in addressing global affairs.

Just so we can get a few things straight, this is not calling for the yuan to replace the US dollar as the "international reserve currency". The PRC has been calling for a reduction in reliance on the United States as an international reserve currency for a few years. Currently about two-thirds of global central bank reserves are held in US dollars. The idea is not to replace the US dollar with the yuan; it is to denominate reserves using a particular currency basket represented by the International Monetary Fund's Special Drawing Right, or SDR.

This idea is a favorite of left-leaning economists and financiers such as Joseph Stieglitz and George Soros; in 2009 it also attracted the positive interest of the Bank of China’s Zhou Xiaochuan, who is revered in Western financial circles as China’s God of Wealth. (See China discovers value in the IMF, June 10, 2009).

The idea is not that the yuan is ready for prime time; it is that the logic of growth (in the BRICS - Brazil, Russia, India,  China, and South Africa) and debt and the danger of default (in the United States and European Union) make it prudent to reduce reliance on the US dollar and denominate transactions in a unit of exchange that reflects the overall, changing character of the world economy.

For that matter, the PRC isn’t even in the SDR yet.

Right now, the US dollar accounts for a little over 40% of the SDR; the euro, the Japanese yen, and the British pound account for the rest. [3]

Since the dollar actually accounts for over 60% of foreign currency reserves held by central banks, one can take the 40% weighting as a back-handed acknowledgment that there are already too many dollars out there compared to the weight of the US in the world economy.

The United States accounts for 16% of the IMF’s funding quota (since IMF decisions require 85% approval, this gives the US a veto); the aggregated EU countries have something along the order of 25%; the China has a 10% share. Japan and the UK, which are probably hearing Chinese footsteps and wondering how long they can hold on to their share of the SDR basket, account for 6% and 4% respectively.

What’s holding back China from taking a share of the SDR basket is the fact that the PRC hasn’t decontrolled its capital markets sufficiently to make central banks comfortable holding yuan reserves. If/when the capital account is decontrolled and the PRC can issue creditworthy, tradable government bonds suitable for parking the reserves of foreign central banks, the PRC can make a case for getting in the SDR basket, maybe at a 10-15% level, maybe at the expense of the US share, maybe by sticking it to the UK or Japan.

Maybe that’s a long way off. But, maybe it isn’t, per Associated Press [4]:

Beijing agreed Tuesday to make London a center for handling investment denominated in China's tightly controlled currency ...

Investors in London will be allowed to apply for licenses to invest yuan directly into China, Osborne announced. He said the Chinese central bank set an initial quota for London of 80 billion yuan (US$12.7 billion).

Finally, Schmitz beats NPR’s "China seeking to replace US$ with yuan as international reserve currency" straw man by accusing the PRC of "not putting its money where its mouth is" hypocrisy, since "third-quarter figures showed that China now has $3.7 trillion in foreign exchange reserves. This figure represented the highest quarterly growth of Chinese investment in US debt in two years."

I do wonder where he got that "investment in US debt" number. Chinese foreign exchange holdings are going up sharply again after two years’ pause, ironically since the PRC is apparently acquiring "Asian safe haven" status compared to the other local economies that don’t have tight capital controls and expect to get pummeled by capital flight when the QE taper eventually kicks in. But those holdings don’t all get invested in US debt.

The most recent Treasury numbers I could find go up to July 2013 and show that official Chinese holdings of securities have declined since they reached their peak in April 2013, at around $1.3 trillion. Even allowing for the slop of incomplete reporting and the routing of some transactions through the Cayman Islands, there is no picture of heightened Chinese enthusiasm for placing their forex holdings in US Treasuries. [5] [Subsequently, I saw some reporting of a recent spike in Treasury purchases by all Asian buyers, not just the PRC, for the ironic reason that Asian central banks were stocking up out of fear of a dearth of Treasuries in case of default.]

As the Western and Chinese financial press have reported ad nauseum, the PRC plows its money into US Treasuries, not as a vote of confidence in American fiscal management and economic vitality but simply because a viable alternative hasn’t yet emerged.

At the same time, of course, China is entering into currency swap agreements with many of its non-US trading partners (200 billion yuan with the UK, 350 billion yuan with the EU) to take the US dollar out of the equation and establish a basis for foreign holding of the yuan - and reduce the trade surplus-related increase in the PRC’s gigantic US dollar reserves.

In an unintended consequence of US sanctions, China has also been able to exploit Iran’s predicament by paying for some energy imports with yuan instead of with US dollars. It is also buying gold and scouting the world for reasonably plausible non-Treasury debt, equity, and resource plays for its forex.

