Tuesday, January 4, 2011

End the Fed?

With Republicans in control of the House of Representatives, Ron Paul plans to conduct oversight hearings of the Federal Reserve Board.  His views on the fed are well know given his book titled “End the Fed.”  Paul and other Members of Congress blame the fed for the financial crisis of 2007-09 and the steady depreciation of the dollar since its fixed-price link to gold was broken during the Nixon administration.

Paul’s interrogation of fed chairman Bernanke will make for interesting theater but likely have little practical effect on the fed’s conduct of monetary policy.  A more important trend that is slowly developing could render the fed a second-team player over the next few decades.

I previously blogged that China has offered to buy Greek, Irish, and Portuguese debt.  On Monday, January 3, 2011, it restated its commitment to buy Spanish debt.

It’s only a matter of time until China makes a similar offer to Italy.  At that point, China will have picked off the “Club Med” countries on the periphery of the eurozone.  All five countries will increasingly conduct trade and financial swaps with China in renminbi.

China is rapidly expanding its business and political ties with Africa, Central America, Latin America, Southeast Asia, and Central Asia.  Over time, the renminbi will become the dominant currency in their trade with China, but also serve as a reserve currency for trade among themselves, especially as it is likely to steadily appreciate against the U.S. dollar in the coming years.

China’s currency will become a rival to the dollar much faster than most economists suppose.  Many economist believe the eurozone will break up in the next five years, reducing the use of euros as a reserve and transaction currency.  The pound, yen, Aussie dollar, and other national currencies will become relatively smaller in global affairs relative to the renminbi.

Who knows?  Maybe someday China will complain about the undervalued dollar?

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