The federal reserve is expected to cut rates next week in an effort to alleviate a credit market in crisis. In the meantime there are other developments which may be coming to the rescue, last week Abu Dhabi Investment Authority bought a $7.5 billion stake in Citigroup helping Americas largest bank, who incidentally have massive exposure to those nasty sub-prime loans that are at the root of the present credit crunch. Perhaps Abu Dhabi Investment Authority see an opportunity to pick up assets at a bargain from amongst the wreakage? The other surprise is that China Investment Corporation have expressed a desire to invest in stocks ‘rocked by sub-prime defaults’. The chairman of China Investment Corporation said that the $200 billion fund he directs will be a ‘stabilizing force in the international capital markets’. Perhaps they are seeking credibility in the business world.
Why would it be any other way? If the U.S.A. goes down it will seriously hurt China. Why? For a start the fact that for the near future most of the worlds commodities are in $USD it would mean that a devalued dollar will drive commodities through the roof in terms of inflationary pressure on China, personally I believe that the commodities bull market has not reached even the halfway point of where it is going. To clear this up a little: China don’t float their currency, and they keep it artificially low so that their exports are cheap, they mostly sell to the US who have a market driven by consumer spending. This is worrisome because the money has to come from somewhere! That aside, if they have a currency which is kept low and the US end up printing money to stay afloat it does a few things
Firstly it will mean that the huge dollar reserves China keeps will be worth much less, secondly it means that developing countries will be able to buy more of the oil and other raw materials they so desperately need, this increased demand, brought about by a weak dollar will stymie chinas ability to continue with its ongoing industrial output it could even be the cause of civil unrest if it went far enough and if you are a communist nation who rely on supression of civil rights, turning a blind eye to the massacres committed by your neighbours, and censorship on the internet this would be a recipie for disaster.
the biggest risk caused by the mortgage slump would be a full blown dollar crisis, markets worldwide could be sent into a spiral and worst of all the fed would be powerless to do anything about it. The strong Euro would get stronger and strangle our ability to trade with the USA and other nations who peg their currency to it. Central banks around the world hold the dollar as their hegemonic currency, this has been a boon for the US economy as it allows them to issue debt in a very cheap manner. The euro is now looming as a new world currency and this brings certain risks.
Russia’s economy is surviving on oil money, the devaluation of the dollar means they are getting less for their oil, Putin having won the recent fixed election, actually to describe it as a ‘democratic election’ would require the extremes of descriptive licence, in any case changing their oil markets to a euro standard would not only mean more money but it would make better sense as they are exporting to europe for the most part. The Baku to Tiblisi oil line means that other nations such as Azerbijan may also prefer Euros to Dollars, that way Europe doesn’t have to be concerned with Dollar movements in their transactions.
Kuwait recently moved away from being pegged to the dollar and they now use a basket of currencies, if other nations follow suit it could spell trouble for an already battered US dollar. In a recent meeting of Central banks in the middle east (December 3rd 2007) the same may be getting put forward by other nations so perhaps others will follow Kuwaits lead. The weak dollar is causing rapid inflation in their countries and moving away appears to be the cure. One note is worth considering: for a nation that was saved from being wiped off the planet by the U.S.A., Kuwait has now turned around and done something that may be the start of a financial disaster for America, a strange way of saying thanks.
The weaker currency has not been all bad however, America has been in the habit of importing more than they export, the ‘made in america’ badge is virtually non-existent on any goods on market shelves. The weak dollar helps to reduce the defecit by making imports more expensive and exports cheaper, but for a nation that doesn’t do much exportation any more perhaps this medecine will have limited healing powers.
The ECB reaction is what we are awaiting, as they will have to look at ways of working with the fed on some level to ensure some form of ongoing stability.