China and a New World Economic Order
 
By
Henry C.K. Liu
 
This article appeared in AToL on January 12, 2010 
 
Merely two years before the end of the first decade of the 21^st century, the post-Cold-War world economic order found itself facing its most serious crisis under the weight of unsustainable deregulated debt capitalism created by dollar hegemony. There are clear signs that out of this current crisis a new world economic order will emerge. China is in a promising position to influence this development toward a sustainable, balanced and cooperative world order of global fairness and universal justice.
 
The root cause of the current crisis can be traced to the dismantlement of the Bretton Woods international finance architecture by the US in 1971 when President Richard Nixon suspended the dollar’s link to gold, and the subsequent deregulation of globalized financial markets that has allowed free cross-border movement of funds.
 
Toward the end of the World War II, the United States, through its dominance in the Bretton Woods Conference of 1944, constructed a post-war international finance architecture based on a gold-back dollar as a reserve currency to revive world trade. The Bretton Woods monetary regime allowed the US, which at that time was in possession of most of the world gold, to take over the role of financial and economic hegemon in a new age of neo-imperialism under finance capitalism previously played by Britain in the age of imperialism under industrial capitalism.
 
Economics thinking prevalent immediately after WWII, drawing lessons from the 1930s Great Depression, had deemed international capital flow undesirable and unnecessary for national economic development. Trade, a relatively small aspect of most national economies at the time, was to be mediated through fixed exchange rates pegged to a gold-backed dollar. These fixed exchange rates were to be adjusted only gradually and periodically to reflect the relative strength of the economies participating in international trade, which was expected to augment, but not overwhelm, the national economies.  The impact of exchange rates was limited to the settlement of international trade.  Exchange rate considerations were not expected to dictate domestic monetary and fiscal policies, the chief function of which was to support domestic development and regarded as the inviolable province of national sovereignty.

During the Cold War, there was no global trade. The economies of the two contending ideology blocks were completely disconnected and did not trade outside of their own blocks.  Within each block, allied economies interact through foreign aid from and memorandum trade with their respective superpowers.  The competition was not for profit but for the hearts and minds of the people in the two opposing blocks, as well as those in the non-aligned nations in the Third World. The competition between the two superpowers was to give rather than to take from their separate fraternal economies. 

The population of the superpowers worked hard to help the poor within their separate blocks. Convergence toward equality was the policy aim even if not always the practice. The Cold War era of foreign aid and memorandum trade had a better record of poverty reduction within either of the two camps than post-Cold War globalized neo-liberal trade dominated by one single superpower. The aim was not only to raise income and increase wealth, but also to reduce income and wealth disparity between and within economies. 
 
In the world economic order that emerged after the Cold War, income and wealth disparity has been rationalized as a necessity for capital formation even in the rich economies. From 1980 to 2007, the total after tax income earned by the top 0.1% of earners in the US more than quadrupled, while the share earned by everyone else in the top 10% rose far less and the share of the bottom 90% actually declined in purchasing power.
 
In China, privatization of state-owned-enterprises since 1978 has pushed a large segment of the working population outside of socialist sphere of free social benefits in health care, education and retirement entitlements. Unemployment is now a serious structural problem everywhere including the Chinese socialist market economy. Excessive reliance on export financed by foreign capital has also left developmental imbalances between the exporting coastal regions and the isolated interior. Despite recurring big trade surpluses denominated in dollars, China has been prevented by dollar hegemony from using sovereign credit to finance domestic development. China is now the world’s biggest creditor nation, yet the Chinese economy continues to require foreign capital that demands rates of return higher than such capital could get in their home economies.
 
Ironically, much of this “foreign” capital comes from the US which is deeply indebted to China. The US is investing in China with money it borrows from China. The US is able to do this because the debt and capital are both denominated in dollars that the US can print at will. 

Today’s post-industrial financial market economies are all plagued by overcapacity created by insufficient consumer purchasing power. The Chinese market economy is a glaring example of this structural contradiction which arises from the need of companies to keep down wages to maximize corporate profit. Workers everywhere are not able to afford all the products they produce, thus causing overcapacity that has to be absorbed by export.
 
American entrepreneur Henry Ford (1867-1943) understood this structural contradiction in industrial market economies and identified rising wages as a solution to overcapacity caused by rising labor productivity. But foreign capital denominated in foreign currency (dollars) rejects the need for high local wages because it earns its dollar profits from export to foreign markets. This is the main reason why emerging economies must avoid excess dependence on export for dollars financed by foreign capital in dollars.
 
