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Don't Bet Against the U.S. Dollar

Written By Geoffrey Pike

Posted March 18, 2015

dddollarThe U.S. dollar has been really strong lately, especially in comparison to the other major currencies such as the euro and yen. The dollar is still king of the world in terms of currencies.

But don’t think this is going to last forever, especially as other countries realize that they don’t really need a middleman (the U.S. dollar) for trade with other countries. This is especially true in our digital world of today.

The massive monetary inflation by the European Central Bank and the Bank of Japan has certainly contributed to the strong dollar. But aside from this, there is also a mercantilist attitude that continues to pervade the world.

This can be seen simply by looking at the foreign holdings of U.S. Treasury debt, which just hit $6.22 trillion. While Chinese holdings went down slightly, Japan increased its holdings.

China still owns the largest share at $1.24 trillion as of the latest report, but Japan is only $500 million behind. This is basically a rounding error when you are talking about a number above one trillion.

Approximately two-thirds of foreign holdings of U.S. debt is owned by foreign central banks. They often hold U.S. debt as a large part of their reserves in order to hold down their own currencies.

China is probably the best example of this because they buy U.S. debt to supposedly prevent the yuan from rising against the dollar. With all of the monetary inflation coming from the Chinese central bank, it’s hard to believe this would be a problem.

The Mercantilist Mindset

Unfortunately, most people in this world simply do not understand basic economics.

Sometimes politicians will prey on people’s ignorance, but I suspect many politicians, and even some central bankers, are ignorant themselves.

The Chinese government and Chinese central bank promote this mercantilist policy of keeping the currency there from rising. This is one of the major reasons the Chinese central bank holds such a large amount of U.S. debt. They want to keep down their currency so that Chinese exporters can sell cheap products overseas, particularly to Americans.

This certainly does help the exporting business in the short term. The problem is that it hurts all Chinese consumers who then have to pay more for goods and services. The Chinese are hurting themselves, while subsidizing Americans, at least for now. In other words, it is bad economic policy.

I don’t believe the U.S. dollar is going to be seriously threatened until foreign central banks stop buying U.S. debt. In particular, we should look at Japan and China. Between those two countries, they own almost 40% of all U.S. foreign held debt.

This does not mean that the central banks of Japan and China have to start a massive selling campaign. It just means they need to stop buying more. They can slowly reduce their holdings by letting the debt mature.

While China’s holdings have gone down over the last year, it is not significant enough to think that the government has changed its policy. I don’t think Chinese officials have learned a lesson in free market economics.

If anything, I can see a better possibility of these two countries reducing holdings for other reasons than good economics. If China ever feels it is being pushed around too much by Washington, then this certainly makes a good form of revenge.

We also have to consider that Japan and China are probably going to go through some hard economic times. Japan is already in over its head with massive debt and recessionary conditions. If the Japanese government is desperate for some money to make good on its promises, then it may tap into its reserves of U.S. debt. Again, this won’t be because Japanese officials have learned basic economics, but just out of necessity.

When will the U.S. government stop being subsidized by foreigners? It doesn’t appear to be any time soon, but things can change quickly if certain economic outlooks change quickly. Until then, don’t bet too much against the U.S. dollar, especially with other currencies.