Full Faith and Credit? How the Chinese are Undermining the Dollar

by Kevin D. Freeman on October 22, 2013

y-d-1Since 1971, the currency of the United States has been backed exclusively by the “full faith and credit” of the United States government. It is not backed by gold or silver. But, “full faith and credit” has been viewed historically as sufficient to encourage foreign governments and others to purchase trillions of dollars worth of our debt and to make the U.S. dollar the primary reserve currency for the world.

Now (as we have pointed out multiple times), enemies of the United States including in Russia, elements in China, Iran, Venezuela, and North Korea have all targeted the dollar’s reserve status as a direct attack on our economy. We said that would be “Phase Three” both in  the original Pentagon research and our NY Times bestseller, Secret Weapon.

We have also explained how many have vociferously denied that there is any risk to the dollar’s status. Almost angrily, many will defend China, for example, claiming that the Chinese would never harm the dollar. They point out how the Chinese have $1 trillion worth of dollar-based investments and that they would never risk them. At best, this is naive. At worst, it is a deliberate deception with treasonous intent.

The reality is that the “full faith and credit” of America has diminished rapidly. Even if there were a desire by nations such as China and Russia to keep the dollar strong, it should be obvious to everyone that the “faith and credit” of America is much less than it once was. And, both friend and enemy have taken notice. The debt ceiling debate and government shutdown gave opportunity for others to question the dollar’s future. This has been an opening for those willing to take down the dollar to hide behind free market arguments as they plot to dethrone America.

It has certainly been effective as even Jim Cramer of CNBC has called the dollar “the laughingstock of the world.”

Consider this from Unrestricted Warfare, a strategy book written and published by the Chinese PLA in 1999. The book demonstrates clearly the economic weapons can be used to destabilize an enemy nation, even the United States. The authors reference George Soros’ devastating attacks on Asian economies in the late 1990s and the dismissive way he justified them:

“Soros’s logic is ‘I entered the room to steal money because your door was not locked.’ In this way, he does not have to be responsible for destroying the economies of other nations and throwing the political order of others into disarray . . . Soros . . . conceals himself in the forest of free market economics . . .”

Basically, what the PLA authors were saying is that it is possible to attack an enemy with economic weapons, especially when the enemy is weakened. Then, in justification of the attack lay blame to the very weakness that enabled it. Sort of an economic Darwinism justifying the strong killing the weak. In this light, if America is perceived as weak, there is justification to attack us economically. The same thought was echoed twelve years later in Qiushi, the official journal of the Communist Party.

Now, consider that these are the same Chinese who went to extraordinary lengths to preserve the Euro and the European Union just a couple of years ago. When George Soros wanted to use his “free market” justification to pound the Euro, the Chinese stepped up against him and he took notice. This is evident from two articles, the first of which appeared in the February 26, 2010 edition of The Wall Street Journal explaining the how and why of attacking the Euro:

Hedge Funds Try ‘Career Trade’ Against Euro

“Some heavyweight hedge funds have launched large bearish bets against the euro in moves that are reminiscent of the trading action at the height of the U.S. financial crisis. The big bets are emerging amid gatherings such as an exclusive “idea dinner” earlier this month that included hedge-fund titans SAC Capital Advisors LP and Soros Fund Management LLC.”

The Wall Street Journal article went on to describe the plan to take down the Euro:

Through small gatherings, hedge funds can discuss similar trades that can feed on each other, in moves similar to those criticized by some investors and bankers in 2008. Then, big hedge-fund managers, such as Greenlight Capital Inc. President David Einhorn, who also was at this month’s euro-dominated dinner, determined that the fortunes of Lehman Brothers Holdings and other firms were dim and bet heavily against their securities, accelerating their decline….

Again, derivatives, known as credit default swaps, are playing a part in the current trading. Some of the largest hedge funds, including Paulson & Co., which manages $32 billion, have bought such swaps, traders say, which act as insurance against a default by Greece on its sovereign debt. Traders view higher swaps prices as warning signs of potential default.

Of course, the Europeans also banned the use of naked Credit Default Swaps against sovereign debt as well as naked short selling of stocks and bonds. In addition, the Chinese stepped up to defend the Euro as noted by George Soros in a Der Spiegel interview from August 15, 2011:

SPIEGEL: That sounds very noble. But in reality, speculation makes any crisis worse. Look at the credit default swaps (CDS) market where speculators can bet on a further decline of currencies and economies. How can that be helpful?

Soros: Of course, speculation will always make a crisis worse. If there is a weak point, it will expose it. And you are right, the CDS market is a very dangerous instrument and I think it should not be allowed. I am one of the very few people who argue that the CDS is a dangerous instrument because it is so lop-sided in favor of a negative outcome.

SPIEGEL: As an investor, would you still bet on the euro?

Soros: I certainly would not short the euro because China has an interest in having an alternative to the dollar. You can count on China to back the efforts of the European authorities to maintain the euro.

SPIEGEL: Is that the reason why the euro is still so strong compared to the dollar?

Soros: Yes. There is a mysterious buyer that keeps propping up the euro.

