*****Food Riots and the Mass Liquidation of Foreign Exchange Reserves*****

As I wrote yesterday, riots are spreading as the global food shortage worsens. It is the reaction of central banks to these intensifying food riots which will bring down the dollar.

Nearly two years ago, I wrote how spiking food prices would lead to a dollar liquidation.

(emphasis mine)

Competitive Currency Appreciation

… spiking food prices will likely cause competitive currency appreciation. Foreign exchange reserves exist for just this time of emergency.
Central banks around the world will lower domestic food prices by either directly selling off their reserves to appreciate their currencies or by using them to purchase grain on the world market.

Appreciating a currency is the fastest way to control food inflation. A more valuable currency allows a nation to monopolize more global resources (ie: the overvalued dollar allows the US to consume 25% of the world's oil despite having only 4% of the world's population). If China were to selloff its US reserves, its enormous population would start sucking up the world's food supply like the US has been doing with oil.

On the flip side,
when a nation appreciates its currency and starts consuming more of the world's resources, it leaves less for everyone else. So when china appreciates the yuan, food shortages worldwide will increase and prices everywhere else will jump upwards. As there is NOTHING THAT BREEDS SOCIAL UNREST LIKE SOARING FOOD PRICES, nations around the world, from Russia, to the EU, to Saudi Arabia, to India, will sell off their foreign reserves to appreciate their currencies and reduce the cost of food imports. In response to this, China will sell even more of its reserves and so on. That is competitive currency appreciation.

When faced with competitive currency appreciation, you do NOT want to be the world's reserve currency. The dollar is likely to do very poorly as central banks competitively appreciate their currencies by selling off their US holdings.

My reaction: Countries around the world now have the choice between waiting for food riots to turn into violent revolution (as has already happened in Tunisia) or selling off their foreign reserves to lower food prices. Not much of a choice.

Soon central banks around the world will be competing to liquidate hundreds of billions of treasury holdings in a desperate bid for domestic stability. The process has already begun.

Example of competitive currency appreciation: ALGERIA

The Wall Street Journal reports that Algeria Seeks to End Food Riots.

JANUARY 10, 2011, 5:26 A.M. ET
Algeria Seeks to End Food Riots But 14 Die in Tunisia

The Algerian government over the weekend said it will reduce tax and import duties on some staples in a bid to end days of deadly clashes between police and rioters protesting food prices in the North African country.

Despite the recent unrest, analysts say
THE GOVERNMENT'S HEALTHY FOREIGN-EXCHANGE RESERVES, estimated at about $150 BILLION, would allow it the flexibility that poorer countries lack, including THE ABILITY TO BOOST ALREADY-HEFTY FOOD-PRICE SUBSIDIES. Indeed, Algeria's cabinet met Saturday and agreed to "temporary and exceptional exemptions" on import duties, value-added tax and corporate tax for sugar and food oils. A statement issued by Prime Minister Ahmed Ouyahia said THE NEW MEASURES ARE AIMED AT CUTTING PRICES MORE THAN 40%.

My reaction: Two key points from extract above:

1) Algeria is boosting food-price subsidies by tapping its foreign-exchange reserves. Algeria's $150 billion worth of US treasuries are being sold to lower food prices.

2) Algeria's moves to reduce domestic food cost will increase its food imports, driving up prices for the rest of the world and increasing pressure on other nations to follow suit.

Conclusion: With food prices still spiralling higher, there is nothing that can save the dollar from the imminent mass liquidation of foreign exchange reserves.

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2 Responses to *****Food Riots and the Mass Liquidation of Foreign Exchange Reserves*****

  1. trevbus says:

    Congrats Eric, you called it right.

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