China needs to accelerate its domestic development with sovereign credit denominated in Chinese currency to proportionally reduce its excessive dependence on export for dollars financed by foreign capital in dollars. China needs to denominate its export trade in Chinese currency to break free from dollar hegemony. This is the key strategy for positively influencing a new world economic order of universal justice to replace current predatory terms of international trade under dollar hegemony.

Since the Cold War, which officially ended with the dissolution of the USSR in 1991, world economic growth has distorted by a shift from aggregate domestic development with sovereign credit within sovereign nations to excessive reliance on globalized neo-liberal trade engineered and led by the US as the sole remaining superpower. International trade has since been denominated in the US dollar, a fiat currency after 1971, as the main reserve currency. International trade has been driven by the huge US consumer market made possible by the high wages of US workers backed not by rising productivity, but by US dollars that the US, and only the US, can print at will through its central bank. 
 
In China, rising worker productivity has not resulted in higher wages, but only in lower export prices. This is the main reason why the Chinese domestic market lags behind in consumer demand despite enormous rise in Chinese worker productivity. Many Western critics erroneously pressure China to revalue its currency to address the persistently large trade imbalance. The only effective measure to deal with this trade imbalance is for China to raise wages rather than to revalue the exchange rate of its currency. 
 
For the past two decades before the global financial crisis that first broke out in mid 2007, economic growth in the dysfunctional world economic order has been, and still is, based primarily on free cross-border flow of capital and speculative funds driven by cross-border wage and regulatory arbitrage. This growth has been sustained by knocking down national tariffs worldwide through the authority of supranational institutions such as the World Trade Organization (WTO), and financed by a deregulated foreign exchange market working in concert with a global central banking regime independent of national political pressure, lorded over by the supranational Bank of International Settlement (BIS) and the International Monetary Fund (IMF).
 
Ever since the end of the Cold War in 1991, which actually began winding down in the early 1970s with US policy of Détente, trade has increasingly overwhelmed domestic development in the global economy, as superpower competition to win the hearts and minds of the world in the form of aid subsided.  Persistent fiscal and trade deficits forced the US to suspend in 1971 the peg of the dollar to gold at $35 per ounce, in effect abandoning the Bretton Woods regime of fixed exchange rates linked to a gold-back dollar.  The flawed international finance architecture that resulted has since limited the global growth engine to operating with only the one cylinder of international trade, leaving all other cylinders of domestic development in a state of permanent stagnation. The venue of sovereign credit for national development has been foreclosed permanently. China needs to free itself from dollar hegemony to use sovereign credit to develop her domestic economy.
 
Since 1978, China has exposed itself to the disadvantages of export trade denominated in dollars. Much of the wealth created in China during the last 30 years has ended up in the US, leaving China in an extended state of capital shortage despite being the largest holder of foreign reserves in the world. When it comes to consumer power and environmental pollution, China is only the kitchen; the dinning room is in the US. In a new world economic order, China should move the dinning room back inside China. 

The global economy is a comprehensive and complex system of which trade is only one sector. Yet economists and policy-makers promoting neoliberal globalization tend to view trade as the entire global economy itself, downplaying the importance of non-trade-related domestic development. Neoliberals promote market fundamentalism as the sole, indispensable path for national economic growth, despite ample evidence in the past three decades that trade globalization tends to distort balanced domestic development in ways that hurt not only the less developed, but also the developed economies. This is why a new world economic order must restore domestic development with sovereign credit as the driving force and reduce world trade as an auxiliary force in which export should be denominated in the exporting country’s currency. 
 
The distributional consequences of predatory terms of global trade liberalization under dollar hegemony work against the developing economies in the world. Such predatory terms of trade also work against the poor and the financially weak in all economies, including the advance economies, putting the less educated and the less skilled in a downward spiral of chronic unemployment and persistent hopelessness.
 
Reductions in tariffs reduce tax revenues for public spending that can help poor people and weaken needed protection for endangered domestic industries. While distributional consequences of trade liberalization are complex and country-specific, the general trend has been to exacerbate income disparity everywhere, which in turn leads to economic underperformance and political instability in all countries.

