Why China Can't Dump The Dollar

Sep 14, 2010, 7:36 AM |

As America's burgeoning debt levels soar, its mammoth trade deficits on the rise and a budget deficit that will hit U$1 trillion to U$1.5 trillion or 7% to 11% of it's GDP FY 2009, questions about the credibility of the US Dollar are on the rise.With China holding U$1 trillion worth of these dollar denominated debt assets, some politicians and economists fear that China might dump these assets due to the weakening dollar and slumping interest rates of these assets. Such a move could trigger the total collapse of the US real economy and send the world into a depression. But is that probable for China to do in the near future?

First of all if China dumps it's US treasury bonds and other dollar denominated assets, the US economy being an economy that China is very dependent on would implode. The global economy would also crash and world trade would collapse. Such a move by China, followed by the mentioned consequences above would have extremely adverse effects on the Chinese economy. As China's economy is very dependent on exports and trade especially with the US (which buys more than 21 percent of China's exports) China would also see it's economy go bust due to a collapse in demand for Chinese goods. As a result business bankruptcies in China would soar on an unprecedented scale. In 2008 some 65000 Chinese factories have closed down due to the fallout of the credit crunch in the West and if China aggravates the situation by dropping the dollar, the entire Chinese manufacturing industry will head for a meltdown. To make matters worse unemployment rates in China would also surge followed by job riots, a phenomenon that the Chinese ruling elites are afraid off. Surging unemployment could also mean the development of a social crisis in China. This is because hundreds of millions of rural Chinese citizens who have flocked to China's cities in a search for greener pastures are dependent on China's industrial powerhouse. As a consequence if these industries fail many of these workers would be laid off and they would the first to participate in social unrest movements such as riots, crime and the building of illegal squatters. Such a thing would be a nightmare for China's government officials.          
Secondly if China decides to dump the dollar, where else could they park these hundreds of billions of dollars worth investments as the dumping of those assets would send economies and stock markets across the world crashing. So all of China's hard work, it's investments in it's economy for over 30 years would just vanish. China could also find it extremely difficult to trade with other nations as most export goods are invoiced in dollars. China will also see commodity prices surge as the dollar weakens tremendously. Such a thing could mean the end of massive food and energy subsidies in China. As a consequence China's inflation rates will skyrocket as the prices of food to consumer durables surge. And this will directly result in surging Chinese poverty levels, the destruction of China's middle class purchasing power and the obliteration of China's economic potential in the near future.

Thirdly, China could fall into a painful debt crisis if it's dumps the dollar. This is because during the past 30 years the Chinese government has given out hundreds of billions of dollars in loans to inefficient state owned enterprises and ordinary Chinese businesses. Because of that China has fallen into the trap of overproduction. With too many loans given to too many businesses producing the same goods or providing the same services which has encouraged overproduction, China drastically needs world trade soaring and strong global economic growth to keep these businesses operational. Keeping these businesses operational is the only way for China to recover those hundreds of billions of dollars in loans. If China dumps the dollar resulting in the collapse of world trade, many of those businesses and state owned enterprises that took government loans would fail. And that would result in the Chinese government and state owned banks being stuck with hundreds of billions of dollars if not trillions of dollars in non performing loans or bad debts. To make matters worse, state banks ( which hold a vast portion of China's 2 trillion dollars in household savings) will bear the full brunt of the debt crisis and may fail or require massive central bank intervention. Both of which will result in depositors and pensioners losing their deposits and retirement accounts. These problems compounded by skyrocketing inflation and surging unemployment could well produce an economic disaster.
Finally, if China decides to drop the dollar, the Communist party's grip on power would diminish. This is because a US economic collapse followed by China's own one will cause the Chinese people's tolerance of totalitarian state to fade away. Social crises, job riots, and anti government protests would follow on suite on a massive scale across China. As a consequence China's elite will have no choice but to either allow the riots to continue and see their power wane or launch a bloody crackdown which will cost China it's political standing in the world and increase the resentment of the Chinese people against their government. Not only that, with the turmoil taking place throughout China and the iron fisted one party rule on the decline, the Dalai Lama could use this as an opportunity to further his agenda and declare Tibet's independence from China, an autonomous province that serves as a buffer against India and its mountains being the main source of China's water supply. The Islamist separatist movement in Sinkiang province will also be emboldened and become much more aggressive causing China's rule of that autonomous province which is rich in oil and gas deposits to decline. At last China's ruling party's biggest nightmare could become a reality, which is Taiwan's declaration of independence from China. If China dumps the dollar and China's economy starts to decelerate, the most badly affected parts would be the southern provinces of China (Kwantung , Fujian, Hunan and Zhejiang) as it houses China's mammoth industrial powerhouse and Taiwan which is still considered to be a part of Red China. As a consequence Taiwan might use the period of turmoil on the mainland as an opportunity to declare it's independence, a move that could set off a chain of reactions, which include the revival of the Chinese civil war and a possible fragmentation of China due to the southern Chinese provinces breaking away from Beijing to join Taipei.