China, Russia Flee the Dollar

by Addison Wiggin

  • Giant bears gone wild… what it means for the U.S. dollar… and your standard of living…

  • Irish bailout terms set… stock market vigilante Dan Amoss on why a “dramatic debasement” of the euro is coming

  • Middle East intrigue: Iranian nuke scientists killed, Saudi king pushes for U.S. attack on Iran

  • The app-killer? Our tech maven Ray Blanco on the next Internet revolution

  • Readers sound off on South Korean ingrates and “effective” airline security

While you and 78 million other American families gobbled down turkey over the long holiday weekend, China and Russia were engaged in their own unsavory activity on the other side of the planet:

First, China and Russia will start bypassing the dollar in their trade with each other. Russian Prime Minister Vladimir Putin and Chinese Premier Wen Jiabao have agreed to use the renminbi and the ruble instead.

As of last Monday, China’s interbank market is now trading the ruble against the renminbi. Russia will return the favor next month. The ruble joins six other currencies trading directly against the yuan — the U.S. dollar, the Hong Kong dollar, the yen, the euro, the pound and the Malaysian ringgit.

Tomorrow, China will sell 8 million yuan ($1.2 billion) worth of bonds in Hong Kong — the second time it’s done so. Over half of the issue will be sold to institutional investors.

These events represent three more steps in the in the Demise of the Dollar we postulated in a book first published in 2005.

“Although not really market moving,” says currency trader Richard Lee, writing in The Daily Reckoning this week, “since March 2009, central bankers in Beijing have called for the replacement of the U.S. dollar as the world’s reserve currency.

"Chinese leaders, in addition to leaders in Russia, India and Brazil, fear that consumer inflation is being transported across the Pacific Ocean from the United States.”

The “hot money” created by the Federal Reserve is flowing overseas, where it has a better chance of getting a decent return. The flow of cash drives up prices: Officially, Chinese consumer prices have risen 4.4% in the last year.

Food prices are up even more. The Beijing city government is handing out $15 in food subsidies to each of 223,000 low-income people, just to keep the masses placated.

But there’s a bigger aim to all of this than just containing inflation. China is gently and persistently prodding the International Monetary Fund to create a “supranational” currency.

“Last week,” Rich explains, “IMF officials deemed the Chinese yuan unfit for the IMF’s Special Drawing Rights valuation basket, which includes above all else the U.S. dollar. Now, the Chinese government is attempting to broaden the yuan’s influence, showing the IMF that the yuan is ‘freely usable.’

“But this strategy will continue to complicate things for the Asian superpower. As China’s money continues to flow in and out of the country, inflation will become an even worse problem."

That might prompt China to finally take serious steps to curb inflation — namely, raising interest rates. “This will fuel yuan appreciation against the U.S. dollar even more, as yuan investments will offer a higher yield than comparable U.S. yields.

“Taking everything into consideration,” Rich concludes, “it won’t be long till we hear more suggestions for a supranational currency. The suggestion may not be wholeheartedly rejected the second time around.”

[Ed. Note: Otherwise, why would someone have translated that viral video about “quantitative easing” into Mandarin?]

Still, "Who cares?" one might be tempted to ask. Well, you should, for starters. Historic deficits and debt in the U.S. are only possible because the dollar has enjoyed "reserve currency of the world" status since the end of World War II.

When foreigners stop using dollars as a store of wealth and stop buying Treasuries (or, worse, sell them) it's "game over." Interest rates rise, cost of debt service increases, interest as percent of the federal budget becomes unsustainable… yada, yada. We've been suggesting this for over a decade now.

Without reserve status, the U.S. is as screwed as any penny-ante, post-bubble eurozone economy seeking a bailout… like, say, Ireland.

On cue, the final provisions of the Irish bailout are now in place. Ireland’s government is going another $113 billion into hock — more than $25,000 for every Irish man, woman and child — to solve a problem caused by too much debt in the first place.

“Since early 2010, when credit spreads on the eurozone's periphery started blowing out, I've viewed the EU bailouts as futile efforts to refinance themselves out of a solvency crisis,” says Strategic Short Report editor Dan Amoss. “If you're truly bankrupt, trying to put it off by refinancing never works out.”