In the United States, the Mecca of free-market entrepreneurship, spending by the statist sectors – government operations, public finance, defense, health care, social security and public education – have kept the economy afloat in recurring protracted recessions, while entrepreneurial ventures in corporate finance, insurance, high-tech manufacturing, airlines and communication languish in extended doldrums needing government bailout. 
 
Unregulated markets lead naturally to monopolistic consolidation and abuses in corporate governance and finance through the concentration of market power.  It has become clear and undeniable that “free” markets are inherently self-destructive of their own freedom. Free markets depend on enlightened government regulations to remain free and to prevent them from turning into failed markets.  Government, from monarchy to democracy, within capitalist market economies or socialist economies, exists to protect the weak from the strong and to maintain socio-political stability with a just socio-economic order. A new world economic order will have to be based on this principle of universal justice between and within sovereign nations. For China to exert influence on the formation of this new world economic order, it must construct its domestic economic order on the same principle of equality and fairness.
 
World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy. The world’s interlinked economies no longer trade to capture Ricardian comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign capital and debts and to accumulate dollar reserves to stabilize the value of their currencies in world currency markets. To prevent speculative and manipulative attacks on their currencies, central banks of all trading governments must acquire and hold dollar reserves in amounts that can withstand market pressure on their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold.  Only the Federal Reserve is exempt from this pressure, because the US Treasury can print dollars at will with relative immunity.  This creates a built-in support for a strong dollar that in turn forces the world’s central banks to acquire and hold more dollar reserves, making the dollar even stronger.
 
This phenomenon is known as dollar hegemony, which is created by a geopolitically-constructed peculiarity through which critical commodities, among the most notable being oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel since 1973.  The trade value of a currency is no longer tied to the productivity of its issuing economy, but to the size of dollar reserves held by its central bank.

By definition, dollar reserves must be invested in dollar assets, creating an automatic capital-accounts surplus for the dollar economy. Even though the US has been a net debtor since 1986, its net income on the international investment position has remained positive, as the rate of return on US investments abroad continues to exceed that on foreign investments in the US.  This reflects the overall strength of the US economy, and that strength is derived from the US being the only nation that can enjoy the benefits of sovereign credit utilization while amassing external debt denominated in dollars, largely due to dollar hegemony.  Unlike other economies, the USS economy incurs no foreign debt, only domestic debt denominated in dollars held by foreigners. These debts can always be repaid by the Federal Reserve, the US central bank, printing more dollars. Since such a move will devalue the exchange rate of the dollar, foreign holders of the US dollar sovereign or private debt are prevented from demanding payment. Further, when basic commodities are denominated in dollars, the US essentially owns all such commodities. Foreign owners of dollar assets are merely unwitting temporary agents of the US dollar hegemony.
 
Under the Westphalian world order of sovereign nation states, which has framed international relations since 1648, only coordinated economic nationalism that focuses on domestic development can pull the world economy out of its current downward spiral.
 
Economic nationalism should not be confused with trade protectionism. Decades of predatory cross-border neo-liberal finance and trade have generated strong anti-globalization sentiments in every country around the world. It has become a class struggle between the financial elite and the working poor in rich and poor countries alike.
 
Before the end of the first decade of the 21st century, in a world where market fundamentalism has become the operative norm, misguided trade protectionism appears to be fast re-emerging and developing into a new global trade war with complex dimensions. The irony is that this new trade war is being launched not by the abused poor economies that have been receiving the short end of the trade stick, but by the U.S., as leader of rich nations which have been winning more than they have been losing in the current economic order and trade system. Much of this protectionism is designed to protect industries that the rich nations have voluntarily moved offshore for financial and environmental advantage. Such protectionism aims to protect non-existent economic activities by imposing tariffs on goods that the importing nations chose not to produce.
 
The biggest battles of this new trade war are being fought on the currency exchange rate front under dollar hegemony, a global monetary regime in which export nation ship real wealth produced with low wages and high environmental abuse in exchange to fiat paper money of uncertain exchange value and zero intrinsic worth.
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Rich nations need to recognize that their efforts to squeeze every last drop of advantage at all levels from already unfair finance and trade will only plunge the world into deeper depression. History has shown that while the poor suffer more in economic collapse, the rich, even as they are financially cushioned by their ill-gained wealth and structural advantage, are hurt by the sociopolitical repercussions of such a collapse, in the form of war, revolution or both.
 
