Long Live the Asian Bond Market!
Asians tend to save for the future while Americans borrow from the future.
The irony of the situation is that America, the only superpower left
in the world, is financing its standard of living with excessive borrowing
from the world, in particular Asia. This is due to the status of the
US dollar as the world’s reserve currency and the lack of alternatives
in the existence of a deep, liquid and well governed and functioning
Asian Bond Market.
If Asian countries were to substantially reduce their holdings of US Treasury
bonds, they would remove a key source of finance for the US investment and
the war on terror spending. President Bush is recklessly turning the United
States more heavily into debt and the need for a local alternative to the US
bond market is suddenly becoming an issue again.
China is under intense US political pressure to revalue its currency and in
order to pave the way for the inevitable full convertibility of the Renminbi,
China is hosting the 1st Annual Asian Bond Market Forum in Beijing this coming
November.
President Bush and the Us Federal Reserve is making clear the degree to which
they are willing to bet the integrity of the global financial system in its
determination to keep the game going. Spend and not save, consumption vs. production
and borrowing from the future. The US Federal Reserve Bank controls its own
balance sheet. It can print as much money as it likes but if it is liquidated
by the American commercial banking system and credit contracts then deflation
will surely follow. This is not just theory.
Like gold or any commodity, US dollars have value only to the extent that they
are strictly limited in supply. But the US government has a printing press
that allows it to produce as many US dollars as it wishes at essentially no
cost. By increasing the number of US dollars in circulation, or even by credibly
threatening to do so, the US government can also reduce the value of a dollar
in terms of goods and services which is equivalent to raising the prices in
dollars of those goods and services.
Under a paper money system, a determined government can always generate higher
spending and hence positive inflation. Domestic monetization and deliberate
depreciation of the dollar are major policy alternatives available to the American
government to fight deflation. This is obviously a real issue for America,
the world’s largest debtor nation and its foreign creditors many of which
are in Asia.
It is quite realistic to assume that the US dollar standard will become obsolete
by the end of this decade, while at the same time I expect the Renminbi to
become fully convertible and Asia to have its own fully developed bond market.
All of this will have huge implications for Asia, financial and geopolitical,
given the massive foreign exchange reserves accumulated by the region and the
huge percentage of them held in US dollars.
Renewed efforts are now under way to set up an Asian bond market whose purpose
it is to lessen the dependence on the United States and to better circulate
local money within the region and funnel it into a variety of Asian public
and private sector bonds.
The Asian bond market initiative is led by member countries of the Association
of South Asian Nations (ASEAN) plus Japan, China and South Korea. These countries
hope that by establishing the market, the pool of savings will be used to buy
new bonds issued by private firms and governments within Asia. The plan is
to establish a system to enable institutional investors in the region to purchase
local currency-denominated bonds issued by Asian governments and private sector
firms.
If the Asian Bond Market becomes a reality, many fear that Asian investors,
who are the largest foreign owners of US Treasuries, may cut their holdings
of US government debt, withdrawing a key source for America’s large current
account deficit.
Continued weakness in the US dollar could make Asian investors even less willing
buyers of American debt. However, for the time being many Asian central banks,
institutional and private investors do not have a choice. The US has captive
buyers for its debt due to the lack of an Asian bond market.
One of the key motivating factors behind the creation of the Asian Bond Market
was the 1997 Asian financial and currency crisis that hit the region. The establishment
of deep financial and capital markets is one of the best measures to prevent
a repeat of the financial collapse that spread among the region.
A deep and well functioning bond market lessens a company’s dependence
on the often volatile equity market and improves a companies capital structure.
This is turn will make it easier to withstand any financial storms. However
the IMF spearheaded by the United States strongly resisted any efforts to establish
an Asian Bond Market then.
At that time, the United States had a president who was more global and farsighted
in his thinking and the Clinton administration favored a strong dollar. Now
under President Bush, the focus is more narrow and domestic in nature and the
US has adopted a weak dollar policy.
President Bush’s strategy seems to be to run the US even more into debt
and let the dollar fall. As a result of this, foreigners who still buy US debt
are net losers, and the US can continue to live beyond its means.
The last time such an aggressive policy was attempted was not the Reagan “star
wars” program, as some commentators have suggested, but the “guns
and butter” policies of another populist president, Lyndon Johnson, in
the mid 1960s. The exporting of the resulting US inflation lead to two Sterling
crises, the shattering of the gold standard and the explosive growth of the
eurobond markets, which attempted to recycle the massive “petro-dollar” surpluses.
China and Asean's favorable response to the Asian Bond Market is therefore
significant because it reaffirms the effort to design and build financial protection
for Asia with a more balanced financial infrastructure, thereby diversifying
risk of intermediation across a large number of institutions and market players.
It would also offer an additional source of funds, instead of being tied solely
to borrowing from international financial institutions and would help China
to pave the way for full convertibility of the Renminbi.