SPIEGEL: And it is not you.

Soros: It is not me (laughs).

A few thoughts. First, Soros knew that there was a play against the Euro with Credit Default Swaps and other weapons of economic warfare. While he says that he argued for them to be banned (which they were in Europe), it is clear that he would use them if available to him. But, he notes that a mysterious buyer was backing the Euro. He says “mysterious” even though he full well was aware it was China and even directly hinted it.

What has happened to the Euro as a result? When the Germans first surprised the markets by banning naked Credit Default Swaps and naked short selling in May 2010, it took just $1.20 U.S. to buy a Euro (the ban was made permanent, Europe wide in October 2011). The Euro rate now is closer to $1.40. Thus, with the support of China and the banning of Credit Default Swaps, the Euro has not only survived but is thriving DESPITE serious internal weakness in the European economy.

So, when the Euro was weak, the Chinese stepped up to defend it. What is the Chinese position now? Dump the dollar. This was the position in 2011 in Qiushi. And, it is the position of the official news agency today. In 2010 and 2011, the Chinese made effort to undergird the Euro while today they stand ready to undermine the dollar. This is true even as the American economy is in a substantively better position than that of Europe two years ago. Consider these comments from China in February 2012:

China Pledges Sustained Euro Holdings With Plan to Invest in Bailout Funds

By Bloomberg News – Feb 15, 2012

China pledged to invest in Europe’s bailout funds and sustain its holdings of euro assets, spurring gains in the currency and Asian stocks on optimism the region’s debt crisis will be overcome.

“China will always adhere to the principle of holding assets of EU sovereign debt,” People’s Bank of China Governor Zhou Xiaochuan said in Beijing today. “We would participate in resolving the euro debt crisis,” he said, echoing comments by Premier Wen Jiabao yesterday.

The remarks offer a carrot to European finance ministers, who are increasing pressure on Greece to deliver budget cuts in exchange for a second bailout. At stake for China is helping to stabilize the economy of its largest export market amid a global slowdown that has curtailed growth in Chinese shipments abroad.

“Wen and Zhou are giving the best support China can offer now, which is to send out positive messages such as promising not to cut euro assets and to buy European bonds to help bolster market confidence,” said Shen Jianguang, a Hong Kong-based economist . . .

“China’s willingness to support Europe to cope with sovereign debt problems is sincere and firm,” Wen said at a joint press conference yesterday in Beijing with European Union President Herman Van Rompuy. “China is ready to get more deeply involved in participating in solving the European debt issue.” . . .

In Beijing, Governor Zhou said that while the five BRICS countries – Brazil, Russia India, China and South Africa – all hold a “very positive attitude” toward helping Europe, they have to wait for the right time and right opportunity to invest.

It should be abundantly clear that China stands behind Europe. But what about America? Consider:

  1. The official Journal of the Communist Party has called for a direct assault on the dollar: 

    “Financial War. The fact that the U.S. dollar is the world’s reserve currency makes the U.S. a financial superpower. Currently, China’s increased share in the International Monetary Fund and its increased voting rights are a very big step forward. The problem is not that the value of this share is expressed in U.S. dollars, but that it would be best if the share could be expressed in RMB. Therefore, for China to challenge the position of the U.S. dollar, it needs to take a path of internationalization and directly confront the U.S. dollar.”“Of course, the most important condition is still that China must have enough courage to challenge the U.S. currency. China can act in one of two ways. One is to sell U.S. dollar reserves, and the second is not to buy any U.S. dollars for a certain period of time.  The key to success is that China needs to have enough courage and determination to take the U.S. pressure. This is exactly what we need. It just shows how much the U.S. needs China. The more pressure we can take, the more successful this strategy. It will indicate that this ‘weapon’ is highly effective and the U.S. will start to fear us.”

  2. The official News Agency of China has run an editorial calling for the sale of Chinese-held dollars and a de-Americanized world:
    “. . .it is perhaps a good time for the befuddled world to start considering building a de-Americanized world . . .

    What may also be included as a key part of an effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant U.S. dollar . . .”


  3. A Chinese editorial has laid out a specific plan for replacing the dollar in Chinese holdings:
    “Many argue that this is because of a lack of alternative ways to manage China’s large foreign currency reserves. This is an incorrect supposition. One alternative – although it might not be easy – is to sell half of its Treasuries (about $1.2tn) and to allocate the funds among three categories of financial asset.
    First it could buy up to 5 per cent of the shares of all multinationals that have been operating in the Chinese market and are listed on global stock exchanges. Buying shares in these companies is like investing in China itself. Second, it should increase the holdings of all non-US sovereign bonds rated higher than double A plus, such as German or Australian government bonds. This can help hedge against the risk of a dollar depreciation against other currencies. Third, it could buy up to 5 per cent of the shares of public utility companies in mature market economies. Such an approach would greatly reduce Beijing’s dependence on Treasuries.”Even if the US is able to avoid the catastrophe of a default, the potential for a repeat of the uncertainty means there are no guarantees the Chinese government can resist domestic pressure, not least from economists, calling for diversification away from investments in Treasuries. Netizens are also stepping up the pressure on China’s decision makers to stop lending to the US federal government.”
  4. A ratings agency in China has downgraded US debt even AFTER the debt ceiling deal: 

    “A Chinese ratings agency downgraded its US sovereign credit rating Thursday despite Washington’s resolution of the debt ceiling deadlock . . . Dagong lowered its ratings for US local and foreign currency credit from A to A-, maintaining a negative outlook, the agency said in a statement.”

