For some time now I have been reading along with a lot of other people about how the US financial system is in the early stages of meltdown. Without going into the gory details the point is that when the dot bomb hit us the Fed under Allan Greenspan used interest rates to restart the engines, which directly led to the runaway real estate boom and then immediately after that the subprime crisis.

Along with printing money, the US went into a costly war that not only led immediately to a huge uptick in spending on arms, replacing inventory, but also led directly to massive increases in the price of oil.

To enable all this to happen the US had to get foreign countries to buy its treasury notes. Countries like Japan, a traditional ally of the US obliged. So did China, and as China's fortunes continued to improve they became the largest holder of US debt in the world. The other big holders of US debt are the oil producing countries in the gulf – most of which have their local currencies tied to the value of the US dollar.

Fast forward to today.

China announced casually today that they are planning to diversify their currency holdings. Investors there  reduced their holdings of US paper to $400 Billion by the end of August. They look like they are going to continue. If there is a significant sell off of US paper it will clearly drive the greenback down further. What will that mean to the US and the rest of us, since we now all have interdependent economies?

Here is my take on it.

I believe that we are in the early stages of the real WW III. And the war in Iraq and possibly Iran are certainly part of it. America has been suckered into waging a proxy war for energy in the middle east in the same way that Russia was suckered by the Americans into fighting a war in Afghanistan. That war crippled Russia and led to the collapse of the Soviet Union. The war in Iraq is destroying America both financially and morally. (The sophistry of the White House about torture is causing Americans with decent values to realize that their nation is now acting immorally and contrary to everything that they have been told about what makes America a great nation).

The financial mess of subprime blowout is rippling through global markets and is causing a massive hollowing out of real estate prices even in California which has managed to weather the storm up until recently. Its moving across to the UK too.

But I think it is important to look at the big picture here and consider a few scenarios.

First – the connection between the renmimbi and the dollar. While the Chinese keep their currency in lock step with the dollar it frankly doesn't matter how much the US fed allows the dollar to sink in order to increase consumption of local products and therefore to underpin the job market. Chinese imports will continue to be the same price come rain or come shine. As long as oil prices continue to rise the US consumer will be feeling pain. And the real pain is coming soon. It is the pain brought on by reduced equity in their homes and tighter lending practices by banks regardless of artificially low interest rates.

So America will slide into recession.

And if the White House continues to beat the drums of war and starts a war with Iran, the price of oil will really get into overdrive.

Which brings up another point. Oil is priced in US dollars. So the  countries that feel the pain of increasing prices most are the countries that lock their currencies into the US dollar. Now you might think that China would therefore not want increased oil prices wouldnt you? But China is getting it oil from countries that are not particularly friendly with the US – Iran and Venezuela to name two? Who knows what deals have been done between these nations and China to enable China to secure its energy requirements?

In 1997 I think it was, two Chinese colonels put out a book about war strategy. It was about assymetric warfare – war by any means possible. I think that the concepts of that book are being pursued today.

China is in the process of doing to the US what the US did to the USSR not too many years ago. We are seeing the collapse of the American empire. Of course they wont go down without a fight.  And at the same time as that we have climate change as the wild card…

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Posted in Economics Main Page by Chris Gilbey No Comments Yet