China and Russia ceased using the dollar for bilateral trade and will go forward exchanging rubles and yuan. Image: CC squeakymarmot/Flickr

China and Russia announced Wednesday they will no longer trade with each other using the U.S. dollar. The announcement came as top officials from China and Russia met in St. Petersburg to forge bilateral cooperation in trade and energy. The China-Russia dollar decision isn’t seen as detrimental to U.S. currency and could force the value of the yuan in line with other global currencies.

China and Russia quit using dollar for bilateral transactions

China, Russia and the dollar formally ended a long relationship Wednesday. China and Russia are former enemies that required importers from each country to use a third-party currency for bilateral transactions. The dollar was the third-party currency of choice, and last year Russia-China trade was valued at $38.8 billion. Russia-China trade is expected to reach $60 billion in 2010. As of Nov. 24, either rubles or yuan must be used for all Russia-China trade.

Behind the China-Russia dollar move

The Russian ruble is already traded on the Chinese stock exchange. The Chinese yuan is expected to start trading in Moscow in December. The International Business Times reports that the China-Russia dollar move isn’t intended as a challenge to the U.S. Rather, it is a precautionary measure aimed at mutual protection of the two countries’ economies in the aftermath of the global financial crisis. A China-Russia oil deal may be the main reason for the switch from the dollar. A new Siberian oil pipeline will soon pump 1 billion barrels of Russian oil into China every year. Russia wants its commodities exchange to trade for oil in rubles.

The international currency issue

The China-Russia dollar move isn’t expected to change the dollar’s role in international trade. According to Joe Weisenthal at Business Insider, China and Russia switching to yuan and rubles for bilateral trade is something the world has been waiting for. The U.S. in particular wants the yuan to become a real trade currency, valued on the same level in relation to other currencies, instead of being manipulated by the Chinese government.

Sources

International Business Times

Business Insider

NASDAQ

Keynesian economics lie at the center of the political debate over government spending, deficit reduction and economic recovery. Image: CC Ivy Dawned/Flickr

Keynesian economics advocates using government spending in hard times to stimulate consumption and economic growth. A wave of austerity measures sweeping through Britain signals that Keynesian economics are being abandoned in the birthplace of John Maynard Keynes. American conservatives are using the example of Britain and the struggling U.S. economy to declare Keynesian economics dead.

Keynesian economics 101

Keynesian economics is based on the cycle of money. Spending by one person creates earnings for another in a healthy economy. During the Great Depression people stopped spending, the cycle of money stopped, and the economy tanked. Keynes argued that the government must spend to revive the cycle of money. He was ridiculed by proponents of laissez-faire capitalism, the most popular economic theory of the time. Keynes’ ideas were taken to heart by the Roosevelt administration, which spent to build roads, dams and other public works projects. Then World War II came along with massive government defense spending and the U.S. economy boomed for 50 years.

Europe rejects Keynesian economics

The global financial crisis exposed massive government deficits in Europe as the continent’s economy crashed. U.S. Treasury Secretary Timothy Geithner recommended Keynesian economics to European governments. Instead, Europe is heading the other way with austerity measures. Britain is cutting $130 billion in spending that will erase 500,000 jobs and affect the military, pensioners, the middle class and the poor. Nobel Prize winner Joseph E. Stigliz told The Guardian that the British government’s plan will result in less growth, less tax revenue and higher national debt.

Keynesian economics and the midterm election

A U.S. economy that remains sluggish despite billions in government stimulus has conservatives arguing that the Obama administration should follow Britain’s example. Right wing pundits eagerly anticipating Republican gains in Congress are trumpeting the 2010 midterm election as the official declaration that Keynesian economics have failed. The White House cautions that an abrupt end to government economic stimulus will extend the downturn. Conservatives argue that the economy has stabilized, and it’s time to wean the country from deficit spending.

