Asian Doubts Regarding the Dollar

Although the American public is oblivious to the growing debate over the future purchasing power of the dollar in international trade, Asian economists and policy-makers are beginning to discuss it.

Because Japan and China own hundreds of billions of low-return, dollar-denominated assets, especially U.S. Treasury bills, Asian policy-makers take seriously the possibility of a speculative move by currency traders against the dollar. For the same reasons that stock fund managers worry about a fall in the U.S. stock market, so do Asian central bankers worry about the rise of their nations’ currencies against the dollar. To get stuck with a few hundred billion dollars’ worth of depreciating assets is no central banker’s idea of a good time.

On September 28, China Daily ran an article by Jiang Ruiping, who is identified (in broken English) as the director of international economics at the China Foreign Affairs University. Dr. Jiang had some disturbing things to say about the future of the dollar. He began:

Many international institutions and renowned scholars have recently warned that the possibility of a US dollar slump is increasing and may even lead to a new round of “US dollar crisis.”

Since China holds huge amounts of US-dollar-denominated foreign exchange reserves, the authorities should consider taking prompt measures to ward off possible risks.

It is still too early to conclude if the US dollar is heading towards a crisis. But it is an indisputable fact that it has gone down continually. Its rate against the euro, for example, has dropped by 40 per cent since its peak period and it lost 20 per cent of its value against the euro last year alone.

It is becoming more and more evident that the possibility of a further slump of the US dollar is increasing.

Dr. Jiang does not mention the fact that currency moves, up or down, tend to continue in the same direction for years. The fact that the dollar has slumped against the euro is already bothersome for China’s central bankers, who peg the Chinese yuan to the dollar. The yuan has also fallen 40% against the euro.

The problem for the dollar, Dr. Jiang says, is the continuing twin deficits in the Federal budget and the trade account of the United States. The Federal deficit for fiscal 2004, which ended on September 30, will be over $400 billion.

From a domestic perspective, the worsening fiscal deficit will put great pressure on the stability of the US dollar.

In 2001 when the Bush administration was sworn in, the United States enjoyed a US$127.3 billion surplus. The large-scale tax cuts, economic cool-down, invasion of Iraq and anti-terrorism endeavours have abruptly turned the surplus into a US$459 billion deficit, which accounts for 3.8 per cent of the US gross domestic product (GDP).

By the 2004 fiscal year, the US Government’s outstanding debt stood at US$7.586 trillion, accounting for 67.3 per cent of its GDP, which exceeds the internationally accepted warning limit.

Dr. Jiang passes over the inconvenient fact that the U.S. government counts the annual surplus in the Social Security Trust Fund as a windfall to the Treasury rather than as a long-term obligation of the Treasury, which it is. So, even under Clinton, there was never a budget surplus except in the technical accounting sense that Social Security obligations are counted as off-budget obligations of the U.S. government.

Dr. Jiang then goes on to deal with the deficit in the U.S. current account with its trading partners.

The deteriorating current account deficit of the United States is another factor menacing the future fate of the dollar.

In recent years, the US policy that restricts exports of high-tech products, coupled with overly active domestic consumption and the oil trade deficit caused by rising oil prices, has deteriorated the US current account balance. This poses a great threat to a stable US dollar.

During the 1992—2001 period, the average US current account deficit was US$189.9 billion. In 2002 and 2003, however, the figure soared to US$473.9 billion and US$530.7 billion respectively. Experts predict that following its increasing imports in the wake of its economic recovery and continuing high oil prices, the United States will hardly see its current account balance improve.


The policy of China’s central bank is to subsidize this deficit by creating fiat money domestically and using this newly created money to buy dollars, which are then used to purchase low-return investment assets. Other Asian nations have the same policy.

If foreigners did not invest in the United States, then the deficit could not continue. The excess of purchases over sales of goods by Americans is funded by an excess of investment by foreigners. Some of this investment is direct. But it is now declining.

