China to shift reserves out of dollar to Euro

The Chinese appear to have finally come to the limit of their ability to support the dollar as an international currency.

The Bush administration has been able to run massive deficits because the Chinese, Japanese and oil producing nations have been buying American bonds. The largest purchaser has been the Chinese, because it supported the dollar and their sales to the U.S. have been a major part of Chinese economic development.

As the Chinese slow their purchases of U.S. bonds, the dollar will drop in value in international financial markets. This will lead to an increase in the cost of oil and to inflation in America.

Inflation in America will lead the Federal Reserve to either increase interest rates (leading to recession) or accepting the inflation to jump-start the already declining American economy. My bet is that the fed will accept the inflation, because further increases in the interest rate will cause the economy to immediately decline just as the elections in November are approaching.

The Republican majorities in the House and Senate will not survive both the current Republican scandals AND a declining economy. The fed sets interest rates to first elect Republicans, so watch for inflation in 2006. The fed will not be able to prevent it.

See the Washington Post Article for the Chinese economic actions.