Another battlefront opens in currency wars
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A new round in the currency wars has been launched by the US recently, nominally aimed at "opposing currency manipulation and trade protectionism" and promoting "rebalance of the world economy."
Its main target is China.
Like every currency, the US dollar is backed by the country's ability to repay its debts. When printing money to provide stimulus through quantative easing, the US Federal Reserve often looks to monetize the colossal US debts through purchasing US treasuries as well as bonds and bills held by financial organizations.
Under these circumstances, printing dollars en masse reduces the value of the claims held by US debtors, as the value of the dollar itself diminishes. In the wake of the financial crisis, the dollar's worth is still in doubt, which is why the price of gold, a reliable currency, has nearly doubled, going from $700 an ounce in 2008 to $1,350 an ounce today.
Since 2008, the flow of US dollars into China has poisoned the Chinese banking system. China settles US dollars that come in through foreign trade, direct investment, and other channels in yuan, and then sells the dollars to the People's Bank of China.
This leaves these tainted dollars spoiling the yuan's balance sheet. The yuan bills, issued with China's US dollar holdings as their security, end up held by many parties.
It might seem as though it's the government that holds huge foreign reserve assets in US dollars, but these assets are actually in the hands of ordinary Chinese people who hold yuan.
At present, the US is urging yuan appreciation. If China has foreign exchange assets of $1 trillion, and the exchange rate of yuan to dollars is 8 to 1, then China will have issued 16 trillion yuan with these assets as security. The effect of these is amplified by their passage through China's banking system.
While public attention is drawn to topics like trade balance or currency exchange rate manipulation, the real drama will be around the large volume of existing assets through yuan appreciation.
Accompanying the yuan's higher nominal purchasing power will be a shrinking ability to purchase the colossal amount of existing assets, the price of which has already been driven up by the excessive issuing of the US dollar. This process will bring about inflationary pressure in China.
What's worsening the situation is that the 16 trillion worth of yuan is regular currency rather than being any kind of complicated assets.
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