Why the rupee can keep falling

S A Aiyer in Times of India

People ask me, will the exchange rate go to Rs 70 to the dollar? I reply, why not Rs 80?

Indian analysts are in denial. They don’t dare face up to the full consequences of the global financial hurricane originating in the US. This will keep blowing for 12-18 months.

To revive the US economy, the Federal Reserve has been pumping out $85 billion of cash per month (called quantitative easing). With the US economy recovering, the Fed plans to reduce this cash bonanza in stages to zero. Emerging markets like India have long enjoyed a slice of this $85 b/month. Not only will fresh flows stop, older flows will reverse to the US, a net turnaround of hundreds of billions.

This storm has knocked the rupee down almost 25% in two months. It is the first of many storms that will hit not just India but the whole developing world, with every tightening of the money tap by the Fed.

Expect a second Asian Financial Crisis. This will cause much less damage than the earlier one in 1997-99. Then, Asian countries had low forex reserves, excessively high debt, and semi-fixed exchange rates. Learning from 1997, Asian countries (including India) now have large forex reserves, less debt, and floating exchange rates. This makes them far more resilient, so they will not collapse as in 1997. But they will suffer substantial damage. Countries with large current account deficits like India will suffer the most. But even Malaysia, which runs a surplus, has seen its currency crash 10%.

A crashing currency raises the prices of all items that can be imported or exported. This erodes people’s purchasing power — by maybe 2.5 to 3% of GDP in India’s case. That is hugely recessionary, as is already evident in the latest data showing falling production of services as well as manufactures.

Such a recession can, in theory, be combated by monetary and fiscal stimuli, as in 2008. But today money must be kept tight to check inflation, so no monetary stimulus is possible. Finance Minister P Chidambaram has sworn to limit the fiscal deficit to 4.8% of GDP, so no fiscal stimulus is possible either. With GDP growth and revenues falling far below budgeted numbers, and oil and fertiliser subsidies rising, he will have to slash Plan investment to meet his fiscal target.

The breach will not be filled by private investment — few businessmen will invest when domestic demand is collapsing. So, the economy will spiral downwards.

One theoretical solution is use a depreciated currency to stimulate export-led growth. If exports grow 20% per year for two years, that will help weather the storm. However, as we found in 1997, when all developing countries are hit, all cannot suddenly increase exports at the same time: the West lacks enough absorption capacity. Besides, India’s investment climate is terrible — files just don’t move, with or without bribes. Many Indian companies would rather invest abroad. Politicians are more focused on distributing goodies before the election than on slashing red tape.

Finance ministry analysts say the equilibrium exchange rate is Rs 58-60 per dollar. They say irrational panic has caused overshooting, and economic fundamentals will soon force the dollar’s value back to Rs 60.

Warning: similar things were said when Asian currencies began to slide in 1997. Far from recovering, they crashed further. The Indonesian rupiah went from 2,500 per dollar all the way to 18,000.

Why so? Because when a currency crashes, that itself changes the economy’s fundamentals. Domestic purchasing power falls, causing a recession. Prices shoot up, negating the positive effects on exports. Corporations that have borrowed abroad heavily go bust. Banks that have lent to such borrowers (and others hit by recession) cannot recover their loans. International rating agencies downgrade such economies, inducing further capital flight.

India’s fundamentals have already changed. GDP growth in the first quarter is down to 4.4%. It could fall to 3.5-4% over the full fiscal year. A slowing economy will help reduce the current account deficit, but hit the fiscal deficit. Wholesale prices had been falling but are accelerating again, dampening purchasing power. All industries face slowing revenues and rising costs, eroding profits. Tax revenue may grow by hardly half the budgeted estimate of 19%.

Disinvestment can happen only at throwaway prices. Chidambaram is a determined disciplinarian, but may be powerless to stop global hurricanes. The threat of a credit downgrade has become very real.

Right now, there is a lull in the financial storm, and the rupee has regained some ground. But this storm will blow, off and on, for 12-18 months. Gird your loins.

So how long can the US hold the world to ransom with the dollar?

Satyajit Das

On 8 November 2010, the German finance minister Wolfgang Schäuble told the Wall Street Journal: "The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base."

US gross government debt currently totals around $16trillion (£10trn). The US government holds around 40 per cent of the debt through the Federal Reserve and government funds. Individuals, corporations, banks, insurance companies, pension funds, mutual funds, state or local governments, hold 25 per cent. Foreign investors, China, Japan and "other" (principally oil exporting) nations, Asian central banks or sovereign wealth funds hold the rest.

Historically, America has been able to run large budget and balance of payments deficits because it had no problem finding investors in US Treasury securities. The unquestioned credit quality of the US, the unparalleled size and liquidity of its government bond market, ensured investor support. Given its reserve currency and safe haven status, US dollars and US government bonds were a cornerstone of investment portfolios of foreign lenders.