The structural problem of the Chinese economy can be described in one sentence: China produces from plants on its soil financed by foreign investment that operate with low domestic wages for foreign markets that pay with dollars that cannot be used in the Chinese domestic economy.
 
The solution to this structural problem can also be summed up in one sentence: China must finance Chinese plants with sovereign credit to produce for the domestic market where consumer purchasing power will come from high wages, with sovereign credit repaid by increased tax revenue from a vibrant domestic economy.
 
The adverse impact from the current global financial crisis on the Chinese economy originates from the bloated export sector financed in large part by foreign capital denominated in dollars. Foreign markets have abruptly contracted since mid 2007 to cause massive closure of ten of thousands of foreign joint-ventures or wholly-owned enterprises, big, medium and small, in the Chinese export sector located along the coastal regions that has caused serious unemployment.
 
Economic recovery through the shifting from export dependency to domestic development requires coordinated actions by both the state and the private sectors. The government’s role is to guide state-owned-enterprises and private sector incentives toward a national full employment program through tax incentives and regulatory regimes. Government fiscal spending should be limited to funding infrastructure, both physical and social, that cannot be efficiently financed by private or even collective capital.  Consumer demand should be enhanced as a priority in a national income policy to quickly raise wage levels in parallel with a well-funded social security program to eliminate the need for compulsory over-saving out of concern for emergency health expenses and provision for old-age security. 
 
In conclusion, China can exert positive influence on a new world economic order by setting an example with its own national development policy. To achieve this goal, China needs to adopt the following policy initiatives:
 
1) China must recognize that a deregulated market economy is counterproductive to national development. The clear evidence of this is what deregulated markets have done to the US economy, destroying US superpower status within three decades. China must revitalize central planning to guide national development and to use the market mechanism only to augment central planning targets. National destiny and national interest cannot be subjected to the dictation of market profit incentives.
 
2) China must place full employment with rising wages as a national economic priority and shift from the current market fundamentalist macro management on GDP growth with unemployment as a natural outcome of a monetary policy of price stability. Economic equality and justice must be the guiding developmental principle within the context of merit-based compensation.
 
3) China must break free from dollar hegemony to use sovereign credit to finance balance domestic development and to reduce excessive dependence on export for dollars and reliance on foreign capital denominated in dollars. A first step in this direction is to require all Chinese export be settled in RMB, not in dollars.
 
4) China should conduct its foreign trade on principle of mutual development for both trading partners rather than as a financial profit center for Chinese capital. China must reject the predatory terms of international trade developed during the age of imperialism. Unlike 19^th century England and Japan, the huge size of the Chinese economy and its domestic market does not require imperialist terms of trade to survive. The US model failed because it aped the British model of empire after World War II. China must avoid making the same error. 
 
5) China must guard against the fallacy of hoping to use green-tech investment as a stimulus to recover from the current global financial crisis. The global environment needs protection. But the time scale difference between the needs of the environment is not congruent with that of the current global financial crisis. The environmental protection problem cannot be solved without first solving the global financial crisis. Attempting to use green-tech investment to jumpstart the current economic crisis is putting the cart before the horse. Such an approach will only end up falling short on both environmental and economic aims.    




Why China must buy US Treasuries with her Trade Surplus Dollars

By
Henry C.K. Liu


Many have suggested China is not compelled to buy US Treasuries with her trade surplus dollars. They point out that China does so voluntarily because US sovereign debt is the safest insturment as a storer of value.  This is now obviously no longer true. So why doess China continue to buy US sovereign debt? The answer is China has no other options but became a creditor to the US due to US-China trade imbalance. The following explains why.

A debt is not an independent thing. It is a designation of financial relationship between parties. For a debt to exist between parties, one party, or parties, must be the debtor, or debtors, and a counterparty or counterparties must be the creditor, or creditors. A debt cannot exist without a counterbalancing credit position.

Credit drives the economy, not debt.  Debt is the mirror reflection of credit. Even the most accurate mirror does violence to the symmetry of its reflection. Why does a mirror turn an image right to left and not upside down as the lens of a camera does? The scientific answer is that a mirror image transforms front to back rather than left to right as commonly assumed. Yet we often accept this aberrant mirror distortion as uncolored truth and we unthinkingly consider the distorted reflection in the mirror as a perfect representation.