Given the huge US current account deficit, the US dollar, if it is to remain relatively stable, must be backed up by an influx of foreign direct investment (FDI).

In 1998, 1999 and 2000, FDI that flowed into the United States was US$174.4 billion, US$283.4 billion and US$314 billion respectively. Starting from 2001, however, global direct investment began to shrink and US-oriented direct investment also decreased. In 2003, FDI into the United States was 44.9 per cent less than that in the previous year.

The decrease in FDI will put more pressure on the US dollar, which has been endangered by the huge US current account deficit.

Dr. Jiang points to the policy of Japan’s central bank of buying dollars. This, too, is declining.

Internationally, the Japanese Government’s intervention in the foreign exchange market may become less frequent following the gradual recovery of the Japanese economy.

To deter the Japanese yen’s appreciation and promote exports, the Japanese Government used to intervene in the foreign exchange market to keep the yen at a relatively low level. In 2003 alone, it put in 32.9 trillion yen (US$298.76 billion) to purchase the US dollar. The intervention constituted a major deterrent to US dollar devaluation.

As the Japanese economy fares better, the Japanese Government tends to back away from the market. Since April, it has not taken any steps to swing its foreign exchange market.

This raises a question: Where is the investment money coming from today, now that Japan has ceased buying dollars with fiat yen?


Some of the demand for dollars results from the oil trade. Oil exporters demand dollars from would-be oil purchasers. This creates demand for dollars when the price of oil rises, as it has this year. The question now is this: Will this continue?

Another factor behind the risks of a US dollar slump is the weakened role of the so-called “oil dollar.” Given the deteriorating relations between the United States and the Arab world, quite a few Middle Eastern oil-exporting countries have begun to increase the proportion of the euro used in international settlement. Reportedly Russia is also going to follow suit.

If an “oil euro” is to play an ever increasing role in international trade, the US dollar will suffer.

This has not happened yet. The one oil exporter that broke ranks with OPEC and demanded payment in euros was Iraq. The United Nations in 2000 authorized this policy move. Iraq made the shift, requiring that two-thirds of its oil exports be paid for in euros.

On March 5, 2003, as the U.S. invasion of Iraq was beginning, Hillsdale College’s professor of economics, Richard Ebeling, commented on Iraq’s oil pricing policy. (Ebeling now heads the Foundation for Economic Education, which I worked for in the early 1970s.)

Last year, a senior Iranian oil representative suggested in a speech in Europe that European oil purchases might be increasingly traded in euros in the future. China and Russia have hinted that they may begin to hold more of their foreign currency reserve assets in euros in place of dollars.

If the euro were to increasingly become the alternative international currency of choice in competition with the dollar, the global demand for greenbacks would fall, the value of the dollar would decline, and the U.S. government would find it far more difficult both to export inflation and to finance its budget deficits. The financial clout and muscle of the American government would be dramatically undermined over time with the dollar increasingly no longer the only global reserve currency in town.

With the American military serving as the keeper of the oil fields in an occupied Iraq, the first policy change undoubtedly would be that all Iraqi oil sales will be once again exclusively in dollars. This would give the U.S. government the chance to try to stem the tide toward international use of the euro in place of the dollar and to put pressure on the Saudi government to maintain its long-established policy of dealing only in dollars on the oil market. And at the same time Iranian enthusiasm for euro dealings might be tempered if the American liberators are just next door.

This raises a major issue: the ability of the United States to maintain its presence in Iraq beyond 2005. I have written about columnist Robert Novak’s prediction that the U.S. will pull out of Iraq in 2005. If this happens, then Professor Ebeling will have answers to his questions.

It is hard to imagine that in the policy recesses of the State and Treasury Departments this benefit from a successful war in Iraq has not been thoroughly discussed in the briefs circulated among those deciding on war or peace. How else can the U.S. government, with federal budget deficits looming for years on the horizon, go on playing its sleight of hand in which it deludes the American public into thinking that government deficit spending is a continual “free lunch” that others around the world can be made to pay for? How else can the American government continue to play dollar diplomacy in managing its global empire?