During this period, emerging countries such as China fuelled American growth, supplying cheap goods and cheap funding – recycling export proceeds into US bonds – to finance the purchase of these goods. It was a mutually convenient addiction .

Asked whether America hanged itself with an Asian rope, a Chinese official told a reporter: "No. It drowned itself in Asian liquidity."

Given the sheer quantum of US debt, foreign investors may become increasingly less willing to finance America. Japanese and European investors, struggling to finance their own government obligations, may simply not have the funds.

Given its magnitude and the lack of political will to deal with the problem of debt and public finances, the US is now deploying its FMDs – "financial extortion", "monetisation" and "devaluation" – to finance its requirements.

In a form of extortion, existing investors like China must continue to purchase US dollars and bonds to avoid a precipitous drop in the value of existing investments.

Debt monetisation – printing money – is another strategy. The US Federal Reserve is already the in-house pawnbroker to the US government, purchasing government bonds in return for supplying reserves to the banking system. Expedient in the short term, monetisation risks setting off inflation. The absence of demand in the economy, industrial over-capacity and the unwillingness of banks to lend have meant successive "quantitative easing" has not resulted in higher inflation to date. But the risks remain.

Monetisation is inexorably linked to devaluation of the US dollar. The zero interest rates policy and debt monetisation is designed to weaken the dollar. As John Connally, the US Treasury Secretary under President Richard Nixon, belligerently observed: "Our dollar, but your problem."

Despite bouts of dollar buying on its safe haven status, the US dollar has significantly weakened over the last two years, losing around 20 per cent against major currencies since 2009. As the dollar weakens US foreign investments and overseas income gain in value. But the major benefit is in relation to debt owned by foreigners. As almost all its government debt is denominated in US dollars, devaluation reduces its value.

This forces existing investors to keep rolling over debt to avoid realising losses. It encourages them to increase investment, to "double down" to lower their average cost of US dollars and debt. It also allows the US to enhance its competitive export position.

Major investors in US government bonds now find themselves in the position John Maynard Keynes identified: "Owe your banker £1,000 and you are at his mercy; owe him £1m and the position is reversed."

Valery Giscard d'Estaing, the French finance minister under Charles de Gaulle, famously used the term "exorbitant privilege" to describe the advantages to America of the dollar's role as a reserve currency and its central role in global trade.

That privilege now is not only "exorbitant" but "extortionate". How long the world will let the US exercise it is uncertain.

Satyajit Das is a former banker and author of "Extreme Money" and "Traders, Guns & Money"

The demise of the dollar

In a graphic illustration of the new world order, Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading 

By Robert Fisk

Tuesday, 6 October 2009

In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.

The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security."

This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.

The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.
Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East.

China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures.

Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro.

Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency.

The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar."

Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018.

The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets.

"These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate."

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

To secure credit, Europe finds global financial markets no longer attuned to Western interests

Joergen Oerstroem Moeller 

The eurozone crisis has not only raised questions about the viability of the common currency, but could also jeopardize an economic model that has so far reigned supreme. The course taken to resolve the crisis in Europe will have long-term impact on the most vibrant parts of the world – from Asia to Latin America.

In developed countries of the West, debtors have run up a high debt ratio to gross domestic product, even while economic growth was high – overspending when they should have saved. They borrowed to spend more, demonstrating a disastrous failure to grasp basic economic principles as well as flaws in moral behaviour and ethical judgment. Among these borrowers are established heavyweights – the United States, most European nations and Japan. The United States, one of the wealthiest countries, became an importer of capital instead of exporting capital, registering its last balance vis-à-vis the rest of the world in 1991.

After accumulating savings over several decades through prudent and cautious policies, the creditors sit on a large pile of reserves with low domestic debt and government deficits. These reserves are largely held by emerging countries with China at the forefront. As a paradox, the emerging economies have taken it upon themselves to lend to the richer countries – exporting capital almost as vendor’s credit. Indeed, this reversal of roles is one explanation for the global financial crisis. The global monetary system is not geared to function under such circumstances.

This development was framed by the so-called Washington Consensus of the 1980s – a neoliberal formula that spurred globalisation by promoting liberalization of trade, interest rates and foreign direct investment; privatisation and deregulation; as well as competitive exchange rates and fiscal discipline. Fundamental flaws were exposed, raising the question about which economic model might replace it.

There are two possibilities in this competition: One strategy is from the United States and a group of Democrats who suggest that more short-term borrowing and spending could lead to growth, tax revenues and exit from recession – even if the debt grows and deficits become permanent. A breakthrough by the US Congressional super-committee to make substantial cuts over the next 10 years won’t fundamentally change this stance, merely reducing rather than eliminating the deficit. The Europeans have taken the opposite view: They advocate starting the recovery by reducing deficits and debt even if that seems counterproductive for economic growth in the short run. The Europeans are also raising taxes across the board, regarded as indispensable for restoring balance in government budgets.

