Game Plan

by Kevin D. Freeman

  The “people’s currency” of China is redefining the global economic monetary system. The closed-capital pariah is blossoming into a reserve standard and is hedging appeal against the indebted dollar and the untested euro, piquing foreign interest.

  Degenerating credit quality across the board has prompted asset managers to shy away from the dollar, euro, Japanese yen, British pound, and Swiss franc. And some are turning to the yuan, a currency that 10 years ago was completely off limits to foreign investors.

  An HSBC forecast projected that by 2015, the yuan will become one of the three most used currencies in global trade, in league with the dollar and euro.47

  Putin has long desired for Russia and China to join forces against America.48 Middle Eastern interests also want to see the dollar fail and be replaced by the yuan. The supposedly moderate Al Jazeera, based in Qatar, has explored the question “Why China Might Be a Better Superpower”:

  Unlike the U.S., China does not have a substantial history of invading and subjugating the inhabitants of far-flung lands.

  While China is far less free domestically, in international affairs the country continues to ascend both economically and in terms of international influence. It is thus worth asking, is this a positive development for the world at large? Could China be a more responsible, less violent and more constructive superpower than the U.S.?

  The contrast between China’s culturally sensitive approach and the contemptuous and violent attitude taken by the U.S. in Iraq cannot be overstated. In fact, these contrasts are in many ways a reflection of the differing world-views and historical backgrounds of the two countries.

  While the U.S. seems committed to exert imperial hegemony over the Middle East using brute military force and punitive economic blockades against civilians, China has publically committed to a policy of “peacefully rising” and has built mutually beneficial and respectful relationships throughout the region.49

  Such rumblings from the Middle East call into question one of the few remaining pillars of the dollar—its exclusive use in the oil trade. The arrangement dates from the early 1970s and allowed the United States to abandon the gold standard under Nixon and yet strengthen the dollar’s reserve currency status. The United States offered Saudi Arabia military protection and access to weapons and technology. In exchange, the Saudis agreed, informally, to price oil sales only in dollars (“petrodollars”) and to invest the proceeds in U.S. Treasury bonds. By 1975 all major oil exporters were demanding dollars for oil under a similar arrangement.50 This exchange guaranteed a global demand for dollars, as anyone buying oil would have to have them. At the same time, it also guaranteed a growing market for U.S. government debt.

  Of course, the situation in the Middle East has changed drastically since the 1970s. America is no longer Saudi Arabia’s preferred customer for oil. China has taken that role.51 The Arab Spring has toppled or weakened several dictators who once supported the petrodollar system.52 And popular sentiment in the Arab world has turned decidedly anti-American.53 So when Al Jazeera opines that China is the better superpower, we should take notice. If the petrodollar system collapses, the dollar crashes.54 The preferred replacement is a gold-backed yuan.55

  Most American economists dismiss the notion of the yuan’s displacing the dollar as far fetched. They are wrong, suffering from a type of “normalcy bias,” assuming that what has been will always be. Arvind Subramanian, senior fellow at the Peterson Institute for International Economics, has a different view. Within this decade, he says, the yuan could do more than just challenge the dollar for reserve status. “Chinese economic dominance is more imminent and more broad-based—encompassing output, trade, and currency—than is currently recognized,” he wrote. “By 2030, this dominance could resemble that of the United States in the 1970s and the United Kingdom around 1870. And this economic dominance will in turn elevate the renminbi to premier reserve currency status much sooner than currently expected.”56

  If the yuan becomes a reserve currency, there is little doubt that China will use its power for political advantage. In September 2012 a senior advisor to the Chinese government called for an attack on the Japanese bond market. Jin Baisong of the Chinese Academy of International Trade, which works for the commerce ministry, said China should use the “security exception” rule under the World Trade Organization to harm Japan. “It’s clear that China can deal a heavy blow to the Japanese economy without hurting itself too much,” he said. Secretary of Defense Leon Panetta could only call for calm.57

