Belmont Club

The circle closes

M R Venkatesh at Rediff asks whether China’s accumulation of 2 triillion in US dollar reserves has an ominious purpose and whether that card is about to be played. The close linkage between economic and foreign security has rarely been subjected to close scrutiny. The recent financial crisis raises the question whether appointing Barney Frank to his position isn’t at least as important as appointing a General Petraeus to his.

This gargantuan build-up of forex reserves by China has strangely received very little attention of economists, policy analysts, currency traders and, of course, geo-strategists around the world. … After adjusting for all known sources of reserve accretion, experts conclude that approximately an excess of $200 billion could have flown into China as ‘hot money’ — read inexplicable flow of funds — in this period. The Economist — in one of its issue in recent months — quotes Michael Pettis, an economist working in China, who explains how and why hot money flows into China. According to Pettis, hot money comes into China when companies overstate FDI and over-invoice exports.

In effect, is this hot money flowing into China in anticipation of this revaluation of the yuan? Or is it a simple case of China maintaining trade competitiveness through a weak yuan? Or is there something more to it than meets the eye? Are the Chinese acquiring the dollars with some sinister motive? In effect, has the Chinese strategy of a weak currency over the years the un-stated policy of dynamiting the American economy?  … Countries that hold large US dollar denominated forex reserves have a powerful tool in their arsenal — they could wreck American financial markets at a mere click of a mouse by selling their dollar holdings. Imagine China with a holding nearly $2 trillion worth of treasury bonds seceding to sell the same overnight. … And that completely alters the existing global order.

The radical Islamists also wish they could exploit the current financial crisis. Tigerhawk notes that Adam Gadahn has surfaced to claim that America’s woes stem from its refusal to follow the edicts of Islam and thus denies itself the chance to emulate the prosperity of say, Pakistan. Gadahn says America is in “a crisis whose primary cause, in addition to the abortive and unsustainable crusades they are waging in Afghanistan, Pakistan, and Iraq, is their turning their backs on Allah’s revealed laws, which forbid interest-bearing transactions, exploitation, greed and injustice in all its forms.”

But Gadahn shouldn’t count his vultures before they’re hatched. Other people have also been mismanaging their financial affairs and Europe is in the grip of a crisis equal to or possibly greater than the tornado that struck Wall Street:

The euro had its biggest one-day drop against the yen since its 1999 debut as the deepening credit crisis prompted European governments to pledge bailouts for troubled banks while stopping short of coordinated action. The 15-nation currency fell below $1.35 for the first time since August 2007 after European authorities avoided announcing any plan comparable to the $700 billion U.S. bailout. The yen rose the most against the dollar in a decade as global stocks plunged, damping carry trades. Implied volatility on one-month euro-dollar options rose to a record high.

“People are running for safety,” said Ram Bhagavatula, a portfolio manager at Combinatorics Capital LLC, a New York-based hedge fund that has $45 million under management. “There’s a huge premium for safety bets: the dollar and the yen. A global recession is coming.”

Although recently passed bailout bill has been the focus of much discussion, the focus of attention has been its effect on unblocking credit. Relatively little notice has been given to whether it fixes the broken ways of doing business. During the First World War, the Allied Generals on the Western Front attributed every failure to advance to a lack of resources.  They kept throwing more and more millions of men in front of the machine guns until public outrage and a near mutiny among French forces forced the generalissimos to change their methods. Indirect artillery spotting, armored vehicles, fire and movement, etc. And then, lo and behold, they beat the German Army. Despite rhetoric about the economic crisis, there is evidence that, at GHQ, amid the leaders still confirmed in their elegant routines, it is still business as usual. The Times Online described some of the riders politicians tried to tack on to this emergency bill.

Inserted into the modified Bill by two Oregon senators on Wednesday night was a provision repealing a 39-cent excise tax on children’s wooden arrows, which would save Rose City Archery, a company in Myrtle Point, Oregon, that makes the toys. … Also in the revised Bill is $128 million of tax relief for the manufacturers of car racing tracks, aimed at congressmen in Nascar states, such as Virginia and North Carolina. A provision to give $10 million in tax breaks to small television and film producers could convert a congressman from Los Angeles. The help for Alaskan fishermen is aimed at swaying Don Young, a Republican from the state.

Although more money may be necessary to restore the flow of credit into the financial system, the unfinished and arguably more important component of the bailout must be a set of political and institutional reforms. Without that, we may be throwing money into the flames with the same recklessness with which Western Front Generals fed their battalions to the machine guns. Without that, the West could face another wholly predictable surprise from China. Even the Western Front Generals learned eventually. So should we.

The final phase of the battle of the Somme saw the first use of the tank on the battlefield. … The Somme led directly to major new developments in infantry organization and tactics … the British, and the Colonial contingents, reintroduced the concept of the infantry platoon, following in the footsteps of the French and German armies who were already groping their way towards the use of small tactical units. At the time of the Somme, British senior commanders insisted that the company (120 men) was the smallest unit of manoeuvre; less than a year later, the section of 10 men would be so

The disasters of the Western Front were the graveyard of the long accepted adage that the ‘Public School boys governed best’. The public blunders of a social elite damaged their prestige beyond repair. From then on, things would have to be presented for acceptance on evidence, rather than trust. Maybe that process is now taking place in the less sanguinary but equally vital spheres of governance, finance and the media.

Tip Jar.