In the language of finance economics, credit and debt are opposites but not identical.  In fact, credit and debt operate in reverse relations. Credit requires a positive net worth and debt does not. One can have good credit and no debt. High debt lowers credit rating. When one understands credit, one understands the main force behind the modern finance economy, which is driven by credit and stalled by debt.  Behaviorally, debt distorts marginal utility calculations and rearranges disposable income. Debt turns corporate shares into Giffen goods, demand for which increases when their prices go up, and creates what former Federal Reserve Board Chairman Alan Greenspan calls "irrational exuberance", the economic man gone mad.

Monetary economists view government-issued money as a sovereign debt instrument with zero maturity, historically derived from the bill of exchange in free banking.  This view is valid only for specie money, which is a debt certificate that can claim on demand a prescribed amount of gold or other specie of intrinsic value.  But fiat money issued by a sovereign government is not a sovereign debt but a sovereign credit instrument.  Sovereign government bonds are sovereign debt while local government bonds are agency debt but not sovereign debt, because local governments, while they possess limited power to tax, cannot print money, which is the exclusive authority of the Federal government or a central government.  When money buys bonds, the transaction represents sovereign credit canceling public or corporate debt.  This relationship is rather straightforward but is of fundamental importance.

Money issued by government fiat is now exclusive legal tender in all modern national economies.  The State Theory of Money (Chartalism) holds that the general acceptance of government-issued fiat currency rests fundamentally on government's authority to tax.  Government's willingness to accept the fiat currency it issues for payment of taxes gives such issuance currency within a national economy.  That currency is sovereign credit for tax liabilities, which are dischargeable by credit instruments issued by government in the form of fiat money.  When issuing fiat money, the government owes no one anything except to make good a promise to accept its money for tax payment.  A central banking regime operates on the notion of government-issued fiat money as sovereign credit.  A central bank operates essentially as a lender of last resort to a nation’s banking system, drawing on sovereign credit. A lender's position is a creditor position.

Thomas Jefferson famouslly prophesied: "If the American people allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive people of all property until their children will wake up homeless on the continent their fathers occupied ... The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs."   This warning applies to all other peoples in the world as well.

Government levies taxes not to finance its operations, but to give value to its fiat money as sovereign credit instruments.  If it chooses to, government can finance its operation entirely through user fees, as some fiscal conservatives suggest.  Government needs never be indebted to the public.  It creates a government debt component to provide a benchmark interest rate to anchor the private debt market, not because it needs money.  Technically, a sovereign government needs never borrow.  It can issue tax credit in the form of fiat money to meet all its liabilities.   And only a sovereign government can issue fiat money as sovereign credit.

If fiat money is not sovereign debt, then the entire conceptual structure of finance capitalism is subject to reordering, just as physics was subject to reordering when man's worldview changed with the realization that the earth is not stationary nor is it the center of the universe.  The need for capital formation to finance socially-useful development will be exposed as a cruel hoax, as sovereign credit can finance all socially-useful development without problem.  Private savings are not necessary to finance public socio-economic development, since private savings are not required for the supply of sovereign credit.  Thus the relationship between national private savings rate and public finance is at best indirect. 

Sovereign credit can finance an economy in which unemployment is unknown, with wages constantly rising to provide consumer buying power to prevent production overcapacity.  A vibrant economy is one in which there is persistent labor shortages that push up wages to reduce overcapacity.  Private savings are needed only for private investment that has no intrinsic social purpose or value.  Savings without full employment are deflationary, as savings reduces current consumption to provide investment to increase future supply, which is not needed in an economy with overcapacity created by lack of demand, which in turn has been created by low wages and unemployment.  Say's Law of supply creating its own demand is a very special situation that is operative only under full employment with high wages.  Say's Law ignores a critical time lag between supply and demand that can be fatally problematic to the cash-flow needs in a fast-moving modern economy.   Savings require interest payments, the compounding of which will regressively make any financial scheme unsustainable. The religions forbade usury for very practical reasons.

The relationship between assets and liabilities is expressed as credit and debt, with the designation determined by the flow of obligation. A flow from asset to liability is known as credit, the reverse is known as debt.  A creditor is one who reduces his liability to increase his assets, which include the right of collection on the liabilities of his debtors. Sovereign debt is a pretend game to make private monetary debts denominated in fiat money tradable.