The results of either plan won’t be known for a few years. Chances are, however, that the European policy will carry the day for the simple reason that creditors call the tune. It’s highly unlikely that creditors favour continued reliance on deficits as the inevitable consequence will be inflation, eroding the purchasing power of their reserves. Indeed, the Chinese rating agency Dagong has announced that it may cut the US sovereign rating for the second time since August if the US conducts a third round of quantitative easing.

Early in the crisis, as Europe set up a stabilizing bailout fund, there were rumours in the market that China, Russia and Japan might rescue of the euro, either by buying European bonds or going through the International Monetary Fund. It’s unclear how China wants to proceed with such an undertaking, but Russia and Japan have allegedly acted to do that through the International Monetary Fund or by buying European bonds.

Countries with surpluses do not dream of rescuing the euro; they act in their own interest. Economically they prefer the European fiscal discipline, reasoning that American prodigality will shift much burden of adjustment onto them. They may dread being left with the US dollar as the only major international currency, forcing them to endure, at times, whimsical policy decisions by the Federal Reserve System, the US Treasury Department or US Congress. The euro and the European Union are seen, and indeed needed, as a counterweight. The EU may look weak, but it’s a respectable global partner, offering the euro as an alternative to the dollar and serving as a major player in trade negotiations and the debate about global warming, just to mention a few examples.

It can be expected that other nations will step forward to support the euro. But at what price? What conditions, if any, will be put on the table and will the Europeans consent? A case can be made that, as creditors undertake investments to help the euro, they actually help themselves, and there are no reasons why the eurozone should pay any price. We can expect a game of hardball, in which nerves matters, and who gives what to whom may not be clear at all.

Another question has arisen about who decides and who is in charge. The G20 meeting in Cannes revealed a growing consensus to stop the financial houses amassing and subsequently abusing power. If the global financial system is big enough to force Italy into a default-like situation, many countries are surely asking whether they’ll be next. The big financial houses are viewed by many as irresponsible stakeholders, if stakeholders at all. Consider, the US government is suing 18 banks for selling US$ 200 billion in toxic mortgage-backed securities to government-sponsored firms, the Federal National Mortgage Association and the Federal Home Mortgage Corporation, known as Fannie Mae and Freddie Mac. In April 2011 the European Commission initiated investigations into activities of 16 banks suspected of collusion or abuse of possible collective dominance in a segment of the market for financial derivatives.

The market has muscled its way in as judge about whether a country’s political system or economic policy are good enough. But the market is neither a single institution nor a broad, balanced mix of diverse players. It’s become a small group of large financial institutions, the power of which overwhelm what even big countries can muster: 147 institutions directly or indirectly control 40 percent of global revenue among private corporations. A sore point is that they pursue profits without concern over implications for countries and societies. Rather than let measures work, these financiers force the issue here and now, even as they speculate against efforts, many admittedly delayed and inadequate, to resolve debt crises. Financial institutions holding sovereign bonds that could default insure themselves by buying a credit default swaps. What seems like prudent corporate governance becomes a shell game as these obligations are traded among financial institutions, some of which don’t hold sovereign bonds in their portfolios – all of which heightens interest in forcing default.

The temptation to roll back economic globalisation inter alia by breaking up the eurozone or restricting capital movements has been resisted. Economic globalisation is holding firm.

Creditor countries can set the course on future economic policies – likely highlighting fiscal discipline. While the West had vested interest in the big financial houses, the incoming paymasters do not, and they can be expected to increase their control over investment patterns. This can be done either by setting up own financial houses or buying into Western financial institutions as was the case in the slipstream of the 2008 global debt crisis.

The global financial market is changing course, away from looking after Western interests and acting in accordance with corporate governance as defined by the West toward a more global outlook guided by the interests of new group of creditors.

---

Joergen Oerstroem Moeller is a visiting senior research fellow, Institute of Southeast Asian Studies, Singapore, and adjunct professor, Singapore Management University and Copenhagen Business School.

THE US Rating Downgrade Explained - Finance capital is trying to impose the same fiscal austerity on the US as it had foisted on the eurozone.

(From Economic and Political Weekly India's editorial)

 The issuers of mortgage-backed securities (MBS) during the housing boom in the United States in the first few years of the 2000s paid the credit rating agencies – Moody’s, Standard & Poor’s (S&P), and Fitch – for the top ratings that the latter bestowed on those debt instruments. Thank heavens it was not the investors (in those securities) who had to compensate the credit rating agencies for the AAA credit ratings that they gave
the MBS shortly before the market collapsed and the securities defaulted. Now, on 5 August, one of them, S&P, became really audacious – it downgraded US Treasury securities, ignoring the
fact that, unlike in the case of the 17 countries in the European Monetary Union, the US Federal Reserve can sustain the government’s fiscal deficits and refinance the public debt by purchasing the Treasury’s securities. What may have provoked S&P into the act?

