From Credit to Money, Part 1
By Adrian Ash
January 28, 2008
Wouldn't life be much simpler for everyone if
the US didn't spend more than it had overseas...?
ONE U.S. DOLLAR used to buy nearly four Brazilian Reals at the
start of 2003.
Today it buys fewer than half as many. Which you might think implies
higher travel, energy and food costs to come for US consumers.
But it seems to bother the central bank of Brazil much more than it fazes
the Federal Reserve.
The United States bought nearly one-fifth of Brazil's total exports in
2006 – primarily transport equipment, base metals and raw food-stuffs
such as soybeans, meal, and oils.
Then in March '07, George W.Bush signed a biofuels deal with Brazil, the
world's largest producer of ethanol, worth at least $8 billion.
On the other side of the ledger, the US accounts for more than 16%
of what Brazilians buy from abroad. So you'd expect a weak Dollar to make the
perfect ingredient for low-inflation growth in Brazil. Right?
Yet two days after the US Fed slashed its key lending rate by 0.75%
in this week's "emergency" action, the Banco Central do Brasil called
a "snap auction" of its own currency, the Real. And bidding only for
greenbacks, the Banco sold Reals at a rate of 1.7879 per Dollar on Thursday,
claiming that the Dollars were needed to build up its currency reserves.
Which was an odd excuse for trying to suppress the Real's
relentless rise vs. the greenback.
Brazil has grown its overseas trade so fast since the start of 2003
– and most notably to China, which now buys well over 6% of Brazil's exports
– that its current account balance with the rest of the world went from a
deficit worth 4.6% of its annual economic turnover to a surplus of 1.3% of GDP
in 2006.
Hence the record $185 billion foreign currency reserves it's
already got. And if it really fancied extending its reserves further with a
bundle of super-cheap Dollars this week, it should have waited until Friday.
Because by Thursday's close in Brasília, the Dollar had dropped another 2% of
its value despite the central-bank's purchase. The Real has now risen by almost
one-fifth vs. the US currency since this time last year.
"The bank resumed buying Dollars in early October after a
two-month hiatus from the currency market," explains Reuters. "It had
previously bought greenbacks daily for months, helping lift Brazil's reserves to
an all-time high of about $185 billion."
"The yield differential is a factor supporting the real in
these times of crisis," according to one forex analyst in Sao Paolo – and
Brazilian interest rates were kept on hold at 11.25% when the Banco do Brasil
met on Wednesday.
So even without a weakening Dollar, you could now pick up an easy
7.75% profit per year, simply by selling Dollars for Reals. And that's exactly
the situation which Brazil's central bank faces, only in reverse. It's earning
less on its huge Dollar holdings than it pays out in yield on its own sovereign
bonds. So too do most of the rest of the world's export-rich countries.
"Things just got a lot more complicated for the managers of
China's economy" for example, as Stephen Green, an analyst at Standard
Chartered Bank in Shanghai, noted on Tuesday. They're already in way up to the
necks thanks to the ongoing flood of dollars into China, sent to pay for 15.5%
of what the US now imports.
Yes, Canada tops the US-imports list with 16.4% of America's trade;
Mexico comes third with 10.7%. But they both have a land-border with the USA.
Whereas Chinese goods, on the other hand, have to cross 6,590 miles of sea to
get from Shenzen to the Port of Long Beach – just like the dollars that flow
back to pay for them.
But the export firms that then collect all these dollars don't have
much use for them back in the Middle Kingdom. And rather than simply selling
them Yuan in exchange for these greenbacks – which would only plug America's
flood of cheap dollars straight into China's money supply – the People's Bank
tries to "sterilize" them before they cause any trouble.
"Sterilize" as in scrub clean. Because otherwise, all
those Dollars might infect China's economy with something nasty...something
like, say, inflation. The disinfectant, for what it's worth, is a regular issue
of Chinese government bonds.
These soak up the cash flooding in from the States, taking money
out of the economy and tying it up in fixed-income bonds that will be redeemed
some time in the future. Trouble is, until then, they cost much more in interest
than the dollars they sterilize bring in.
"The trend is clearly accelerating as the reserves continue to
grow faster than GDP," says Hong Liang, China economist for Goldman Sachs.
She reckons the People's Bank of China is now losing some $4 billion per month
trying to cover the gap between what it pays on its own government bonds and
what it earns on the mountain of US Treasuries it's built up.
Just this month, the PBoC sold off some 5 billion Renminbis' worth
of short-term notes in one day, sucking cash out of the economy to
"sterilize" the money coming in from the US. But by issuing
short-dated notes rather than longer-term bonds – because the buyers prefer
cash, which is what they got in the first place – the Bank finds its
obligations mounting each.
"It has more than a trillion RMB's worth [$137bn] due to
mature over the course of this month alone," according to The Telegraph
– enough to keep any central bank busy, even before you figure in the $4bn
lost on interest-disparity and the on-going loss of value in the US Dollar.
What to do? The PBoC has now lifted its interest rate eight times
since the start of 2006, but still the economy grew by 11% last year and
consumer inflation hit an 11-year high. It's also told Chinese banks to keep 15%
of their cash deposits in the PBoC's vaults, taking them out of circulation in
an attempt to cap lending.
Indeed, it's even forced the banks "to hold at least part of
their new required reserves in the form of dollars at the PBoC since
August," reports Michael Pettis, finance professor at Peking University's
Guanghua School of Management. At least that saves the Beijing policy-wonks the
trouble of arranging auctions and paying out more in interest on Renminbi-denominated
bonds! But it also transfers the loss of wealth inherent in the tumbling Dollar
onto China's private banking-sector, forcing lenders to share the pain with the
State...and doing nothing to release the upwards pressure on the value of the
Chinese currency itself, according to Pettis.
"It seems to me that forcing banks instead of the PBoC to hold
dollars says nothing about pressure on the currency," he writes in his blog. "I
would argue that the total net inflows are exactly the same except for one thing
– commercial banks have been asked to assume part of the PBoC’s normal
functioning (i.e. to buy dollars so as to maintain the country’s foreign
currency regime), and as they assume this function the resulting purchases of
dollars are whisked off the PBoC balance sheet.
"But nothing real has changed, except that now banks, instead
of the PBoC, will be forced to assume the foreign exchange losses."
Surging inflation...soaring interest rates...a merry-go-round of
bond auctions and redemptions that costs $4bn per month in the meantime...and
on-going pressure to raise interest rates, pushing the Renminbi's value higher
still, just to contain the inflation infection spread by the ever-plunging US
Dollar.
Wouldn't it just be simpler if the US raised instead of cutting its
interest rates, thus cutting back on its consumptive excesses?
And wouldn't the problem of sterilizing all those sick dollars
vanish if the world had only one kind of money?