Sunday, December 05, 2004

So, here's a scene from a Neal Stephenson novel. From all over China, they were selected and groomed at an early age, through stage after stage of rigorous training and brutally tough exams. Fewer than two dozen, filtered from over a billion Chinese, they are the best of the best. In math. Forbidden to accept gifts, they are fêted almost every night by foreigners seeking to curry favor, with food, good cheer, and tickets to romantic Mandarin operas -- for westerners, an acquired taste at best. And every morning, they make their way to a rented room on the fourth floor of an insurance building in Beijing, where beneath a jeweled globe with seas of lapis lazuli, they trade on behalf of Communist China's central bank.

But it's not science fiction. This future is here. You just haven't noticed yet.

Which is a shame. Because if you're living in the States, it does make a difference to you.

Here's the deal. Because of our trade deficit, dollars keep flooding out of the country. And you'd think that flooding the rest of the world with dollars, raising the supply, would lower the price -- that is, the value of the dollar, as expressed in Japanese Yen, Chinese Yuan, Indian Rupees, or whatever, And yet, so far, it hasn't -- in large part, because Asian central banks, particularly the Japanese and our friends under the Chinese jeweled globe, have been soaking the dollars up. And for the Japanese, who have 90% of their foreign currency reserves in dollars, this is becoming a problem. Quoting the same New York Times article that describes the jeweled globe in the rented room:

The problem for Japan is that it is in so deep that to a large degree it is chained to its American debtor.

"Imagine that tomorrow people hear, 'Hey, Japan has decided to divert from U.S. dollars to euros,' " Mr. Asakawa said. "That would create a hugely undesirable impact on the U.S. Treasury market, and we have no intention at all to make an unfortunate impact on the U.S. Treasury market."

Any selling move by Japan would move the entire market - and cut further into the value of Japan's own portfolio.

[As] Richard Koo, chief economist for the Nomura Research Institute ... sees it, anything Japan might do to slow its dollar purchases would only create a self-inflicted wound. "If they could move it all out of dollars in one day, I am sure they would do it in an instant," Mr. Koo said. "But if they move 10 percent, and the dollar goes down 20 percent, they are stuck with 90 percent of the portfolio worth 20 percent less."

But if the Japanese can't sell their dollars, how much can they really be worth?

As for the Chinese, apparently all those Ph.D.'s in math have been paying off. They are only 35% in dollars. Which is still enough to be a problem, but not nearly so severe. Which means that if the Chinese stopped buying dollars, and stopped doing their part to stanch the flood, perhaps they'd get hurt -- but the Japanese, would get hurt worse, at least as regards the central bank reserves. And the U.S. would likely also face severe consequences, starting with having to pay for energy imports in real money. This is all a pretty crude way of looking at things, of course. (For one thing, the Chinese would also be hurting their manufacturing sector, now heavily dependant on exports to the U.S.). But the point is that a fall in the value of the dollar hurts everybody.

Now, consider this from the point of view of the real Chinese leadership, the ones who give orders to the math wonks beneath the jeweled globe. To them, this might not look like such a bad deal. What they are playing for is regional dominance and global power. Ask anyone who plays Go, the strategy game played for millenia in China, and they'll tell you that hurting yourself is a perfectly fine way to win, so long as you hurt your opponents worse. If we're too distracted dealing with our own problems to interfere when the Chinese start playing hardball with Taiwan, maybe that's worth it to them. Go strategy is just about impossible to understand until you have an appreciation for the merit of a well-played sacrifice.

In the meantime, as we watch the continuation of a dollar decline that already seems to be happening, we may have to see conventional wisdom about many things change. Another article this week noted that

The repercussions of a long-term decline in the dollar could be far-reaching. A permanent change in the relative prices of goods and services produced in the United States and abroad could hamper some important and long-running economic trends, like the growing productivity of the American work force.

Or is it that the productivity of the American work force has been overstated for years now because its output has been measured in inflated dollars?

There's a lot more writing on this subject on the Net right now; here's a nice review in a diary on the Daily Kos of the extent to which our problems now are self-created: the Chinese Communists may be in a position to hang us now, but only because we sold them the rope.


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