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THE REST PART 3

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March 20, 2008 – Comments (0)

For the Chinese, the basic racket is too delicious and too ironical. They
industrialize their country at the expense of the de-industrialization of the
U.S. Not only is it sweet revenge for more than a hundred years of humiliation
at the hands of Europeans and Americans, but also at the end they are relatively
strong and the U.S. is relatively not. What do they care if the deal isn’t quite
as good as it would be in a perfect world and they lose a third, half,
two-thirds of their savings in U.S. Treasuries? Besides, in an even mildly less
imperfect world, the U.S. President would not make such a blatantly corrupt
bargain against the people of the U.S. Billionaire investor Warren Buffett calls
this system of indebting U.S. citizens to foreign governments “a sharecropper’s
society,” to distinguish it from Bush’s supposed “ownership society.”

No wonder Chinese central bank governor Zhou Xiaochuan told a press interviewer
at the time of the G-7 session in London in early February, “now is not the
time” to revalue his currency, the yuan.[8] Of course it is not. He is clearly
not stupid. The time to revalue is after China has sucked all the remaining jobs
out of the U.S. that it can or just before the U.S. gets a less dishonest
government. For the Japanese, the basic sweetness of the deal plus geopolitical
strategic reasons may keep them tied to the U.S. There is also the spirit of J.
Paul Getty’s famous line: “If you owe the bank $100 that's your problem. If you
owe the bank $100 million, that's the bank's problem.” Some Japanese clearly
think they have a problem. Prime Minister Junichiro Koizumi said on 11 March
2005 concerning his government’s U.S. dollar holdings, “I believe
diversification is necessary.” This instantly shook the currency markets,
causing the director of the Japanese finance ministry’s foreign exchange
division, Mastatsugu Asakawa, to blurt out, “We have never thought about
currency diversification.”[9]

Mr. Asakawa has been kept busy making this point. On 23 February 2005 he had
already stated, “We have no plans to change the composition of currency holdings
in the foreign reserves and we are not thinking about expanding our euro
holdings.”[10] He added, “Valuation loss is not our primary concern. My opinion
is that I don’t have to care seriously about that.”[11]

There are, of course, other major single party buyers of dollars and Treasuries
besides the central banks of Japan and China. In fact Mr. Asakawa’s earlier
remark was precipitated by a market panicking statement on 22 February from the
Bank of Korea. They indicated they were considering diversifying some of their
$200 billion in currency reserves, 70% of which were in dollars. The dollar
plunged 1.2% against both the yen and the euro. Part of this was due to
programmed trading which kicked in with sell orders after the dollar hit a
threshold of $1.3210 to the euro.[12] After the dollar suddenly fell, South
Korean officials quickly announced they wouldn’t sell any of their existing
dollar reserves, leaving open the possibility of putting new reserves into other
currencies.

South Korea, presumably, can be muscled. Other central banks are less
susceptible to pressure. On 5 February 2005 Russia announced that it would no
longer peg the ruble to the dollar, but instead to a shifting weighting of
dollars and euros. Russia had been selling dollars and buying euros since
October 2004, during which time the U.S. dollar had tumbled significantly
against the euro.[13] This of course corresponded to the period when Bush was
seen to be back in power for another four years.

The overwhelming consensus of financial writers was that both the dollar and
Treasuries would really hit the skids in the new year, 2005. The consensus was
global. For example, the French financial paper, Les Echos wrote in its edition
of 21-22 January: “Until now, it was a question of the great bet adopted nearly
unanimously by foreign exchange traders—the dollar will fall in 2005.”[14]

Of course, as implied by the quote, the dollar did not fall. Nor, of course, did
its fat twin, U.S. Treasuries, which are little more than interest paying
dollars. Is this because the trade deficit improved? Not really, although it
showed a slight gain in early February, long after the dollar and Treasuries had
materially improved. The dollar had gone up 3.6% from 1 January 2005 until 22
February 2005. Why? Did Bush raise taxes, thereby erasing some of the fiscal
deficit? Not at all. On the contrary, he cut taxes—as usual for a select
group—and that’s why the dollar rebounded.
Plunge Protection’s New Cash

In late October 2004, the U.S. public was looking the other way when the tax cut
was passed. Most people were obsessing over who would win the presidential
election. Few were paying much attention to what the Republicans in Congress
were doing, which was giving billions in tax cuts to U.S. corporations which had
profits parked in tax havens around the world, such as in Ireland or Singapore.
Bush signed the law enabling this tax giveaway on 22 October 2004. The tax
changes were noted by a few at the time, even before the law changed. But the
general level of financial journalism is so bad that they got no real echo in
the press. Most people speculating against the dollar had no idea they were
about to get stung. Obviously a few knew what the implications of the tax law
were. They made out, more or less literally, like bandits. But one cannot
legitimately claim insider trading since the tax law changes were publicly
available knowledge, and even made it to the internet on various accountant
websites in October. But they don’t seem to have gone much beyond these
specialists. On 15 January 2005, I had a long talk in Paris with a top European
stock market guru. Well connected and with a devoted following which he
obviously did not want to burn, he had in all sincerity advocated buying gold to
a gathering of thousands of his devotees a couple of months earlier, in
November, after the passage of the U.S. tax law.

Most speculators were caught unaware on this source of currency pumping money,
so it is unreasonable to assume that there will not be other surprises, which
will be announced in due course.

The law Bush signed in late October 2004 goes by the obscenely false name, the
American Jobs Creation Act. If there is one thing it will not do is to create
jobs. It will instead create takeovers, which nearly always produce losses in
jobs—in the name of synergy. Takeovers are on the limited menu of activities
companies are permitted to do with the money they can “repatriate” under this
law. Not that the limited menu makes much difference, since the money brought in
does not have to be fenced off in any way. So if $10 billion were spent by a
company on takeovers, that frees up another $10 billion to do whatever was
prohibited under the law, such as paying dividends, buying back stock, or
filling the pockets of executives with extra bonuses. Normally such profits
earned in foreign subsidiaries of U.S. companies would be subject to a tax rate
of 35% if they were brought home, which is why the money had stayed parked in
the tax havens. But the law gives companies a one-year window for the
“repatriation” of this cash at a tax rate of only 5.25%. Nobody knows how much
will be brought in. When the law was passed in October, the general expectation
reportedly was that the figure would be about $135 billion.[15] But one player
has estimated it at $319 billion. “This has some investment bankers salivating,”
wrote David Wells in the Financial Times.[16] But how much would be converted
into dollars from other currencies? According to two different investment banks,
the figure is somewhere around $100 billion.[17] That would be the minimum
available from this source to pump the dollar for one year. Recall that the
Exchange Stabilization Fund has less than half that for eternity.

The Bush administration’s use of repatriated foreign profits to pump domestic
markets shows that they are not going to let “thin ice” signs stifle their
version of the economy, at least not without a fight. However, the underlying
weakness of the economy because of the twin deficits remains, so basically all
that Bush and his Plunge Protection team are doing is moving the “thin ice” sign
out onto thinner and thinner ice. The weight of the Bush team will eventually
crash through that ice into exceedingly cold water.

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