The sovereign state, representing the people, owns all assets of a nation not assigned to the private sector.  This is true regardless whether the state operates on socialist or capitalist principles. Thus the state's assets is the national wealth less that portion of private sector wealth after tax liabilities, plus all other claims on the private sector by sovereign right.  High wages are the key determinant of national wealth.  Privatization generally reduces state assets while it may increase tax revenue.  As long as a sovereign state exists, its credit is limited only by the national wealth.  If sovereign credit is used to increase national wealth, then sovereign credit is limitless as long as the growth of national wealth keeps pace with the growth of sovereign credit. 

When a sovereign state issues money as legal tender, it issues a monetary instrument backed by its sovereign rights, which includes taxation. A sovereign state never owes domestic debts except by design voluntarily.  When a sovereign state borrows in order to avoid levying or raising taxes, it is a political expedience, not a financial necessity.  When a sovereign state borrows, through the selling of sovereign bonds denominated in its own currency, it is withdrawing previously-issued sovereign credit from the financial system.  When a sovereign state borrows foreign currency, it forfeits its sovereign credit privilege and reduces itself to an ordinary debtor because no sovereign state can issue foreign currency. Dollar hegemony prevents all states beside to US to finance their domestic development with sovereign credit.

Government bonds act as absorbers of sovereign credit from the private sector.  US Government bonds, through dollar hegemony, enjoy the highest credit rating, topping a credit risk pyramid in international sovereign and institutional debt markets.  Dollar hegemony is a geopolitical phenomenon in which the US dollar, a fiat currency, assumes the status of primary reserve currency in the international finance architecture.  Architecture is an art the aesthetics of which is based on moral goodness, of which the current international finance architecture is visibly deficient.  Thus dollar hegemony is objectionable not only because the dollar, as a fiat currency, usurps a role it does not deserve, but also because its effect on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments beside the US to use sovereign credit to finance the development their domestic economies, and forces them to export to earn dollar reserves to maintain the exchange value of their own currencies.

Money issued by sovereign government fiat is a sovereign monopoly while debt is not.  Anyone with acceptable credit rating can borrow or lend, but only sovereign government can issue fiat money as legal tender. When a sovereign government issues fiat money, it issues certificates of its sovereign credit good for discharging tax liabilities imposed by the sovereign government on its citizens.  Privately-issued money can exist only with the grace and permission of the sovereign, and is different from sovereign government-issued money in that privately issued money is an IOU from the issuer, with the issuer owing the holder the content of the money's backing.  But sovereign government-issued fiat money is not a debt from the government because the money is backed by a potential debt from the holder in the form of tax liabilities.  Money issued by a sovereign government by fiat as legal tender is good by law for settling all debts, private and public.  Anyone refusing to accept dollars in the US for payment of debt is in violation of US law.  Instruments used for settling debts are credit instruments.

Buying up sovereign bonds with government-issued fiat money is one of the ways government releases more sovereign credit into the economy. By logic, the money supply in an economy is not government debt because, if increasing the money supply means increasing the national debt, then monetary easing would contract credit from the economy.  But empirical evidence suggests otherwise: monetary ease increases the supply of credit.  Thus if fiat money creation by sovereign government increases credit, money issued by sovereign government fiat is a credit instrument.

Economist Hyman Minsky rightly noted that whenever credit is issued, money is created.  The issuing of credit creates debt on the part of the counterparty; but debt is not money, credit is.  Debt is negative money, a form of financial antimatter.  Physicists understand the relationship between matter and antimatter.  Einstein theorized that matter results from concentration of energy and Paul Dirac conceptualized the by-product creation of antimatter through the creation of matter out of energy.  The collision of matter and antimatter produces annihilation that returns matter and antimatter to pure energy.  The same is true with credit and debt, which are related but opposite.  They are created in separate forms out of financial energy to produce matter (credit) and antimatter (debt).  The collision of credit and debt will produce annihilation and return the resultant union to pure financial energy un-harnessed for human benefit. The paying off of debt terminates financial interaction.

Monetary debt is repayable with money.  Sovereign government does not become a debtor by issuing fiat money, which, in the US, takes the form of a Federal Reserve note, not an ordinary bank note. The word "bank" does not appear on US dollars.  Zero maturity money (ZMM) in the dollar economy, is equal M2 plus all money market funds, minus time deposits. It measures the supply of financial assets redeemable at par on demand. ZMM grew from $550 billion in 1971 when President Nixon took the dollar off a gold standard, to $9.6 trillion as of December 2009, is not a federal debt.   It amounts to about 67.3% of US GDP of $14.26 trillion, slightly over the national debt of $12.33 trillion at the same point in time. Sovereign credit is what gives the US economy its inherent strength.

