Recent news that China and Russia have agreed to conduct bilateral trade with their own currencies could not have come at a worse time.

By The Freeze|Men With Foil

China and Russia have been tactful in saying that “this action is not aimed at challenging the dollar”, but in fact that is precisely what it does.  It comes at a time when the verdict on recent Federal Reserve actions have come under great criticism from around the world.  This action by China and Russia is part of the verdict about to be written on the Fed’s policies.

Lets look at why they are doing this.   The US dollar is losing its value as a direct result Obama’s “stimulus packages” and Fed intervention.  There was in fact a QE1 (Quantitative Easing number 1), before the more commonly discussed QE2.  While QE1 helped banks clean up their balance sheets by lowering their cost of money, it did absolutely nothing for the average American or businessperson.  Somehow rewarding banks for bad behavior using taxpayer money (yes, it will have to be repaid at some point) seems to be self-defeating.  QE2 seeks to do more of what didn’t work the first time.

The outcry from our trading partners has been deafening.  China’s Zhou Xiaochuan, governor of the central bank was delicate in his remarks, saying the Fed’s plan (QE2) “was not necessarily optimal policy for the world.”  Not so much love from a Chinese credit ratings agency which was more blunt, stating that QE2 was ” like drinking poison.”  Typical for Japan, while no doubt very unhappy about the Federal Reserve’s move, timidly offered that they would “keep a close eye” on things.  Germany perhaps was the most honest as far as remarks from official sources go.  Finance minister Wolfgang Schauble calls the Fed’s move “horrendous”, accusing the United States of hypocritically manipulating it’s currency, much the same as China has done.  Indeed that is precisely true.

The many nations to whom we owe money are in a real bind.  They are getting back far less than what they gave us, and we are forcing it on them as a policy, not as a result of normal market dynamics.  As an example, lets say you bought something from a store on credit for $100 dollars.  Then you call them up and say you are only willing to pay $50 bucks and they can take it or leave it.  Furthermore, in the future, when you shop at their store, you will only be paying half price – and they have no choice.  They would have every right to be upset at your actions.  This is what we are doing to our trading partners.  Their normal reaction to what we have done is exactly what China and Russia have done.  Eliminate the dollar because the dollar has become the problem.

Is the Federal Reserve and the Keynesians controlling economic policy insane? Albert Eistein said it best in his definition of insanity: Doing the same thing over and over again and expecting different results."

The hopes of Keynesians and the purpose of Quantitative Easing is to pump money into the markets, specifically banks.  In return this should stimulate banks, who now have cheaper money to loan more to businesses and individuals.  However, real interest rates have been at near zero for quite some time, proving well in advance that low interest rates are not having much if any stimulative effect on the economy.  Doing more of the same, when the same didn’t work, is well defined as insanity.

In the short term, QE1, in 2008 did appear to boost the stock market.  But it was an increase in prices without a foundational improvement in the economy.  As easily gained as lost.

Another reason China and Russia are doing this is to end what they consider to be “United States hegemony.”  Loosely translated, they don’t like the power that the dollar-as-reserve currency to the world gives us and they want it to stop.  China is currently working with other major trading partners to accomplish the same thing – avoiding the use of the US Dollar in trade.  Seen from their point of view, they are held prisoner to the whims of the United States fiscal policy, and the Fed has burned them.  Many times.

They can’t get rid of the dollar just yet.  The power of the American economy, even on its back, dwarfs the rest of the world.  So the dollar remains, for now, the backbone of the world trading system.  All oil is priced in dollars, most (well, basically all) commodities are priced in dollars.  This means trade between third parties, not even involving the United States, is done with our currency.  This is the biggest benefit of our dollar being the world’s trading currency and reserve currency – that we do not see large swings in prices BECAUSE all trade is done in dollars.  Many other currencies are also linked to the dollar.  However if we lose reserve currency status, that goes away, along with the many benefits.

“Death by a Thousand Cuts”  is what we are experiencing right now.  A single cut may not be noticed.  But over time, the sum total of all these cuts, or attacks on the dollar, will result in an incalculable loss to the American people.  Simply by having our dollar as a world reserve currency helps prop up our economy to an extent most people are unaware of.  If current trends continue, our children will see China’s Renminbi as the world’s reserve currency.  Today’s story about the deal between Russia and China is a major step in that direction.  We as a country will be poorer for it.

To think it was (and still is) so avoidable, had conservative fiscal economic principles been applied instead of theoretical Keynesianism.  What will we tell our children, who will face higher taxes and a potential of lifetime economic malaise because their parents generation did not act, in time, to prevent the catastrophe of losing our economic primacy in the world.

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