Borrowing Money From China: The Blowback Begins

Posted on January 10, 2006

This morning brings some bad news for the U.S. economy: China is going shift some of its foreign exchange reserves out of U.S. dollars and into either the Euro or the Yen. China currently holds more than $800 billion U.S. dollars; dumping even a fraction of those dollar is going to cause ripples in the U.S. economy -- the dollar is going to fall, interest rates will rise and the housing market bubble could collapse.

As China's manufacturing industries flood the world with cheap goods, the Chinese central bank has invested roughly three-fourths of its growing foreign currency reserves in U.S. Treasury bills and other dollar-denominated assets. The new policy reflects China's fears that too much of its savings is tied up in the dollar, a currency widely expected to drop in value as the U.S. trade and fiscal deficits climb.

China now boasts the world's second-largest cache of foreign exchange -- behind only Japan -- and is on pace to see its reserves climb past $1 trillion later this year. Even a slight diminishing of the dollar as a percentage of those holdings could exert significant pressure on the U.S. currency, many economists assert.

In recent years, the value of the dollar has been buoyed by major purchases of U.S. Treasury bills by Japan, China and oil-exporting countries -- a flow of capital that has kept interests rates relatively low in the United States and allowed Americans to keep spending even as debts mount. Some economists have long warned that if foreigners lose their appetite for American debt, the dollar would fall, interest rates would rise and the housing boom could burst, sending real estate prices lower.

The comments of the Chinese senior economist, made on the condition of anonymity because the government disciplines those who speak to the press without express authorization, confirmed an analysis in Monday's Shanghai Securities News stating that China is inclined to shift some its savings into other currencies such as the euro and the yen, or into major purchases of commodities such as oil for a long-discussed strategic energy reserve.

This is the direct result of borrowing from China to finance the Iraq War, which is not (as was promised by the Bush administration) going to pay for itself. Recent reports show that United States consumers have a negative savings rate, that is, they are saving nothing but adding credit card debt at an alarming pace. This is a recipe for economic disaster, because the engine of the U.S. economy is fueled by the buying of the consumer.

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