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Cathartic monetary disorder, part II

In part 1 of this article I wrote that I believe in strong monetary cooperation between all three reserve currency stakeholders:  the USA, Europe and Japan. As Japan is suffering the most from deflation it got carte blanche from other two to engage in massive debasement of its currency. Once Japan is done the next will be the Fed with its QE2. Now what about non-reserve currencies? The biggest is China, which in my understanding doesn’t have money at all. They have a money substitute called Yuan (the name comes from the Mongol Hubhilai empire that invented paper money). The Yuan is pegged to dollar and the proceeds from dollar purchases are sterilized. Sterilization means that the People’s Bank of China is printing Yuan-denominated bonds and forcing domestic banks to buy them. Why forcing? Because PBC cannot pay much higher interest than US Treasuries are yielding, which is well below inflation. How does the dollar peg work? Essentially, any currency is pegged to something. It would be nice to be able to peg to a basket of other currencies but unfortunately it’s impossible because clever hedge funds will arbitrage it to insolvency. For the same reason, it is impossible to […]

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