The first currency war with an unpredictable outcome. Dollar versus yuan.

In September Congressmen from House of Representatives adopted the bill on measures of counteraction to the low yuan exhange rate. In particular, this bill allows American companies to file the claims for imposition of import duties for the Chinese goods in order to compenste the effect of low exchange yuan-dollare rate.

In fact the wealthiest country in the world owes great amounts of money to China, which owns 20% of all American state securities.

Chinese are holding the detonator, capable of exploding an entire American financial system in their hands. U.S. Department of Finance bonds are just the loan securities, which American government is obliged to pay up with an interest — that’s actually what governments of other countries and various financial institutions are buying them for. Why then — despite the U.S.-born financial crisis — investors from all over the world are still buying up these securities?

            Part of economists believe that actual yield of American bonds to be growing up, as long as inflation in the USA is regularly decreasing. According to them, investors prefer low yield, given the background of low inflation. But this is just a part of an answer. All the more, numerous experts believe American bonds to turn into trash in the nearest prospect.

            Jim Rogers, who co-founded the Quantum foundation along with George Soros was also one of those who predicted the financial tornado of 2008 and precautioned everyone from excessive passion for American securities. According to Soros and Rogers these very securities make up the last soap baloon that is to collapse sooner or later. This may eventually lead to the final destruction of American economics.

            Profitability: it was much better 200 years ago

Today’s profitability of the U.S. bonds is the lowest in their history and there are certain reasons for that. Bonds with a 2-year maturity term offer less than 2% of an annual interest, and the ones with a 30-year maturity term offer less than 3%. According to James Montier — Société Générale Bank analyst — average profitability of the 10-year maturity term bonds made up 4.5% in the 1798, while today it’s less thatn 2.5%. Thus, profitability of American securities dropped much lower its average value during the last 200 years. That gives no particular explanation to the funds’ inrush to the USA and the growing demand for these bonds, but it makes an evidence of a growing phony speculative baloon n this sector.

            Togers points out to the second factor, having believed that the USA have almost bankrupted by now and their bonds’ market value is zilch. That goes from the fact that today’s public debt of America makes up $13.6 trillion, which makes up 94% of American GDP — mind that lately every single American (including newly-born infants) owes $35.000 to the state, which are to be recovered from him via taxes. According to Rogers’ opinion, this can’t go on forever and the U.S. bonds are hugely overestimated. That’s why American financier recommends investors to withdraw their funds from that unprofitable market and invest them into the bonds of the countries with a better-balanced budget — like Switzerland, for example, which featured 38.8% public debt by the end of 2010. Such bonds are all the more safer, as long as the EU norms define 60% to be the safety line.

            U.S. public debt — like the one of numerous other coutries —may increase a bit more in the nearest future. This may become a consequence of excessive amounts of money pouring into the economics — this takes place in America and in quite a number of other countries, too. Such volumes of this aid may completely ruin the financial systems of many countries. Failed attempt of German bonds emission that took place on the 7^th of January, 2009 may be treated as the first signs of such course of events. Investor’s interest for these securities turned out to be insufficient to buy out an entire offered package, which, in its turn makes an evidence of the fact that numerous participants of the Federative Republic public finance sector give a negative estimate to the situation in it.

What’s the difference between Tokyo and Washington?

            In the past numerous experts tended to believe  that the market of Japanese bonds is largely overestimated as well (profitability rate on this market was trembling between 1 and 2 percents annually).  As a result of the longest economic crisis in Japanese history, such low interest rate stayed on this level for more than 10 years, despite the simultaneous growth of Japanese public debt. Today Japanese state bonds market — which value is estimated to be approximately $8.7 trillion — is the second largest in the world. Besides that, Japanese state debt to the GDP ratio is significantly higher than the American one. This ratio is to remain unchanged even after the expected additional emmission of American securities in the amount of $2 trillion. Still, Japanese haven’t bankrupted yet. Then why Americans are expected to ?

            There’s, however, one significant difference between these two countries. Japanese government was dealing with the lenders inside of the country, while the USA fund their deficit mostly for the account of foreign investors — and especially Asian ones.