  5. Chinese state media has been mocking the United States: 

    “Chinese state media have been filled this week with cartoon images of America’s leaders, mocking them for stumbling on a debt deal while depicting the nation as a beggar. CBS reported that a Commerce Minister adviser to the Chinese government, Mei Xinyu, said the ‘gentlemen’ on Capitol Hill are unconcerned how their ‘monkey business’ is impacting the world and degrading America’s image across the globe. He also said that if America does default on its loan obligations, China will likely quit buying U.S. Treasury bonds.” 

  6. China has been preparing to internationalize the RMB as a reserve currency with Russian support: 

    “China has been making a concerted effort to establish itself as an international currency reserve. China already has agreements with Russia, Vietnam, Thailand, and Japan allowing trade to be settled in yuan instead of dollars . . .”
    “The internationalization of the yuan is an official priority of Chinese leaders . . .” 

  7. China has been a massive buyer of gold: 

    ” . . . in the past two years since September 2011 (ironically the same month we wrote “Wikileaks Discloses The Reason(s) Behind China’s Shadow Gold Buying Spree” namely that the PBOC was quietly seeking to make the renminbi the new gold-backed reserve currency) the mainland has imported an unprecedented 2,116 gross tons of gold from Hong Kong (in addition to the hundreds of tons produced domestically), for the first time crossing the 2k gross ton import barrier in a two-year period!”

Is there any wonder that Jim Cramer of CNBC said:

“the U.S. is “a laughing-stock around the world, maybe worse than Italy in some ways when I look at benchmarks. We have obviously lost the faith of a lot of countries . . .”

Or, that the head of the World Bank said issued warnings in regard to our debt ceiling debate:

“The president of the World Bank on Saturday warned the United States was just ‘days away’ from causing a global economic disaster . . .”

Or that analyst Jeffrey Gundlach believes that our “full faith and credit” has seriously eroded recently:

“Reflecting on the collapse of the USD, the surge in gold, the Chinese ratings agency downgrade, and the groundhog-day-like world in which the US government (and markets) live, DoubleLine’s Jeff Gundlach warns that “America’s credibility is slowly eroding.” In his typical manner, Gundlach rapidly and efficiently covers a lot of ground in these brief clips; from the growing skepticism of the rest of the world towards the US’ full faith and credit, to no end in sight for QE and reignition of bond inflows under an even more interventionist Yellen . . .”

Or that Lord Monckton, former aide to Lady Thatcher has said that the dollar is over:

“Christopher Monckton of Brenchley . . . long has warned that the West is on a terminal financial course, from which recovery eventually will not be possible.

In a recent commentary, he wrote that it’s not a matter of ‘whether but when.’

More than a year ago, he told WND that the financial collapse of the West was plausible based on its path at the time. He then adjusted the forecast from ‘plausible’ and ‘likely’ to ‘imminent.’ Specifically, he believes President Obama’s financial policies of unprecedented borrowing and spending, trillion-dollar deficits and massive outlays for social engineering are an ‘existential threat.’

‘The gravy train has now tipped into the gulch. The cash for such criminal indulgences has run out. It is now time for governments everywhere to get a grip on the costs inflicted upon taxpayers by governmental employees at every level. Unless this is done, and very soon, the West will fail,’ he said.

Now he’s moved beyond. ‘Forget the dollar. It is finished. America needs a sound currency.’

But it gets really bad when Cyprus looks down on us:

“Two other countries – the financially failed Cyprus and the financially manipulative China – now are telling America how to run its finances . . .

But the rest of the world has been watching the implications for the U.S. dollar, the favored currency globally for people and nations to have, and several countries now have started offering advice. Former Cypriot Finance Minister Michael Sarris, for example, said spending cuts are going to have to happen in the U.S.

‘The U.S. has been fortunate in the sense that it’s like a bank, it prints the money that other people accept. So you can live beyond your means over an extended period of time without being punished by the market,’ he said.

However, he added, ‘Clearly we have seen that enough people are now seriously concerned about that and both domestically and internationally so the answer is yes, [America has been living beyond its means.]’

It should be obvious that the “full faith and credit” value of America has diminished greatly in recent weeks.

BOTTOM LINE:  This is not just about free markets. If it were, the Chinese would have dumped Euro two years ago. Instead, they very strongly supported the Euro both in word and deed despite Euro turmoil. This is economic warfare and the recent rhetoric and actions by China are designed to undermine confidence in the dollar. Sadly, we are making it easy for them. Does anyone doubt that the “full faith and credit” of the US Government has declined in the past few years? Get ready, the economic war is just beginning.

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