As to where this is all going, I expect that China’s high-profile demands that the United States get its house in order represent a planned one-two propaganda punch as the US phases out quantitative easing 2 and the PRC presents itself to the Asian democracies as a counterpoint to the US - a stable, responsible, and well-heeled practitioner of the arts of fiscal management and international finance - and the best-qualified partner for bilateral trade and multilateral regional finance and trade agreements, including the $100 billion BRICS rescue fund for emerging markets that China is pushing as an alternative to the IMF.

It’s going to take more than misdirection, mockery, and indignant bluster in the US media to turn that situation around.

Notes:
1. See here
2. See Xinhua, October 13, 2013.
3. See IMF data here.
4. See London to become hub for China's yuan, Reuters, October 15, 2013.
5. See here for US Treasury data.

Communist China and the Western Commentariat Finally Get on the Same Page About this Stupid Democracy Thing

It’s finally become clear to everyone the key problem in the current Eurozone crisis is just too much democracy.

Pesky voters opposed to austerity measures get in the way of efforts to cut government expenditures in order to reduce deficits and make repayment of national debts more likely.

China’s Global Times on Greece, November 2:

Greece's oldest legacy may be its downfall

[E]ven at this critical moment now, the government may still be wavering between the public's demand and the country's long-term future.

…
At a time of economic difficulty, the government needs to demonstrate more determination to go against popular will.

Exactly one week later, Megan McArdle (via Kevin Drum) has her own authoritarian epiphany: democracy makes even the most advanced, free-est, smartest, most pundit-blessed, whitest countries incapable of doing “the right thing”:

I used to write about developing countries a fair amount. Time and again they would make these bizarre and pointless moves, like suddenly and for no apparent reason defaulting on a bunch of debt....And the other journalists and I would cluck our tongues and say "Why can't they do the right thing when it's so . . . bleeding . . . obvious?"

Then we had our own financial crisis and it became suddenly, vividly clear: democratic governments cannot do even obvious right things if the public will not tolerate it.

Just one week!  The gap between elite attitudes in China and the United States is really not that great.  

And I’m not joking here.

Count the voters of Greece and Italy cowed, if not entirely convinced by media handwringing on behalf of the vengeful gods of the bond market.

Greece, of course, walked back on the referendum plan.  Instead, it has installed Lucas Papademos, previously VP of the European Central Bank, as PM to shepherd the austerity program.

In Italy, Berlusconi is on his way out and a government of “technocrats” i.e. economists focused on deficit reduction and tasked with ignoring public squawking about austerity—will soon be in.

What is perhaps less well understood is that the true nature of many Western governments is being revealed.

The quick and dirty shorthand is that government is like a business.  When it borrows, it’s to bridge the temporary imbalances between the income and the outgo.

Not so.  Western governments today are not businesses managing revenue and expenditures on behalf of their shareholders (the voters) and working to increase business volume (i.e. economic growth) in order to maximize revenues (tax receipts).

The issue is not the deficit (yearly revenue shortfall); it’s the indebtedness (the ability of the enterprise to issue debt).

Many national governments are quasi-state bucket shops for investment banks, providing a flow of debt product to investment banks for packaging and sale--very much like the mortgage brokers who frantically signed up suckers in the free-money era so the investment banks would have plenty of mortgages to securitize, CDO-ize, and pour into the hedge funds.

Now national governments issue the debt, providing the sovereign low-risk imprature that allows investment banks to send debt-backed securities flooding into the market in search of the greatest fool.  

When the naked lunch moment—the time when it looks like the greatest fool is going to wise up, and the wise guy sees it’s time to cash out—arrives, everybody clubs together to make sure that the people responsible for this glorious party, the investment bankers, don’t get hurt.

When debt repayment becomes a problem, governments don’t turn to the prosperity solution; they turn to the austerity fix.

Almost automatically, national governments tilt toward policies that protect the ability of the banks to recover on the debt—and, perhaps more importantly, sustain the viability of the government as a vehicle for continued issuance of debt in the future-- by cutting the expenditures that might prop up personal and national incomes and could be seen to interfere with the flow of interest payments.

In the last analysis, the governments aren’t working for the shareholders (voters), even if examples like Argentina hint that a country might do well by defaulting on its debt.

I don’t even think they’re working for the bondholders, at least not for the dumb sheep who end up getting shorn (“taking haircuts”).

They’re working for the investment bankers who look forward to rolling over, increasing, securitizing, and slicing and dicing government debt—which is the most marketable, available in enormous volume, and is a perceived lower risk because taxpayers are, in the final analysis, hostages of their government when it comes to debt repayment (as long as they can be persuaded they don’t have an alternative).

How governments turned into debt vehicles is a matter for historians to sort out.  But I guess it has something to do with trying to keep the rich happy (by cutting taxes) while keeping the rest of us happy (by spending money on services).

When the bills come due, the rich (who have a perpetual interest in low taxes and an addiction to leveraging their profits through investment banking) turn out to have the most votes in our post-democracy democracies.