Federal Reserve Responsibilities Outsourced to China

Thursday, July 21, 2005 | 11:25 AM

The Fed Chairman was overheard to remark: “If we can’t do it, maybe they can”

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The Peoples Bank of China (PBOC) announced to day that they are effectively taking over the interest rate responsibilities from the US Federal Reserve.

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.

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Trillion Dollar Baby
All 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 possibilities:

    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 war.

    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.

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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.

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China’s top ten trade partners (in Dollars):

The European Union (18.5%)

Japan (18%)

United States (17.5%)

Hong Kong (11%)

ASEAN nations (11%)

South Korea (9.5%)

Taiwan (8.5%)

Russia (2%)

Australia (2%)

Canada (1.5%).

Source: Bank of NY

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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 . . .

Thursday, July 21, 2005 | 11:25 AM | Permalink | Comments (15) | TrackBack (2)
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This is pretty funny.The Peoples Bank of China (PBOC) announced to day that they are effectively taking over the interest rate responsibilities from the US Federal Reserve. The Chinese Central Bankers announced that, effective immediately, they are beg... [Read More]

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Comments

thanks for the trade figures. i wouldnt have thot EU had more trade than US. the news today that Malaysia is pursuing similar strategy sounds new note of maturity for the Tigers. as US has become increasingly erratic and unreliable on the world stage (one-party politics, destabilizing military projection, Fortress America economics) the rest of the world will seek to immunize their systems

Posted by: scorpio | Jul 21, 2005 12:22:51 PM

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