Geithner's Goof

Now that I have taken some of my Euro/US off the table with a significant profit, I wanted to address what Geithner did the other day. The best person to do that is (angry) Larry Levin, who knows more about our country's problems then anybody. My explanation was rushed, so take a minute and read this:

New Currency Standard?

I haven't read this in the mainstream media, so I am writing about it tonight to bring it to your attention. No surprise there right; after all there is so much we need to know about "OCTOmom." Sickening, but true. Anyhow, the world is serious about using a currency other than the US dollar as the international reserve currency, which is a very dangerous proposition for the USA, and the mainstream media is ignoring it.

Earlier this week China's central bank said it is nervous about the massive increase in US deficit spending. Whether we believe the heightened spending is needed or not is irrelevant; the Chinese hold approximately $2 trillion of foreign exchange reserves in US dollars and that makes their opinion important. Printing new money out of thin air by the Federal Reserve will decrease the value of all dollars currently in existence, which gives China 2 trillion reasons to be upset. Moreover, if they sell their current holdings or just slow their current buying of US debt, we are in worse shape.

Zhou Xiaochuan, head of the People's Bank of China, proposed the creation a new international reserve currency in an essay published on the central bank's Web site last Monday. Zhou is expected to attend the Group of 20 meeting in London on April 2 where reform of the global financial system is on the table.

According to its English translation on the central bank's Web site Zhou said, "The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies." He went on to say that a super-sovereign reserve currency managed by a global institution could be used to both create and control the global liquidity. Zhou suggested that the International Monetary Fund's Special Drawing Right (SDR) should be given a greater role. The SDR is an international reserve asset, created by the IMF in 1969. Its value is based on a basket of key international currencies.

"Today, the SDR has only limited use as a reserve asset, and its main function is to serve as the unit of account of the IMF and some other international organizations," says an IMF fact sheet. "The SDR is neither a currency, nor a claim on the IMF." China disagrees. Its central bank says "the SDR has the features and potential to act as a super-sovereign reserve currency."

So what does the US think about this? Certainly policy makers are against this, however, Tax-Cheatin' Timmy slipped up recently. Speaking at a conference in New York, Timmah (think South Park) was asked his thoughts about comments from Zhou Xiaochuan cited above. "I haven't read the entire proposal," said Timmah. "But the governor is a sensible man [and] anything he says deserves consideration." As for "increasing the IMF special drawing reserves, we are favorable to that." What an idiot! With that remark the US dollar plunged over 1% in just minutes, forcing Timmah to quickly reverse his statement.

A monumental move of this proportion where the entire world moves from US dollars as the world's reserve currency to something new will not happen overnight. However, the repeated call for it by major countries such as; China, Russia, oil-rich Gulf States, and several Latin American countries is disturbing. If it happens (five years from now perhaps?) the America-gets-whatever-it-wants lifestyle propagated by Congress for decades will be over.

But what if it were to happen faster? Let's skip the Armageddon scenario for now and contemplate how China could make it happen on their timetable - not ours. First, China could not DUMP all of their current holdings without massacring the balance of their holds - right? Sort of. China could dump some of its Treasuries after purchasing CDS contracts on US sovereign debt. The values of these contracts have already gone up quite a bit recently, so I wonder if China already has bought them! Once China owns these CDS contracts (credit default swaps) and it's known that China is fleeing the dollar, it can recoup losses on its remaining dollar holdings via the increase in its CDS values. It's a simple hedge that allows China or any other country to get out of the US without much harm - as long as it's not all at once. If it were all at once, it would be doubtful that the one who sold the CDS would be able to make good on the bet.