            What is this difference about to mean? Had American economics collapsed, foreign investors would have lost twice as much on the American bonds. Firstly, an increase of the interest rates would have taken place — the one, leading to the drop of market value of American bonds inside of the foreign investors’ portfolio. Secondly, dollar would have depreciated a lot which would have subsequently depriciated the foreign investments. Due to the double risk, growing deficit and the apprehensions of U.S. bankruptcy, part of investors might have already made a decision to pull their investments out of the American bonds market. So why investors aren’t easening their grip of these not so secure securities? Massive sales of any bonds or securities would inevitably cause their depreciation, so foreign investors are trying to “hold” them by all means necessary, unwilling of their own investments to lose their value. It is, however, unknown, how long will it last? According to certain financial analysts, this may last for several months more but sooner or later American bonds market is to suffer an inevitable collapse.  Peter Schiff — president of Euro Capital Pacific— has recently written in the Wall Street Journal that this may happen much sooner than the most people believe it to. He believes that American authorities headed by Barack Obama reckon that foreign investors would keep self-sacrificingly fund the U.S. state debt. Thanks to that debt, American economy is to pass through the crisis in an unpredictably long-term prospect. In reality, though, government believes that the foreign investors — especially China, Japan and Saudi Arabis — are to keep financing trillion-dollar-worth stimulus programs for American economics, having kept buying the American bonds up. Despite that, Peter Schiff believes that to become possible only if these states would sacrifice some domestic investments, re-alloting the remained free funds to the purchse of American securities, thus, financing the growing American deficit. Any other country — having it got into the kind of financial situation America did – would have limited the budget spending and the social payments. American government, however, is not doing so due to one simple reason — it had never done that in the past. The same dangerous financial policy may eventually lead to a collapse of U.S. economics.

Asian states are the main lenders of America

As of October of 2010, foreign investor have funded more than 25% of American state debt. Just for you to compare — in 1988 their share made up merely 13%. Despite the dollar devaluation, foreign share on the American bonds market makes up about 45%. Mostly, it is the central banks of various countries, who hold these securities — they use them as a currency reserves. Central banks of China and Japan dominate among them — their joint share makes up more than a half of the whole foreign part of that market. For the sake of comparison, we may refer Germany that holds just 1.45% of it.

            Such great degree of dependance from foreign investor that American government features means extremely high political risks and this may esspecially be applied to China. Chinese governement has been working out a strategy of withdrawing their investments from the high-risk American market for months now. In a tense situation like that a slightest breath of wind would be enough to break the fragile balance of issuer’s and investors’ interests. For example, it takes merely nothing for Turkey — which has certain financial troubles with forming profitable part of its own budget — to sell out its currency reserves, deposited mostly in the American bonds. Despite the fact that Turkey owns just a 1.09% of the market, such step may as well cause panic among other investors and ruin the American financial market.

            That’s how the shares of major foreign investors at the American bonds market look like:

China - 20,45%

Japan - 20,04%

Great Britain - 11,83%

OPEC  - 6,37%

Brazil - 4,96%

Given a situaion like that, Chinese behaviour gains a great importance as well as its possible decision to sell out the currency reserves in the amount of $1.3 trillion. At the moment China abstains from that move, being aware that it would cause the collapse of American market and devaluation of dollar — which would subsequently mean tremendous losses for China as well. From the other hand, most economists believe that China has no other way but to sell them, as long as there are hardly any grounds for developing Chinese economics — featuring an extremely low level of public debt (less than 7% of GDP) — to have such high level of currency reserves. So, most of the experts think that sale of American bonds by China is a matter of when, rather than if. Natural response of the U.S. Federal Reserve System in that case would be the increase of an interest rate, which could have theoretically attracted investors and bring their capitals back to the American market, but given the conditions of recession, growing unemploymeте rate and troubles at the mortgage market this seems to be unlikely.

China as a hostage of the USA

It is much more probable that Federal Reserve along with American government would keep passively looking at the events in American economics, expecting the weakening dollar to allow them to increase the competetiveness of American commodities at the world market, while and increasing cost of export would have allowed to lower the deficite of U.S. foreign-trade budget. Such scenario would be unwelcome by the major exporters to the USA — China and Japan, as long as their goods would become less attractive to American consumers in this case.

            Paradoxical nature of the situation is expressed in the fact that the USA — having actually bancrupted — still attract the funds from without, as long as the major exporters, supplying the goods to American market (and the major U.S. creditors at the same time) have become hostages of America. Without doubt, China could have ruined American economy but by doing so it would have simultaneously lost an essential part of its investment portfolio and the export market. Globalization turned the major world economics into the communicating vessels — with all ensuing consequences to that.

            In regard of the American securities, we may just admire the insight of Great Leader Chairman Mao, who dubbed America to be a “paper tiger” many years ago.

           

            America should consider all that before unleashing the “dollar-versus-yuan” war.