But that won’t stop the EU from trying. Greece came first, then Ireland… and Portugal is probably next. Combined, those three will probably eat up half of the EU’s bailout fund. Spain alone may need the other half.

“The problems in Spain,” Dan continues, “lie not so much in its government debt, but in its banking system. The opaque accounting for bad mortgage and construction loans throughout the Spanish banking system makes the U.S. look like a model of transparency.”

Thus, “the euro is likely to continue falling against the U.S. dollar,” Dan concludes. “Many holders of euros will soon conclude that the European Central Bank will dramatically debase the currency in the near future,” no matter the objections from the stout Germans carrying on the anti-inflation legacy of the first post-World War II West German leaders.

“The inflationists at the ECB will eventually win out as we see more riots, strikes and social turmoil in Europe. The ECB has a lot of catching up to do in order to match Ben Bernanke's turbocharged printing press. A falling euro is bearish for risky assets, so we're likely to see a continuation of the ‘risk off’ trade.”

Sure enough, the U.S. stock marked opened down close to 1%. The Dow is very close to breaking below 11,000.

Likewise, the dollar index, which broke above 80 late last week, is close to breaking above 80 today — territory last seen more than two months ago.

But gold is holding its own, the spot price $1,361 as we write. As we’ve seen during much of 2010, gold and the dollar are serving as dual safe havens whenever the “safety trade” is on.

The euro isn’t the only worry. Geopolitical tensions are back in view…

Car bombs in Tehran have killed an Iranian nuclear scientist and wounded another. According to state media, men on motorcycles attached the bombs to the cars and then set them off remotely.

To no one’s surprise, President Mahmoud Ahmadinejad says the United States and/or Israel are behind the attacks.

Iranian intrigue also figures into the diplomatic cables just released by Wikileaks. They reveal Saudi Arabia’s King Abdullah has repeatedly pushed the United States to attack Iran to stop its nuclear program. During a meeting with Gen. David Petraeus, Abdullah urged America to “cut off the head of the snake.”

Wow… That one statement reconfirms everything Byron King has been telling us about the 1,354-year old conflict between Sunni and Shia Islam… and how it has the potential to explode anytime.

That could mean a run-up to $220 oil and $8 gasoline in just days. If you haven’t seen Byron’s full briefing on this situation, there’s no better time to get up to speed than right now.

The entire “under the hood” architecture of the Internet is about to change, says Ray Blanco, the latest addition to our tech team. “Webpages do much more than just present text and images these days,” he explains. “Web applications have become a dominant feature.

“At Yahoo's finance page, for example, you can manipulate dynamic stock charts. If you get lost, you can find directions using Google Maps. On Facebook, you can keep in touch with more people than you probably should. You can easily kill your productivity entertaining yourself watching videos on YouTube.

“None of these things were written into the original HTML standard or its subsequent revisions. To do all of this stuff, Web designers needed to turn to formats like Adobe's Flash or Sun's Java and glue all the pieces together (which is complex).” And clunky. And prone to glitches and crashes.

But a new standard called HTML5 is about to change all that — making everything flow seamlessly. “It grows the core Web presentation language past pages and into applications,” is how Ray puts it.

“My takeaway is that HTML5 is going to accelerate rich, open content for the mobile computing market. The closed ‘app store’ model used by companies such as Apple and RIM is going to be affected by this trend, and probably not in a positive way.”

Still, there are other ways to make money off the smartphone explosion. Did you know you can collect a “royalty” every time Apple sells an iPhone, or an iPod, or an iPad? Both Ray and Patrick Cox have been following this trend for years… You can see the fruits of their research right here.

“When South Korea comes calling for our help because their neighbors are bullying them,” writes a reader following the Korean border skirmish, “I hope our national leaders remember just how uncooperative South Korea was as we tried to get them to sign the most recent trade agreement.

“Perhaps our cold shoulder might make the South Koreans a little more grateful for all of the troops and treasury we have provided them over the years. When we went to them for some relief last month, we got their smile and a firm 'No thanks.' They need to hear the same from us. Man up, Mr. Obama.”

