Monday, May 18, 2009

On Treasury Bonds and Trade Wars II

I first discussed the onset of impending trade wars in my previous post On Treasury Bonds and Trade Wars. In the three weeks hence, there have been some interesting new developments.

"A policy mistake made by some major central bank may bring inflation risks to the whole world," said the People's Central Bank in its quarterly report.

"As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise," it said. The bank fears a "big consolidation" in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.

Simon Derrick, currency chief at the Bank of New York Mellon, said the report is the latest sign that China is losing patience with the US and aims to diversify part its $1.95 trillion (£1.3 trillion) foreign reserves away from US Treasuries and other dollar securities.
Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz Inácio Lula da Silva, Brazil’s president.

The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency.

Mr Lula da Silva, who is visiting Beijing this week, and Hu Jintao, China’s president, first discussed the idea of replacing the dollar with the renminbi and the real as trade currencies when they met at the G20 summit in London last month.

China has been pretty blunt with their intentions. They have said repeatedly over the past few months that they are worried about the dollar and they favor an alternative to the dollar as the world's reserve currency. This is just another step towards China's goal of distancing itself from the dollar. The first step is to stop using the dollar as a medium of exchange. The second step is to stop buying (or even sell) US dollar based treasury bonds. The countermeasure by the US Government is likely to be protests of currency manipulation and the imposition of tariffs on Chinese goods. In other words, a trade war.

Why would China want to distance itself from the dollar? If you visit this site regularly you should already know the answer to that question but here is one picture that summarizes the situation pretty nicely (from

The US Government is massively increasing spending at the same time that tax revenues are cratering. Foreign heads of state are simply trying to protect themselves against the inevitable fall in the value of the dollar.

Going back to trade wars, China is one thing but what do we have here? Strained trade relations with Canada? Trade Wars Brewing in Economic Malaise:

Is this what the first trade war of the global economic crisis looks like?

Ordered by Congress to "buy American" when spending money from the $787 billion stimulus package, the town of Peru, Ind., stunned its Canadian supplier by rejecting sewage pumps made outside of Toronto. After a Navy official spotted Canadian pipe fittings in a construction project at Camp Pendleton, Calif., they were hauled out of the ground and replaced with American versions. In recent weeks, other Canadian manufacturers doing business with U.S. state and local governments say they have been besieged with requests to sign affidavits pledging that they will only supply materials made in the USA.

The article covers some interesting anecdotes of discrimination against companies which are technically not headquartered in the US but have large operations in the US with many jobs for US workers. Trying to categorize companies as American or not-American is a process that died in the 19th century and was definitely buried in the last ten years. Political pressure by the Canadian business community could lead to a response by the Canadian government.

Trade wars are just starting to heat up. We will keep you posted on new developments as they happen.
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