A holder of fiat money is a holder of sovereign credit.  The holder of fiat money is not a creditor to the state, as some monetary economists mistakenly claim.  Fiat money only entitles its holder a replacement of the same money from government, nothing more. The dollar, being a Federal Reserve note, entitles the holder to exchange the note to another identical note at a Federal Reserve Bank, and nothing else. The holder of fiat money is acting as a state agent, with the full faith and credit of the state behind the instrument, which is good for paying taxes and is legal tender for all debt public and private.  Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit.  It is a certificate of state financial power inherent in sovereignty.

The Chartalist theory of money claims that government, by virtual of its power to levy taxes payable with government-designated legal tender, does not need external financing.  Accordingly, sovereign credit enables the government to finance a full-employment economy even in a regulated market economy. The logic of Chartalism reasons that an excessively low tax rate will result in a low demand for currency and that a chronic government fiscal surplus is economically counterproductive and unsustainable because it drains credit from the economy continuously. The colonial administration in British Africa used land taxes to induce the carefree natives to use its currency and engage in financial productivity.

Thus, according to Chartalist theory, an economy can finance with sovereign credit its domestic developmental needs, to achieve full employment and maximize balanced growth with prosperity without any need for sovereign debt or foreign loans or investment, and without the penalty of hyperinflation.  But Chartalist theory is operative only in predominantly closed domestic monetary regimes. Countries participating in neo-liberal international “free trade” under the aegis of unregulated global financial and currency markets cannot operate on Chartalist principles because of the foreign-exchange dilemma.  Any government printing its own currency to finance legitimate domestic needs beyond the size of its foreign-exchange reserves will soon find its convertible currency under attack in the foreign-exchange markets, regardless of whether the currency is pegged at a fixed exchanged rate to another currency, or is free-floating.  Thus all non-dollar economies are forced to attract foreign capital denominated in dollars even to meet domestic needs.  But non-dollar economies must accumulate dollars reserves before they can attract foreign capital.  Even with capital control, foreign capital will only invest in the export sector where dollar revenue can be earned.  But the dollars that exporting economies accumulate from trade surpluses can only be invested in dollar assets, depriving the non-dollar economies of needed capital in domestic sectors. The only protection from such attacks on domestic currency is to suspend full convertibility, which then will keep foreign investment away.   Thus dollar hegemony, the subjugation of all other fiat currencies to the dollar as the key reserve currency, starves non-dollar economies of needed capital by depriving their governments of the power to issue sovereign credit for domestic development.

Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Dollar hegemony essentially taxes away the ability of the trading partners of the US to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will with relative immunity.

The Mundell-Fleming thesis, for which Robert Mundell won the 1999 Nobel Prize, states that in international finance, a government has the choice among (1) stable exchange rates, (2) international capital mobility and (3) domestic policy autonomy (full employment, interest rate policies, counter-cyclical fiscal spending, etc). With unregulated global financial markets, a government can have only two of the three options.

Through dollar hegemony, the United States is the only country that can defy the Mundell-Fleming thesis.  For more than a decade since the end of the Cold War, the US has kept the fiat dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized financial system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony which makes possible US finance hegemony, which makes possible US exceptionism and unilateralism.

When China exports real wealth to the US for fiat dollars, it is receiving US sovereing credit in exchange of material wealth in the form of goods. Thus the US trade deficit denominated in dollars is in fact US lending to China through buying Chinese goods on soveriegn credit.  China now is a  holder of US fiat money and as such is acting as a state agent of the US, with the full faith and credit of the USe behind the US sovereign credit instrument (dollar), which is good for paying US taxes and is legal tender for all debt public and private in the US.  Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit.  It is a certificate of state financial power inherent in sovereignty. Since China does not pay US taxes, the dollars that China recieves  can only be used to buy US sovereign debt (Treasuries) through extingusishing the US sovereign creidt instruents (dollars). Through this transaction, China changes its position from that of an agent of US sovereign credit to that of a creditor to the US. This is why China must buy Tresuries with its surplus dollar - to change it s poistion from that of a US agent to that of a US creditor.

The only way for China to become free of this dilemma is to require all Chinese exports to be paid in Chinese currency.

January 5, 2009