Full Faith and Credit?
By Robert Romano
When Treasury Secretary Timothy Geithner responded to a question after a speech at Peking University in China on Monday, saying “Chinese assets are very safe,” the student audience had the common sense to laugh in his face.
They're not the only ones laughing at the full faith and credit of the United States. Unfortunately, on this side of the Pacific, “It ain't funny, McGee.”
With over $1.5 trillion in dollar-denominated assets of its $1.95 trillion of foreign currency reserves, the Chinese government itself has also raised significant concerns over the ability of United States to make good on its word and pay its debts. And that concern is shared—by the American people who are straddled by those debts, by investors worldwide who depend upon a financial system denominated largely in dollars, by U.S. allies who either back their currency with or outrightly use dollars, and on down the line.
In March the Chinese Premier said, “We have lent a huge amount of money to the United States. Of course, we are concerned about the safety of our assets. To be honest, I am definitely a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China's assets.”
According to a recent working paper from the Council on Foreign Relations, “China's $1.5 Trillion Bet,” some $768 billion of China's holdings are in U.S. treasuries, $489 billion in agency bonds (Fannie Mae, Freddie Mac, Ginnie Mae, and Federal Home Loan bank), $121 billion of U.S. corporate bonds, $104 billion of U.S. equities, and $41 billion in deposits.
China's fears do not stop there, however. As ALG News has previously reported, the head of China's central bank, Zhou Xiaochuan, went so far as to advocate replacing the U.S. dollar as the world's reserve currency with the International Monetary Fund's Special Drawing Rights (SDR). He recently wrote that the “SDR has the features and potential to act as a super-sovereign reserve currency.”
China is caught in a bind. If it does not purchase U.S. debt, the U.S. resorts to debt monetization—i.e. printing more money to purchase debt—causing dollar depreciation and thus devaluation of their dollar-denominated assets. If it continues to purchase the debt, it exposes itself to ever-increasing risk of critical losses should U.S. debt be downgraded or if the U.S. simply defaults on the debt.
That's why an SDR reserve currency makes so much sense for the Chinese. It would allow them to transition away from dollars into an asset to offset losses should the dollar fall as the world's reserve currency. They would just need buy-in from other nations to do the same and start backing their currencies with the IMF's SDR.
Others are not so much concerned about the apparent weakness of the dollar as they are ready to take advantage of its downfall. For example, the dollar dropped yesterday in trading as the Russian Government once again called for discussion of the idea of a supranational currency, as reported by Bloomberg.
In a June 1st interview with CNBC, Russian President Vladimir Medvedev said “We need some kind of universal means of payment, which could create the basis of a future international financial system. Naturally, because of the crisis in the American economy, attitude to the dollar has also changed.” The Russian President will soon be meeting with his counterparts from India, China, and Brazil to discuss his proposals.
These shots across the dollar's bow all come as the American government acquiesces to foreign powers on an ever-widening scale.
Not even Congress seems to think much of the dollar these days. Yesterday, House and Senate Democrats agreed to a $100 billion line of credit to the International Monetary Fund, increasing the role of the SDR. The $100 billion line of credit itself would be the SDR equivalent of $100 billion on the date of the agreement. Currently the U.S. has a $10 billion line of credit to the IMF worth SDR 6.6 billion.
As ALG News has previously reported, at the G-20 summit, Barack Obama pledged a $100 billion line of credit to the International Monetary Fund (IMF) as part of a $550 billion global effort to bolster the international bank. The G-20 then approved a new $250 billion general allocation of SDR—the bank's reserve asset.
Obama stated in his letter to Congress, “We committed to this expansion, and other countries are looking the United States to deliver on our commitment.”
If invoked, the $100 billion line of credit would be worth SDR 75.0 billion. Additionally, the provisions would authorize the sale of 13 million ounces gold from the IMF—worth about $11.9 billion. The proposal would also increase the U.S. share in the IMF by SDR 4.97 billion at a cost of $8 billion.
The provision should have been removed. Senator Jim DeMint proposed an amendment to kill any IMF expansion in the Iraq and Afghanistan war-funding bill—which passed the House with at a cost of $96.7 billion and the Senate at $91.3 billion.
Unfortunately, the amendment failed by a vote of 30-64, which can be viewed in full here. The IMF provision now proceeds to both the House and Senate for final passage, perhaps sealing the dollar's final fate.
Members of both chambers should vote with full knowledge that they are proposing to extend a $100 billion line of credit when the nation does not have a $100 billion to lend—necessitating either more borrowing from overseas or printing the money—all to enable and advance an agenda of foreign powers to supplant the dollar as the world's reserve currency.
Currently, Russia, India, China, and Brazil are already prepared to purchase their first round of IMF bonds—denominated in SDR. According to the Wall Street Journal, “The IMF is preparing its first bond offering, potentially tailored to Brazil, Russia, India and China. Russia's [$10 billion] offering would equal that of India and would be about a quarter of the $40 billion China is expected to contribute to boost the IMF's resources.”
While in China, Treasury Secretary Geithner even had the courtesy to promise to help the Chinese gain more voting power at the IMF. Speaking at Peking University he said, “China is already too important to the global economy not to have a full seat at the international table, helping to define the policies that are critical to the effective functioning of the international financial system.”
So much for full faith and credit. Of course, it is no wonder foreign powers want to do business elsewhere. Between a $1.8 trillion deficit that can only be financed by printing more money as China slows its investment in U.S. treasuries, the $3.6 trillion budget that is drowning out private investment into the economy, the $11.3 trillion national debt that may never be paid back, and $104 trillion of unfunded liabilities the nation created for itself through the entitlements Medicare and Social Security, they do not believe the U.S. will keep its word.
And when the run on the dollar leaves the U.S. with stratospheric inflation, a wrecked financial system, and nothing but a pile of worthless paper, the only ones who will be laughing are the nation's enemies.
Robert Romano is the Senior Editor of ALG News Bureau.