Sources

Wisegeek.com

New York Times

National Review

A China interest rate hike caught the world off-guard and shows the government is more worried about inflation than it is willing to admit. Image: CC peruisay/Flickr

The first China interest rate hike since 2007 caught analysts by surprise and knocked  world markets off-kilter. The Chinese government offered no explanation, but consensus among experts is China has recognized the need to stem inflation in its economy. Fears that the China rate hike could drag on global recovery sent stock markets in Europe and the U.S. downward Tuesday, but some analysts think China will avoid any significant economic slowdown as it prepares for a 2012 leadership transition in the communist party.

The China interest rate hike

The China interest rate hike raises benchmark one-year lending and deposit rates by 0.25 percentage points. The New York Times reports that the China rate hike is proof that the Chinese government is struggling to control inflation, skyrocketing housing prices and an economy overly dependent on exports and excess investment. Many economists stress that China should raise the value of its currency, the renminbi, to fight inflation and increase imports. But the Chinese government fears that allowing the renminbi to rise will kill tens of millions of export jobs. Instead, it hopes the China rate hike will slow growth, get lending under control and encourage saving.

China’s overheating economy

A huge economic stimulus package and aggressive lending by state-run banks pushed China out of the global financial crisis in 2008. CNN reports that since then, the Chinese economy has expanded rapidly while western economies remain sluggish. China’s gross domestic product grew at a 10.3 percent annual rate in the second quarter. U.S. GDP rose 1.7 percent. China’s exploding GDP has lead to soaring wages, food prices and real estate values. Consumer prices in China rose 3.5 percent in August spurred by a 7.5 percent increase in food prices. Real estate prices rose 9.1 percent compared to a year ago in China’s largest cities.

Why China’s rate hike won’t work

Michael Pettis at Business Insider said that the China rate hike is too little to offset its inflation rate. China’s economy is so dependent on artificially low interest rates, the smallest increase will cause financial distress. Pettis writes that more China rate hikes in the near future may put a dent in the country’s over-reliance on excess investment. But with a communist leadership change looming in 2012, that is unlikely, no matter how badly China needs it.

A gold bubble burst would hurt investors who dumped their portfolios into gold as a safe haven during the global financial crisis. nathalielaure/Flickr photo.

Talk of a gold bubble burst is spreading. Investors have perceived gold as a safe haven during the global financial crisis. But after rising in value steadily since October 2008, the gold bubble may be reaching the bursting point as the global financial crisis fades. If the markets continue to rally, the demand for so-called safe investments like gold will fall. For those investors who bought gold when it reached a record high of $1,266.50 on June 21, a further drop from the Aug. 3 level of about $1,185 could be disastrous.

Signs of a bursting gold bubble

Some say the gold bubble is about to burst because gold prices are too volatile. Brian Rezny at Seeking Alpha writes that India and China, the world’s first and second largest gold markets respectively, are buying a lot less gold. He said that gold is a commodity with a value based entirely on the assumption that it will increase in price. Gold became a safe haven during the global financial crisis based on perception. The only reason gold is valuable is because investors have believed it is valuable. A gold bubble burst would change that perception overnight.

Markets overreact to European credit crisis

One reason the gold bubble may be about to burst is because the markets may have exaggerated the effects of the credit crisis in Europe to the global economy, according to Ron Acoba at Daily Markets. With recent news about the surprise earnings of European and U.S. banks, Acoba said the effect of the credit crisis on their business turns out to be minimal. Rezny said that the gold bubble is about to “end in tears,” and that the recent decline in gold prices will get worse. He reminds us that back in 1980, gold was used as an inflation hedge, and it peaked at $850 an ounce. Adjusted for inflation, that $850 was equal to $2,300. And then it tanked, falling to $253 by 1999.

A safe haven gets risky

The gold bubble is precariously large as millions of people are buying gold. Celebrities are endorsing gold. Hucksters like Glenn Beck are convincing average people to dump a large percentage of their investment portfolios into gold — even their life savings — to be safe when the global economy collapses into the stone age. Beating Broke wonders what will happen if (when?) the economy recovers. Those who bought gold at $1,100 and $1,200 an ounce may see the gold price adjust back down to something like $800 or $900. If these investors lose 30 percent of their savings or portfolio, the gold bubble will burst. The price of gold will drop even further as people rush to sell off their holdings. True believers in gold will lose even more.