Friday, June 13th, 2008...5:30 am
Dope, Dollars & Deficits
London, England
- Gulf States brimming with greenbacks…and inflation,
- Could it be the way of the opium den for the dollar?
- British gun boats, the Treaty of Nanjing, why deficits DO matter and more…
Joel Bowman, reporting from Dubai, UAE…
The world’s reserve currency has enjoyed a bit of a rally this week, spurred on by optimism from the Bernanke camp and stronger than expected retail sales for the month of May.
The Fed head assures us that the risk of a deeper economic slowdown is receding…even in the face of record high oil and a severely constipated financial system.
Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets tells us “the consumer refuses to die,” which is “helpful for the dollar.”
But a “not as bad recession” is still a recession. And consumers spending more on credit cards in the face of falling home values hardly presents a strong case for a robust economy.
While your editor welcomes a tiny bump in the value of the currency his paycheck is denominated in, we are not quite ready to break open the champagne and toast the end of the dollar’s decline.
What happens if, for example, foreign governments catch on to the growing fad of “dissin’ the dolla’?” Could the one-time reserve currency of the world become mere memorabilia, like tie-dyed T-shirts, Star Trek lunch boxes or Vanilla Ice albums?
Here in the Middle East, where five of the six countries that make up the Gulf Cooperation Council peg their dinars, dirhams and riyals to the dollar, confidence in the greenback is starting to fray. Although the Sheikhs, Kings and sultans of the GCC pay lip service to their staunch support of the dollar peg, most analysts agree that it is only a matter of time before they follow Giselle and Jay-Z and opt for a currency with a little more global “street cred.”
At present, Saudi, Oman, Bahrain, Qatar and the UAE keep their respective currencies pegged to the US dollar at a fixed rate. Here in the UAE, for example, it takes 3.67 dirhams to purchase one dollar. As such, GCC central banks are forced to lower and raise their interest rates along with “Sheikh Bernanke” in order to maintain the constant value of their currency relative to the dollar.
But while the Fed pounds the dollar into the pavement in an effort to stimulate the floundering economy, GCC states are caught in a curious position. Record-high oil prices have led to booming economies in the Middle East…economies that are overheating and spewing out double-digit inflation figures as they boil over.
Inflation rates in Saudi Arabia, the world’s largest oil exporter, and Qatar, the largest exporter of gas, are both running at multi-decade highs. And the rest of the Gulf is not far behind. The impetus to at least revalue their currencies, if not eliminate their dollar-pegs altogether, rises with every creeping inflation figure.
With $1.7 trillion in dollar reserves brimming from the Gulf’s coffers, the movers and Sheikhers of this little oil patch might make some noise if they decided to abandon the greenback. What if, instead of accepting dollars for their oil exports, the GCC states began demanding euros…or even gold?
It may sound farfetched, but it wouldn’t be the first time the party with all the goodies demanded payment in more than just worthless paper. In the column below, Adrian Ash of BullionVault reminds us of a time in the not so distant past when the British Empire was faced with a similar conundrum to that of the U.S. Unable to find a market for fish and chips and warm beer in China, the Brits were forced to drain their gold chest in an attempt to balance their books. When that didn’t work, they tried opium and, eventually, war.
Could things get this bad for US/Gulf relations? The similarities are quite striking. Read on and let us know your thoughts…
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Dope, Dollars & Deficits
By Adrian Ash
DO DEFICITS MATTER? Right around the time that English missionaries produced the first Bible in Chinese, the British Empire found itself with a trickier kind of translation problem. Exporting the English language to China – alongside a little Protestant godliness – was proving much easier than exporting British-made goods.
And while Britain was busy finding a market for its goods in the land of the sleeping dragon, imports from abroad were growing as the industrial revolution steamed ahead at home, sucking in the new consumer favorites – tobacco, sugar, coffee, calicoes, porcelain and silk.
“The British were spectacularly unsuccessful in finding trade goods that the Chinese wanted or needed,” Jonathan Spence, professor of history at Yale, noted in his Reith Lectures for the BBC earlier this week.
Thus “there was the problem of trade imbalances.” And stuck for consumer items to ship back across the oceans, London’s merchants were forced to pay in cash.
For the British, money meant gold, just as it did until the last gasp of the Gold Standard one hundred years later. But the Chinese wanted silver.
(They never did get round to using gold, in fact. And while Britain recovered early from the Great Depression by abandoning gold for credit-money in 1931, one theory holds that China side-stepped it entirely by sticking to its silver standard…)
Translating English pounds into Chinese yuan in the 1830s meant selling gold for silver, and that meant dealing on Europe’s precious metals market. Paying a commission to the bullion dealers of Paris or Prussia – as well as shipping it all back and forth – only added further to the transaction costs of running up that yawning trade gap.
