Friday, August 19, 2005

Looming banking crisis in China

Tip of the hat to the esteemed Kate at small dead animals.

This is part of my larger point about the American economy being susecptible to recession. James Grant, of Grant's Interest Rate Observer pointed out on several occasions what is happening with China and U.S. current accounts deficit. Grant has noted that the U.S. buys billions in Chinese made goods, tangible property, in return for U.S. paper in the form of dollars and Treasuries. This only works for as long as the Chinese accept U.S. paper. Prior to 1971, the Chinese could theoretically ask for payment in gold to the tune of $35/oz. Now it's a fiat currency, and the U.S. economy will only continue to chug along as long as the Asian central banks accept U.S. dollars in trade.
What would happend if this was not the case would be a monumental spike in interest rates and a sudden spike in inflation, as well as disruption to the money supply. What this indicates is that the Federal Resevse only has de jure control over U.S. monetary policy. It is there colleagues in China, Taiwan, Korea, and Japan that have de facto control.
At least with a gold standard, I think it wouldn't have gotten to this.

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