Dr. Jiang then gets around to China. He writes:

In China’s case, its rapidly increasing foreign exchange reserve will incur substantial losses if the US dollar continues to weaken.

At the end of 2000, China’s foreign exchange reserve was US$165.6 billion. By the end of 2002, it rocketed to US$286.4 billion before it soared to US$403.3 billion by the end of 2003. By the end of June this year, the reserve was registered at a staggering US$470.6 billion.

About two thirds of the reserve is dominated by the US dollar. As the dollar goes down, China will suffer great financial losses.

Experts estimate that the recent US dollar devaluation has caused more than US$10 billion to be wiped from the foreign exchange reserve.

If the so-called US dollar crisis happens, China will suffer further loss.

The high concentration of China’s foreign exchange reserve in US dollars may also incur losses and bring risks.

How long will the central bank of China continue to subsidize the dollar? Answer: for as long as the Chinese government tells the central bankers what to do. Keeping the yuan fixed to the dollar lets Americans buy all those low-cost goodies. But this policy has a price: China’s accumulation of T-bills.

The low earning rate of US treasury bonds, which is only 2 per cent, much lower than investment in domestic projects, could cost China’s capital dearly.

Due to high expectations of US treasury bonds, international investors used to eagerly purchase the bonds, which leads to bubbles in US treasury bond transactions. If the bubble bursts, China will suffer serious losses.

A major reason why interest rates are low in the United States is the purchase of T-bills by foreign central banks. The Federal Reserve System is not the main reason for high demand for T-bills, and therefore a low price (interest). The adjusted monetary base has increased by a moderate 5.2% over the last year — well within the FED’s familiar range. Foreign central bank demand for dollars is today more important than FED policy. But this is unlikely to continue for much longer.

Dr. Jiang understands that China’s central bank is creating yuan in order to buy dollars. He understands that this has created a domestic inflationary environment in China.

Moreover, since the Chinese trading regime requires its foreign trade enterprises to convert their foreign currencies into yuan, the more foreign exchange reserves China accumulates, the more yuan the Chinese authorities will need to put in the market. This will exert more pressure on the already serious inflation situation, making it harder for the central authorities to conduct macro-economic regulation.

He then offers a policy recommendation. This recommendation bodes ill for the continuing high value of the dollar in relation to the yuan.

To ward off foreign exchange risks, China needs to readjust the current structure, increasing the proportion of the euro in its foreign exchange reserves.

Considering the improving Sino-Japanese trade relations, more Japanese yen may also become an option. During the January—June period this year, the proportion of China’s trade volume with the United States, Japan and Europe to its total trade volume was 36.5 per cent, 28.6 per cent and 37.4 per cent respectively. Obviously, seen from the perspective of foreign trade relations, the US dollar makes up too large a proportion of China’s foreign exchange reserves.

China could also encourage its enterprises to “go global” to weaken its dependence on US treasury bonds.

There is another use of dollars, he says. “And using US assets to increase the strategic resource reserves, such as oil reserves, could be another alternative.” In short, sell T-bills, buy oil, and stick the OPEC political regimes with a high-risk currency. That would move the flow of oil toward China rather than the rest of the world. Better to stock up on oil than T-bills.

This policy makes sense to me. Will it make sense to the Chinese government? On the day that it does, the dollar will resume its fall. Interest rates will rise.


China Daily is published on mainland China. The fact that an academic such as Dr. Jiang is allowed to offer critical comments about China’s central bank policy indicates how far Communist China has departed from the ways of Mao.

But there is another possibility. Dr. Jiang’s article may be serving the government as a trial balloon. If this is the case, then the days of dollar supremacy are numbered. If China floats the yuan, buys oil or euros, and sells off T-bills, the dollar will fall and U.S. interest rates will rise.

In my view, it’s a matter of when, not if.

October 1, 2004

Gary North [send him mail] is the author of Mises on Money. Visit

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