Thursday, July 2, 2009

The Debts of the Lenders: Chinese Power Struggle Over the Dollar

The official comments from the Chinese media continue to repeat in a schizophrenic loop - one day, they issue calls for a stronger dollar and no plans to change reserve currency status. But the next day, there are bombastic attacks against the dollar/treasuries and calls for a new world order led by a China backed SDR currency.

Well, which is it?

The fallacy in most Western media reporting is that reporters tend to assume that whenever China speaks, it is w/one voice. This is not true. Even in a tightly controlled police state, there is room for dissent - especially in a country as large as China.

The West is hearing an INTERNAL debate that is being made public for two audiences:

a) Domestic audience
b) Western audience

A) Those of us outside China are unable to grasp the full story but details are slowly beginning to emerge:

It seems as if a power struggle is currently playing out between the Foreign Ministry and the Central Bank - both of which are at loggerheads. This is what happens when diplomacy mixes w/economics and finance.

The foreign ministry's goal for the past 25 years has been to promote a cheap yuan in order to lead export based economic growth and provide jobs for the legions of poorly educated peasant class. In contrast, the Central Bank has a more realistic grasp of the global macro situation and is trying to slowly diversify state assets away from the dollar.

Here is some food for thought. What would happen if China were to mark all their dollar denominated assets right now to fair value? They lent money that will never be paid back - at least not in real terms (nominal yield is a different story).

China's economy is held together w/Keynesian scotch tape. Contrary to popular opinion, they have a lot more overcapacity than commodity bulls believe.

B) This debate is being broadcast to the West in order to gauge Western policymakers' reactions to the arguments of each faction. After digesting these reactions, each side has a better assessment on the facts and can prepare for the next verbal riposte.

On a longer time scale, the factions are preparing for China's emerging role as a political and economic counterweight to the OECD. Additionally, these moves are also being orchestrated for the benefit of other observers that are currently sitting on the sidelines, such as the other BRIC states. Such strategy hearkens back to the Cold War era when Maoist China hastened to extend its sphere of influence among the UN Non-Aligned Movement.

Some analysts have described these moves as a global game of chess. A better analogy would be "weiqi", or "go" (as the game is popularly known in the West) where the players wage a "3d" battle w/black and white stones that is spread across multiple dimensions. Instead of exchanging stones though, the stakes are a lot higher.
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