The 5: The United States still has 28,000 troops in South Korea.

The South has twice the population of the North, and a GDP something like 30 or 40 times larger. Aren’t the South Koreans capable of defending themselves by now?

What a silly question.

“If we wish to effectively tighten security on airlines,” writes another, “let's primarily look for terrorists instead of bombs. There can be a million possible locations for a bomb (yes, including the crotch, the intestines, etc.), but there can only be a select few terrorists on an airline.

“So let's do what El Al, the Israeli airliner, does: Their security personnel question all passengers and they evaluate the passengers' responses with their intuition. If you claim to be from San Francisco, they might ask you for the name of the local football team and who its quarterback is. With their intuitive sense, they evaluate the whole person. If you've got nothing to hide, you're less likely to break out in a sweat.

“Furthermore, El Al explicitly performs the quasi-taboo practice of racial profiling. It is an unfortunate fact that most suicide bombers are (a) male, (b) of Arab ethnicity, (c) Muslim, (d) under 29 years of age, (e) unmarried and (f) childless. A person that meets most of these criteria has to be thoroughly (and respectfully) searched if one wishes to enhance aviation security in a most effective way.

”And of course, for ultimate aviation security, we as a nation need to cease invading and occupying other nations and rebuild a sense of trust with the international community (particularly with the Arab populace) by keeping our armies within our borders and by becoming more of the exemplary humanitarian nation we can be.”

The 5: You sure you want Israeli-level security? Our acquaintance Chas Freeman, the veteran U.S. diplomat, sends along this story from the Israeli press, about an Australian woman who’d visited friends in Amsterdam before heading on her second visit to Israel.

Israeli security in Amsterdam asked the names of the friends she stayed with. One them had an Arabic-sounding surname. Before she knew it, the woman was strip-searched. Then, even after she was found to be no threat, her laptop was confiscated.

"I never want to go through that again,” the woman says, even if it means never seeing her Israeli friends again.


Addison Wiggin

The 5 Min. Forecast

P.S.: A few program notes: As you may know, we've been filming a documentary on entrepreneurship in the bailout and stimulus period after the Panic of '08. We've been following, among other folks, the trials and tribulations of undersea salvage superstars Greg Stemm and Mark Gordon in their quest to win the rights to market $500 million in coins they've recovered from a shipwreck off the coast of Gibraltar. As longtime readers of The 5 know, the Odyssey story is pretty fascinating in its own right…

But tomorrow, you have a chance to catch part of the film production in action. Working with Dan Rodricks, host of Midday, a show on WYPR, our local NPR station, we've invited a panel of "experts" to answer a timely question: How can we reignite the fires of entrepreneurship that made America "the most competitive economy in the world" for much of its history?

Among the guests are two Vancouver favorites, president of Odyssey Marine Mark Gordon and venture capitalist Juan Enriquez. Mr. Enriquez, among other groundbreaking projects, helped finance the mapping of the human genome nearly a decade ago.

Also joining us on the panel, University of Virginia professor Sara Sarasvathy, whose work details the process by which founder of the Grameen Bank — a gentleman who won the Nobel Prize for developing a program of "microloans" to women in Bangladesh — overcame seemingly insurmountable roadblocks to achieve his dream of providing capital to the world's poorest citizens.

The show airs live tomorrow between Noon and 2 p.m. EST. If you want to listen in, here’s where to go. We'll have cameras whirring away in the background. You just won't be able to see them. The podcast will be available after the program, if you're not available to stream it 'live.'

P.P.S.: After the show tomorrow, we head south to Tampa, Fla., for another day of shooting at Odyssey's HQ, where we hope we'll get the final sinews for a 'festival cut' of the film which, editing gods willing, we'll submit to the Tribeca Film Festival on Jan. 11, 2011.

On Thursday, we'll be back in the 'Belly of the Beast' visiting Ron Paul at his congressional office for the Liberty Caucus luncheon he sponsors while the House is in session. We'll find out what's been happening behind the scenes during this lame-duck session… and what's likely to become of the so-called "Bush-era tax cuts."

Until then, we'll leave The 5 in the capable hands of 'Dollar Bear' Dave Gonigam. Godspeed!


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