What to do? A little of the British Empire’s raw cotton found a market in China, but it wasn’t nearly enough to close the trade gap. Gold bullion continued to flow out of London, aggravating the “bullionist” school of economists and policy-makers. They feared a shortage of coin in the domestic
British economy coupled with a fall in the Pound Sterling’s international value would leave the London exchequer impoverished should it ever need to fund a military defense of the home front.
And so “it was this melancholy failure of the balance of trade that led to the under girding of the opium business in China,” explains Prof. Spence. Opium grown in India “started to be sold to the Chinese by British traders, and later by American traders, because the West simply could not find enough products to attract the Chinese in a sort of barter exchange at the time.”
Widespread dope-smoking and the social breakdown it can invite rarely chimes with government policy – not domestically, at least. Opium had long been banned by imperial decree from Nanjing. But after ten years of trying to fend off Britain’s drug dealers without damaging the inflows of silver, the Qin authorities finally cracked and made a stand, seizing 20,000 chests of the drug – some 1,200 tonnes – landed in Guangzhou.
London responded first with a gun-boat, and then the all-out Opium War of 1839. It ended three years later with the Treaty of Nanjing. Britain’s military might won the island of Hong Kong, plus reduced trade tariffs, freedom from Chinese law for its ex-pats, as well as “most-favored nation” status.
Whatever trading rights or concessions China would grant in future, the British Empire would also gain as well. Opium was then forced on the Chinese, and the trade gap closed without the need for hard money payments.
The trouble today is, we still don’t make much that the Chinese want to buy. The United Kingdom’s trade deficit with China rose 8% in the year to April ‘08, as Chinese imports swelled by more than 10%.
And now, early in the early 21st century, it’s America’s turn to fumble around for a way of settling its debts with China. Yes, the value of Chinese imports to the US fell slightly during the first four months of this year compared with the first third of ‘07. But US exports to China fell faster still according to the Census Bureau’s latest data. So the trade gap widened again to rack up a deficit three times the size of America’s debt to Canada or Mexico, the United States’ No.1 and No.3 trading partners respectively.
The United States, of course, ships dollars and bonds back across the Pacific, rather than silver or gold bullion. But are dollar bills and Treasurys what China really wants, anymore than it wanted 1,200 tonnes of dope in 1839…?
The People’s Bank of China (PboC) just raised the required reserves ratio – the amount of cash that private banks must keep in reserve – to a massive 17.5%. That should drain something like $58 billion from the domestic lending markets, reckons the RGE Monitor, as the Chinese authorities set about “treating the symptoms of excess liquidity.”
Spooked by the risk of a further slump in the over-heated Shanghai stock market, however, the PBoC continues to hold its key interest rate below the rate of consumer-price inflation. That makes cash a losing asset class in China today, just like it is in the US and UK, too.
Not surprisingly, the Chinese would much rather buy and hold precious metals than clutch onto a depreciating currency. China’s retail investment demand for Gold rose 63% during the first quarter of 2008, reports the GFMS consultancy, amounting to 15.1 tones. Gold jewelry sales grew by 9% –”one of the few examples of demand increasing over 2007 levels” during the global spike to $1,000 per ounce – reaching 86.6 tones.
China now represents the world’s second-largest gold jewelry market after India, over-taking the United States in 2007. But even at a total of 420 tonnes last year, total demand for gold from mainland China, Hong Kong and Taiwan combined remains almost negligible on a per capita basis.
That’s not to say it’s sure to keep rising; but with Chinese goods now accounting for 13% of America’s imports each month – more than Mexican goods and only just less than Canada’s (including petroleum) – we wouldn’t be surprised to see ever more of that wealth swapped for silver and gold bullion.
And despite what Dick Cheney claimed back in 2002, as the Dollar’s 40% decline got started, deficits do matter…especially when the country at the other end of the shipping route gets tired of dollars and starts demanding gold.
Perhaps it’s time you considered adding some to your war chest.
[Joel's Note: If you are interested in swapping some of your dwindling dollars for good ol’ bullion, Adrian is probably the best man to help you get started.
Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK’s leading financial advisory for private investors, Adrian currently is the editor of Gold News and head of research at BullionVault – where you can Buy Gold Today vaulted in Zurich on $3 spreads and 0.8% dealing fees.
To learn more about how you can take advantage of BullionVault’s unique array of gold focused research and investment products, simply click here.
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[Rude Endnote: Your editor is actually on a plane right now, en route to Tunisia for a little adventuring. We won’t be checking email today but, if you know of any good eateries to recommend, please send them on with the rest of your Rude thoughts to the address below.
Until tomorrow…
Cheers,
Joel Bowman
Rude Awakening
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