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Federal Reserve Responsibilities Outsourced to China
Posted By Barry Ritholtz On July 21, 2005 @ 11:25 am In Currency,Economy,Fixed Income/Interest Rates,Politics,Real Estate | Comments Disabled
The Fed Chairman was overheard to remark: “If we can’t do it, maybe they can”
The Peoples Bank of China (PBOC) announced to day that they
are effectively taking over the interest rate responsibilities from the US
The Chinese Central Bankers announced that, effective
immediately, they are beginning a series of incremental rate hikes in the
United States. The first rate hike was for 10 basis points on the 30 year.
The Fed’s inability to significantly impact long rates
anymore is what led to the outsourcing.
Unlike the United States Federal Reserve, who hold interest
rate meetings monthly, the Chinese Bankers will now meet daily. Look for rate
announcements each day at noon.
Trillion Dollar Baby
tongue-in-cheek analysis aside, today’s actions are the net result of the
United States consuming far more goods or services than it produces. Because of
that, the Chinese have accumulated nearly a trillion dollars of US Treasuries.
That makes them a de facto player in setting our interest rate policy
and impacting our economy.
The brunt of the de-pegging on the U.S. economy will not likely be felt for some time to come. But war-gaming the various scenarios of this new development, we can see that many dangers are apparent. If we play out this scenario to its logical conclusion, we are led to some unsettling
1) As we have been writing for quite some time now, the Real Estate Complex has been the most robust segment of the U.S. economy. If the Chinese can succeed (where the Fed failed) in raising U.S. long rates, the strongest
part of the US economy is at risk. While we know real estate had to slow eventually,
the question is how fast will it occur, and how dramatically.
2) US Consumers have grown reliant on ultra low interest rates and ultra cheap Chinese goods. The de-pegging will cause incremental increases in costs, while raising rates. This will negatively impact Wal-Mart, the largest importer of Chinese manufactured products, as well as other Chinese goods resellers.
3) Some theorists have worried about US reaction in the event of
a Chinese attack on Taiwan. In an unlikely – but possible – scenario, the
Chinese can, at will, and without ever firing a shot, inflict as much
economic damage on the U.S. as if we were at war. Armed conflict becomes
unnecessary when countries can net impact their competitors as if they were at
4) The United States Dollar is the default currency of the world.
That gives an unprecedented amount of flexibility to US policy makers. Is the de-pegging the beginning of the end for this global currency structure? It’s too soon to tell. But we wonder how this might play out elsewhere.
What now becomes significant is the basket of currencies to
which the yuan will become ever more pegged. A likely composition will reflect
a basket of currencies in proportion to China’s external trade.
According to the Bank of NY, there are 10 currencies that
make up almost 90% of China’s overseas trade: the U.S., Japan, Hong Kong, EU,
Indonesia, Malaysia, Singapore, South Korea, Thailand and Taiwan.
China’s top ten trade partners (in Dollars):
The European Union (18.5%)
United States (17.5%)
Hong Kong (11%)
ASEAN nations (11%)
South Korea (9.5%)
Source: Bank of NY 
It makes some intuitive sense for the PBOC to replace their
US Treasury holdings with an equivalent amount of Sovereign Treasuries of the
currency basket (Hey, that’s what I would do).
The ultimate impact of today’s events will depend upon how
quickly and how much the PBOC decide to sell off some of their US Treasuries.
Unlike the Fed, the Chinese Central Bankers do not believe in much in the way
of transparency. Their plans have been somewhat uncertain.
What is not uncertain, however, is that our Current Account
Deficit has granted a degree of control and authority to another sovereign
nation over our own economy. The net results of that may be determined over the
coming decade . . .
Article printed from The Big Picture: http://www.ritholtz.com/blog
URL to article: http://www.ritholtz.com/blog/2005/07/federal-reserve-responsibilities-outsourced-to-china/
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 Bank of NY: http://gm.bankofny.com/
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