  Make no mistake—there are plenty of nations that resent the hegemony of the dollar in the world economy. We should understand that no paper currency has ever been permanent. In fact, a recent study demonstrated that most currencies barely make it past age twenty-five: “The average life expectancy for a fiat currency is 27 years, with the shortest life span being one month. Founded in 1694, the British pound Sterling is the oldest fiat currency in existence. At a ripe old age of 317 years it must be considered a highly successful fiat currency. However, success is relative. The British pound was defined as 12 ounces of silver, so it’s worth less than 1/200 or 0.5 percent of its original value. In other words, the most successful long standing currency in existence has lost 99.5 percent of its value.”58

  We shouldn’t bet our future and our children’s future on the U.S. dollar’s surviving a $17 trillion debt that is growing by $1 trillion or more every year—especially since we are facing an unprecedented global economic war.

  The Currency War

  The United States’ debt is on a collision course with reality, yet we keep digging ourselves deeper into the hole of inflation and borrowing. Bill Gross, founder and co–chief investment officer of Pacific Investment Management Company (PIMCO), said in February 2013 that the U.S. economy is on the pathway to extinction. “Our current monetary system,” he said, “seems to require perpetual expansion to maintain its existence. The advancing entropy in the physical universe may in fact portend a similar decline of ‘energy’ and ‘heat’ within the credit markets.” Noting that total government, corporate, household, and personal debt in the United States amounts to a stunning $56 trillion, Gross said that the credit needs of the American economy constitute a “supernova star that expands and expands, yet, in the process begins to consume itself.” It now takes twenty dollars of credit to generate one dollar of GDP, according to Gross.59

  The American debt problem is so horrible that Republicans have tried to use the debt ceiling as leverage to stop government spending. But new and creative solutions are being found to avoid spending cuts, including one incredible proposal to mint platinum trillion-dollar coins, which would not require congressional approval.60 The proposal was for the Treasury to take a small amount of platinum, shape it into a coin, and stamp “one trillion dollars” on it. The Treasury has the right to mint coins of various denominations. In this case, however, they would be telling the world that the coins were “worth” $1 trillion each and use them to pay off debts. Fortunately, despite support from several economists and members of the administration, the outrageous scheme sort of fizzled. If it had been implemented, the dollar would have collapsed immediately.61

  So let’s assume we’re not minting trillion-dollar coins, but we also aren’t interested in cutting our spending. That means we will have to devalue our currency as another way to pay off our debts by printing money the old-fashioned way. The dollar would be a “sitting duck” for others to destroy, as we have already discussed. Then again, some nations may choose to join us in devaluing their currencies and paying down their debt by inflation also. This situation is known as a currency war, one of the most dangerous developments in international economics, says the investment banker and researcher James Rickards. He warns there are abundant signs of a coming currency war, which would threaten the dollar with collapse.62

  If there is a currency war, will the United States win? The economist Peter Schiff says yes—but that if we do, our currency will then implode, m
aking things much, much worse. “There is a currency war going on,” Schiff says. “The irony of a currency war which makes it different from other wars is the object is to kill itself. Unfortunately, I think the U.S. is going to win the currency war.”

  “Anybody who believes there is no inflation isn’t shopping.” Schiff’s point is simple: the only way to win a currency war is by devaluing your currency. But if we do that, we run the risk of inflating prices for everything, destroying our economy, and making it impossible for us to pay off our long-term debts.63 Schiff points out that both in the eurozone and in the United States so much focus has been placed on full employment that devaluing the currency appears to be the only option: “The problem is that economists now believe that the goal of an economy is to provide employment, not goods and services. They see a job as an end in and of itself, rather than as a means for people to get the things they really want. But if we can get all that we want without having to work, who needs to bother?”64