Can the turmoil on the financial markets since the downgrade be attributed to what S&P did? What may be the repercussions of “the deal” between the Barack Obama administration and the Republicans in Congress that permitted an enhancement of the ceiling on the US public debt based, of course, on the quid pro quo
of fiscal deficit reduction, a bargain that US finance capital was presumably not content with?

But, first, what about the settlement between President Obama and the Republicans? From the perspective of S&P’s credit rating, the question was one of sustainability of the public debt. Presumably, even after the agreement to reduce the projected fiscal deficit by $2.1 trillion over the next 10 years,
the projected public debt to gross domestic product (GDP) was rapidly rising from 2015 to 2021. S&P and US finance capital wanted double the cut in the fiscal deficit over the same period. But let us come to the expenditure reduction of $917 billion over the next 10 years that will permit a $1 trillion increase in the
debt ceiling. The many expenditure reductions that this will require have more to do with infrastructure, education, housing, community services, etc, than with defence and homeland security. And, a further $1.2 billion reduction in expenditure – again, more to do with entitlements than with defence – is on
the anvil, besides a balanced budget amendment. So severe cuts in social security, including Medicare, are very much on the agenda. In reality, it seems the Obama administration is not much at odds with the Republicans as regards these cuts, but, of course, the president is seeking another term in office, come November 2012, and so he could not have been able to meet finance capital’s demands to the full.

US public debt has risen rapidly since 2000, but the main reasons for this are the tax cuts for corporations and the rich, the wars in Iraq and Afghanistan (besides the otherwise huge increase in defence expenditure), the costly bailouts of banks, insurance companies and corporations such as the auto companies, and, of
course, the stimulus spending during the Great Recession. The deal with the Republicans will not affect the tax cuts, defence, and the bailouts. But more ominous is the fact of economic stagnation – the first and second quarter 2011 growth rates of 0.3% and 1.3% are dismal for an economy that is claimed to be recovering from the Great Recession. The cuts in government expenditure – coming at a time when additional private consumption and private investment are not forthcoming, and when the US cannot match
the neo-mercantilist powers like Germany and China – may, most likely, push the economy into another recession which will bring on even higher fiscal deficits. In fact, interest rates have declined
in the wake of S&P’s decision! And, of course, with the central banks of the 17 out of 27 countries of the European Union (EU) not allowed to sustain their respective governments’ fiscal deficits and refinance public debt by purchasing their governments’ securities, no solution of the eurozone’s debt crises is in sight.

Even as we look at S&P’s downgrading of US public debt, it might be worth a while to comment on the eurozone’s debt crisis, for the contrast may be enlightening. Here the problem has its roots in the EU’s Stability Pact which commits member states not to increase their fiscal deficits beyond 3% and their public debt to GDP beyond 60%. Countries that violate these stipulations are forced to borrow short-term on the private capital markets for their central banks are not permitted to sustain such fiscal deficits, and are
thus not allowed to refinance public debt by purchasing their government’s securities. The crucial link between monetary and fiscal policy is thus deliberately snapped. Now, besides Spain, Greece and Portugal, Italy too faces a public debt crisis that has its roots in such a financial architecture, and the people are forced
to bear the brunt of the draconian austerity measures imposed.

The United Kingdom (UK) would have also been in a similar boat if the eurozone criteria had applied to it. The financial markets would then have doubted the government’s ability to refinance the public debt because the link between the Treasury and the Bank of England would have been snapped.One might be thankful that the UK is not a part of the eurozone given the current social turmoil it is facing. Much of the eurozone countries’ mercantilist strategies have exacerbated the EU’s macroeconomic problems with their competitive drives to push down the wage relative to labour productivity, this, in the absence of a national currency whose value could have otherwise been depreciated.

Now, the US’ problems are not that of the eurozone but finance capital could not care less. It is trying to impose the eurozone’s fiscal responsibility standards on Washington, and, in this, S&P is its instrument. Finance capital will, after all, snatch as much of its share of the return on capital that it can, and, this, by any and all available means at its disposal, even if this robs the people at large of their very means of keeping body and soul together.

The demise of the dollar

In a graphic illustration of the new world order, Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading

By Robert Fisk

The Independent 6/10/09

 

In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

 

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

 

The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.

 

The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security."

 

This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.

 

The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.

 

Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East.

 

China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures.

 

Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro.

 

Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency.

 

The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar."

 

Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018.

The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets.

"These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate."

 

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

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