Lord help the communist who comes between me and my Chinese, and Lord help the Chinese who comes between me and my dough!

COMMENT: "If China loses faith the dollar will collapse," by Andy Xie, Financial Times, 5 May 2009.

Good descriptions here:

The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have amassed nearly $10,000bn in foreign exchange reserves, mostly in dollar assets. Any other country with America's problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world's dominant reserve currency. The US can disregard its creditors' concerns for the time being without worrying about a dollar collapse.

Well, not completely.

But here's a good reason why Xie says that:

The faith of the Chinese in America's power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar's global status.

This is another way of describing my concept of a "global transaction strategy" from Pentagon's New Map: we supply global Leviathan services, and we get paid for it. So yes, it's nice to have the world's biggest gun, but you have to understand that others pay for its existence and must therefore agree with its employment--not totally and in every instance but enough to keep believing and trusting in America and its vision of a global future.

Now here's where Xie gets very explicit about something I've long preached: we are totally in bed with the Chinese, who love us (and yes, that's not too strong a term) like nobody else on the planet (a huge asset in my mind):

Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets. You have to check the asset allocations of wealthy Chinese to understand the dollar's unique status.

The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility. The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy Chinese tend to send their children to the US for education. They treat the dollar as their primary currency.

So far, quite reassuring. But here's where Xie gets scary:

Diluting Chinese savings to bail out America's failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar's global status. Ethnic Chinese demand for the dollar has been waning already. China's bulging foreign exchange reserves reflect the lack of private demand for dollars, which was driven by the renminbi's appreciation. Though this was speculative in nature, it shows the renminbi's rising credibility and its potential to replace the dollar as the main vehicle for wealth storage for ethnic Chinese.

America's policy is pushing China towards developing an alternative financial system.

In other words, say goodbye to the East Asian Dollar Standard, but also, no more Chinese eating its cake (fixed-rate attached to the dollar) and eating it too (export-driven growth). In short, this most special relationship of the 21st century is going to be significantly revamped from its 20th century origins.

Key point: the global credit bubble hid a lot of Chinese inefficiency by artificially boosting demand.

Then another data point to justify my long-made statement that the US-Chinese relationship, if it can hold with no breaks until 2020, will be safe long-term:

China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China's anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.

While I agree with the logic, I don't see the Chinese looking to collapse anything across this logical transition. Why f--k up your biggest external customer while you engaging in this dangerous transition that can be highly destabilizing for your domestic regime legitimacy?

Xie used to be at Morgan Stanley and now is an independent economist. I like the descriptions and the logic, but as usual with economists nowadays, there's a doomish punchline.

In the end, I would expect China to pair this evolution with a move to create a basketed Asian common currency, even if its just an accounting measure between the major players there in the short run (my short run is longer than most people's long run, so excuse the term there), meaning I expect China to socialize its risk with its regional partners.

America, whether it realizes it or not from today's perspective, needs a third balancing global reserve currency to go along with the Euro and the dollar. We need the collective pressuring effect on any one of those three if they get out of whack (most likely us) from reality, so as much as I know many Americans fear externally-derived disciplining of this fiscal/monetary nature, I think it must happen eventually and therefore it's good.

Of course, the key is the nature of the evolution.