  China is already thinking about a currency war and how to use it to its advantage. The same article from the Qiushi journal quoted earlier states, “Of course, to fight the U.S., we have to come up with key weapons. What is the most powerful weapon China has today? It is our economic power, especially our foreign exchange reserves (USD 2.8 trillion). The key is to use it well. If we use it well, it is a weapon; otherwise it may become a burden. . . . China, Japan, the U.K., India, and Saudi Arabia are all countries with high foreign exchange reserves.” The article continues, “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 U.S. dollars for a certain period of time.”65

  It’s not unusual for fiat currencies—currencies not based on tangible holdings like gold, but on a value set by the government that backs that currency—to collapse. Aside from the pound sterling, major fiat currencies have all collapsed by age forty-two. The American dollar in 2013 was in year forty-two of its fiat existence. And even the British pound is worth merely a small fraction of what it once was.66

  According to Lawrence Goodman, a former Treasury official and the current president of the Center for Financial Stability, the Federal Reserve has been buying a stunning and unsustainable 61 percent of all government debt issued by the Treasury Department. Before the 2008 economic collapse, the Fed was buying “negligible amounts.” If those conditions are not corrected, Goodman warns, the U.S. economy and markets are “at risk for a sharp correction.” The current policy, he says, “not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized deficits.”67 No wonder when Federal Reserve chairman Ben Bernanke announced in the summer of 2013 that a tapering of the Fed’s debt-buying program might be on the horizon, the stock market quickly dropped two hundred points.68

  We’re devaluing our currency. If we stop, the economy drops. If we don’t, our economy could be murdered by our enemies.

  The Coming Attack

  Now, with all that in mind, let’s review my team’s Department of Defense report conclusions concerning economic warfare. In June 2009 we posited that the response to the collapse could

  strain available economic resources for some time with large budget deficits and high inflation risks. The situation would be made significantly worse in the event of further economic attack. It is in this vein that a potential Phase Three must be considered. Based on the assumed nature of Phase One and Phase Two, a Phase Three attack would likely involve dumping of U.S. Treasuries and a trashing of the dollar, removing it from reserve currency status. This is clearly foreseeable as a risk and even could float under the cover of a natural outcome in much the same way that Phases One and Two potentially have been hidden. The implications are extremely serious. If the dollar were not the reserve currency, there would be a mass dumping of Treasury instruments by foreign holders. Treasury interest rates would skyrocket, further worsening the annual deficits due to sharply higher interest payments on expanding debts. The Treasury would have to raise taxes dramatically, further dampening growth or the Federal Reserve would be forced to monetize the debt, worsening inflation concerns. Pushed to the limit, the U.S. dollar would follow the path of the German currency in Weimar Germany following defeat in World War I.

  Despite that warning, the United States is right on schedule.

  In recent years, we have seen economic attacks used to take down regimes. In the 2011 uprising in Egypt that displaced Hosni Mubarak, for example, the final trigger to the unrest was food prices, not anger about human rights per se. It has been widely reported that food inflation was a primary factor behind the initial unrest. Egyptian households spend about 40 percent of their budget on food, and food prices had jumped 20 percent prior to the Egyptian revolution. Corn prices shot up 90 percent, and wheat slightly less.69 Speculation played a role in higher food prices.70 Certainly the global monetary inflation made this possible.

  There should be no doubt that there was a serious economic component behind the revolution in Egypt.71 The question then arises whether additional speculation on food prices could have been a geopolitical lever. Based on our research, the answer is an unequivocal yes. Rapidly rising food prices can destabilize a society, and our enemies know how to drive prices higher through speculative market activity. We will see more destabilization caused by inflation-based riots.72

  I am not saying that the Muslim Brotherhood speculated on food prices as a weapon to topple Mubarak, although some sources say it did. I am saying that it is obvious that such a weapon could have been employed profitably, if imprecisely. The cost is certainly less than a major arms program, but the results are more dramatic.

