Two stories crossed the financial newswires in the last couple of days. Seemingly unrelated to each other, one of the stories got lots of attention, the other did not.

The story that got lots of attention was that the Treasury Department, in the harshest terms to date, once again prodded China to begin the process of floating its currency. They were informed that if the current trend continues they will soon meet the technical definition of currency manipulation, and then things will get ugly.

They were urged to at least adjust the peg a little - the idea being that the U.S. dollar will decline in value relative to the Chinese yuan, consumer prices for Chinese made goods will rise, thereby reducing demand, and the great re-balancing can begin. The re-balancing, that is, of a massive trade deficit that defies comparisons to anything other than a third world country furiously operating a printing press to buy goods from abroad.

The other story, the one that got much less attention, detailed the sudden loss of appetite, on the part of foreign central banks, for acquiring more U.S. debt. The way things work in today's global fiat money free-for-all is that piles and piles of U.S. dollars accumulate in foreign central banks. This is a result of foreign businessmen taking the U.S. dollars they receive from their U.S. counterparts and exchanging them for the local currency.

And, what does one do with a surplus of U.S. dollars? In the past few years, Japan and China have been prolific buyers of U.S. debt of all kinds - this has had a calming affect on the U.S. bond market. It has contributed to the otherwise inexplicable levitation of longer dated bond prices and hence lower interest rates to fuel the housing bubble, also known as the U.S. economy.

Now, the biggest buyers of U.S. debt in recent months are hedge funds from Caribbean banking centers, who some say are covering short positions - there are other much more interesting theories about the nature of these purchases ... but we digress.

So, is there a connection between these two stories?

Probably not, but consider that the very public prodding of China on its currency peg was associated with a report released just yesterday, whereas, the data regarding foreign purchases of U.S. debt was for the month of March - plenty of time to take the offensive in what many believe is the inevitable conflict associated with squaring the trade imbalances. This administration clearly has a penchant for acting pro-actively.

Even if this is completely off the mark, the possibilities should still be considered ...

Has the bartender finally tired of accepting IOUs from his best customer? The drunk that keeps coming back, day after day, buying more and more drinks for he and his friends, but who must always be extended credit for a good portion of his bill.

IOUs have been stacking up behind the bar, and they continue to stack up - based on the drunk's recent behavior, it is unlikely that any of the currently held IOUs will be paid any time soon, but it would be an encouraging sign if the pile stopped rising, even if for just a short period of time.

But it is hard to confront your best customer. What happens if he is offended and goes elsewhere for his libations. Additional staff have been added to accommodate the increased business associated with this one customer, and if he reduces his consumption, there will be less work for all the employees - cutbacks may be required.

And then the employees may revolt.

They've become accustomed to their new found income and prosperity - a days pay for a days work, hard workers all, and lots of hard work to be done due to the spending habits of this one customer. The customer who speaks frequently about what he is going to do to resolve this now uncomfortable relationship with the bartender, but who does little to follow through - actions, not words is what the bartender wants to see.

So, the bartender finds himself stuck in the middle.

It is time to send a subtle message to the drunk - to discreetly indicate his displeasure with the current arrangement and how it increasingly appears that the customer is not going to change his ways.

And how does the drunk react? He becomes offended. He demands that the bartender raise his prices. You see, if the bartender raises his prices, then the drunk will buy less. If the drunk buys less, then there will be money left over to start paying off some of the IOUs, and the relationship will return to a more normal buyer-seller relationship.

Now the bartender is offended.

© 2005 Tim Iacono
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