Saturday, May 27, 2006

Chinese and US Debt, and Dollar Hegemony

Asia Times Online :
The Chinese Ministry of Finance reported that the aggregate national debt balance rose to 3.26 trillion yuan in 2005, but it fell to only 18% of 2005 GDP of 18.23 trillion yuan. This reflects the effect on economic policy analysis with dynamic scoring in which the growth impact of the national debt on the economy can outstrip its nominal rise.

By comparison, the US national debt stood at $8.4 trillion as of April 13, 2006, or 65% of forecast GDP. About $4.9 trillion of the US national debt is held by the public and $3.5 trillion is held intra-governmentally. US national debt is about 20 times China's on a nominal basis, five times on a purchasing-power-parity basis, almost four times on a debt-to-GDP basis, and 100 times on a per capita basis. US per capita income is about 35 times that of China in 2005, which means each US citizen is carrying almost three times the national debt-to-income ratio as his or her Chinese counterpart. On average, US wages are about 50 times those of China because of higher income disparity in China.

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Dollar hegemony eliminates default risk
Because of dollar hegemony, a peculiar phenomenon of the US dollar, a fiat currency, assuming the role of a key reserve currency for international trade and finance, US government securities do not carry default risks, as the United States can print dollars at will with little short-term penalty. The only risk US government securities carry is inflation, a prospect that the Federal Reserve, its central bank, can control through interest-rate policy. High Fed Funds rates can reduce dollar inflation under normal circumstances, unless the economy is plagued by a debt bubble, in which case high Fed Funds rates can actually add to inflation.

Government securities of other nations denominated in US dollars carry default risks, as these governments cannot print dollars. Even government securities denominated in local currencies that are freely convertible carry default risks because the foreign-exchange market limits the ability of these governments to print their own local currencies relative to the size of their foreign-exchange holdings. In that sense, dollar hegemony has reduced all freely convertible and free-floating currencies to the status of derivatives of the dollar.

The governments of such currencies have forfeited their monetary sovereignty with which to manage their economies. The currencies of these nations no longer derive their value only from the strength of their economies, but also from the value of the dollar, rising or falling against the dollar as a benchmark.

The Federal Reserve of the US has become a super-national monetary authority through dollar hegemony, framing policies that prioritize the needs of the United States, from which the prosperity of the rest of the world must derive. This is why, after the abandonment of the Bretton Woods fixed-exchange-rates regime based on a gold-backed dollar, the US has been pushing a global floating-exchange-rates regime based on a fiat dollar in order to impose dollar hegemony on world finance.

Interest rate stability or money supply stability
Monetary-policy authorities have a choice between interest-rate stability and money-supply stability, but no monetary system that operates on fiat money can have both options. The national debt is the lowest cost at which a nation can borrow. Sovereign-debt interest rates act as a benchmark for other debts because sovereign credit is superior to private-sector credit under normal conditions. When the money supply is tight, interest rates on government bonds rise. This causes interest rates on all private debts to rise with them. High domestic interest rates usually exert upward pressure on the exchange rates of freely convertible currencies. "


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