  Now, attacking America with food-price inflation would be difficult because we produce our own food.73 But energy, especially oil, is another matter. Could a huge oil price shock destroy our economy? Many think so.74 As long as the Arab nations, Russia, Iran, and Venezuela are the major producers, a supply shock is always possible, and it is even called for by liberated Iraq.75 And, as with food, speculation can push prices higher even in the face of ample supply.76

  That’s an oblique attack. A currency war, a selling of U.S. bonds, or an attempt to set another currency as the reserve currency would be far more direct and just as damaging. Whether from China or Russia or from rogue states like North Korea counterfeiting currency, America has left herself wide open to all sorts of economic attacks.

  Could It Happen?

  A common objection to my warning is that the Chinese are so connected to our economy that “they” would never harm us. The idea that “the Chinese” would never harm us is ridiculous on its face; there are Chinese who continually hack our systems and who manipulate and undermine our markets. But don’t the Chinese hold so much in dollar debt that they couldn’t afford to see the dollar go down? China’s military doesn’t care. It has a much longer view of things than the next quarter’s export sales. The smug response of those who believe China needs us so much that it must remain our friend is another example of American arrogance.

  There is further evidence of the danger from China. We have no idea how much dollar debt the Chinese really hold. They have so many ways to obscure their holdings that we can’t ever be certain.77 In March 2012, Treasury Secretary Timothy Geithner said he didn’t see any risk to the dollar from China’s attempts to establish the yuan as reserve currency with its trading partners. “What you’re seeing China do,” Geithner explained, “is gradually dismantle what were a comprehensive set of very, very tight controls on the ability of countries to use their currency,” Geithner said. “Over time that will mean—and this is a good thing for the United States—more use of that currency and it will mean the currency will have to reflect market forces . . . So, I see no risk to the dollar in those reforms.” Geithner added that it was virtually impossible for the Chinese currency to become a global reserve curren
cy. “I don’t think so,” he said. “I don’t know, maybe in some long time after we’re all gone, it would be possible.”78 Of course, Geithner also insisted that the United States would not lose its AAA credit rating in 2011. Three months later, we were downgraded.79

  While there are a number of naive analysts who view our codependence as a force that will preserve the dollar forever, a more objective view is provided by Juan Zarate in his book Treasury’s War. Zarate was one of the top Bush administration officials charged with using financial weapons to fight terrorism. He writes:

  Economic historian Niall Ferguson has dubbed this presently symbiotic yet ultimately dysfunctional relationship “Chimerica. . . .” Chimerica is, for Ferguson, highly unstable. A sudden deterioration in political relations, perhaps stemming from a clash over natural resources or Taiwan, could trigger a major war and a corresponding collapse of the international financial system.

  A small but systemically critical event—such as the collapse of the Spanish bond market—could ignite a widespread loss of confidence in paper currencies and a massive transition to hard assets (gold) led by a shrewd and forward-leaning competitor state such as Russia or China.

  Even if one doubts the likelihood of such a crisis, China is nonetheless taking steps to internationalize the renminbi and thereby enhance its power relative to the dollar.

  Though the dollar remains predominant for now and seems to be the currency of choice amid economic turmoil in Europe, it—along with American financial predominance—is coming under direct assault.80

  Here is the sad truth: while it once was in China’s interest to preserve the dollar’s unique status as primary reserve currency, that time is passing rapidly. The Chinese understand that the U.S. debt situation will preclude us from continuing to binge on their products. Without export growth, China must focus on domestic consumption.81 This favors a stronger, not weaker, yuan.82 To survive economically, they have to adapt and use their economic weapons, even at our expense. There are several key factions in China. There is the business community, which had long supported a weak yuan to enhance exports but now needs a strong domestic consumer. There is the ruling Communist party, which has put forward five-year plans for global dominance.83 And there is the People’s Liberation Army, which has promoted unrestricted warfare.84 For the first time in decades, the interests of all three are beginning to align against the dollar.