United States Relationship with Japan and China

There isn’t anywhere that endangers the world economy more implicit than in the United States’ economic relationship with the two giants of Asian exporting, Japan and China. It is calculated that east Asia holds approximately two-thirds of the world’s foreign currency reserves. China and Japan alone hold an estimated 800 billion dollars and 400 billion dollars, respectively, in United States dollar reserves, an average of about 17 percent of the total United States federal debt.

Around Asian financial circles, there is growing, if still muted, talk of a looming “dollar crisis” equivalent to the sterling crises of the 1960s – when London could no longer support the reserve role of the British pound – unless Washington mends its profligate ways and accepts higher interest rates and taxes. A default by the U.S. government is still unthinkable, but not so a unilateral change in the rules of international finance – akin to Richard Nixon’s halt to the convertibility of dollars into gold in 1971, or Franklin D. Roosevelt’s devaluation and repudiation of gold-denominated contracts.

 It is not difficult to understand why Japan and China would be interested in increasing their gold reserves under these circumstances. Even a little shift in the Chinese and/or Japanes reserve position toward gold would have immense implications for both the dollar and gold.

Former International Monetary Fund economist, Richard Duncan, speaks to what this might mean to the world economy of the future:

By accident or by design, Japan is carrying out the most audacious endeavor to conjure wealth out of nothing since John Law sold shares in the Mississippi Company in 1720. so far, the results have been impressive. Japan’s monetary alchemy has been the most important factor in allowing the U.S. government to finance a 700 billion dollar deterioration in its budget over the past three years without pushing up U.S. interest rates to levels that would pop the wealth-creating property bubble there...

These developments highlight a fundamental question that has been debated repeatedly over centuries: can governments create money and make the population richer without setting in motion a chain of events that ultimately ends in monetary chaos? We may be about to find out, as Japan tests the hypothesis on an unprecedented and global scale. If this experiment in unorthodox monetary policy succeeds, then we have arrived at a new international monetary paradigm. Governments will have discovered how to finance limitless deficits through the creation of paper money, and we all can look forward to an age of great prosperity. If it fails – as have all past attempts to create wealth from thin air – then the world may not be able to avoid a severe and protracted economic slump as the extraordinary imbalances in the global economy, caused by the explosion of fiat money in recent years, begin to unwind

In mid-2003, economists at the U.S. Federal Reserve published a paper explaining why the Fed was not “out of bullets” despite having cut short-term interest rates to one percent. That paper stated that “the Fed could even implement what is essentially the classic policy of dropping freshly printed money from a helicopter,” if necessary, to stimulate the economy. Today, that helicopter is in the air. But, strangely, it is not the Stars and Stripes that is painted on the side, but rather the rising Sun. That much is clear. What still is not quite discernible, however, is who is actually in the pilot’s seat.