Skip to comments.China is killing the dollar: China could dump all US Treasury and agency bonds if relationship with America deteriorates further.
Posted on 09/19/2020 5:41:31 PM PDT by SeekAndFind
In the wake of the Feds promise of 23 March to print money without limit in order to rescue the covid-stricken US economy, China changed its policy of importing industrial materials to a more aggressive stance. In examining the rationale behind this move, this article concludes that while there are sound geopolitical reasons behind it the monetary effect will be to drive down the dollars purchasing power, and that this is already happening.
More recently, a veiled threat has emerged that China could dump all her US Treasury and agency bonds if the relationship with America deteriorates further. This appears to be a cover for China to reduce her dollar exposure more aggressively. The consequences are a primal threat to the Feds policy of escalating monetary policy while maintaining the dollars status in the foreign exchanges.
On 3 September, Chinas state-owned Global Times, which acts as the governments mouthpiece, ran a front-page article warning that
"China will gradually decrease its holdings of US debt to about $800billion under normal circumstances. But of course, China might sell all of its US bonds in an extreme case, like a military conflict," Xi Junyang, a professor at the Shanghai University of Finance and Economics told the Global Times on Thursday.
Do not be misled by the attribution to a seemingly independent Chinese professor: it would not have been the frontpage article unless it was sanctioned by the Chinese government. While China has already taken the top off its US Treasury holdings, the announcement (for that is what it amounts to) that China is prepared to escalate the financial war against America is very serious. The message should be clear: China is prepared to collapse the US Treasury market. In the past, apologists for the US Government have said that China has no one to buy its entire holding. The most recent suggestion is that Chinas Treasury holdings will be put in trust for covid victims a suggestion if enacted would undermine foreign trust in the dollar and could bring its reserve role to a swift conclusion. For the moment these are peacetime musings. At a time of financial war, if China put her entire holding on the market Treasury yields would be driven up dramatically, unless someone like the Fed steps in to buy the lot.
If that happened China would then have almost a trillion dollars to sell, driving the dollar down against whatever the Chinese buy. And dont think for a moment that if China was to dump its holding of US Treasuries other foreign holders would stand idly by. This action would probably end the dollars role as the worlds reserve currency with serious consequences for the US and global economies.
There is another possibility: China intends to sell all her US Treasuries anyway and is making American monetary policy her cover for doing so. It is this possibility we will now explore.
Most commentators agree that China has a long-term objective of promoting the renminbi for trade settlement. While China has made progress in this objective, they also agree that the renminbi will not challenge the dollars status as the reserve currency in the foreseeable future. Any changes in the relationship between the dollar and renminbi is therefore believed to be evolutionary rather than sudden.
Recent developments have dramatically altered this perspective. China is now aggressively stockpiling commodities and other industrial materials, as well as food and other agricultural supplies. Simon Hunt, a highly respected copper analyst and China-watcher put it as follows:
"Chinas leadership started preparing further contingency plans in March/April in case relations with America deteriorated to the point that America would try shutting down key sea lanes. These plans included holding excess stocks of widgets and components within the supply chains which meant importing larger tonnages of raw materials, commodities, foods stuffs and other agricultural products. It was also an opportunity to use up some of the dollars which they have been accumulating by running down their holdings of US government paper and their enlarged trade surpluses.
Taking copper as an example, not only will they be importing enough copper to meet current consumption needs but in addition 600-800kt to meet the additional needs of their supply chains and a further 500kt for the governed owned stockpile. The result of these purchases will leave the global copper market very tight especially in the next two years.
Other than the spread of Covid-19 lockdowns outside China, there was no specific geopolitical development to trigger a change in policy towards commodities, though admittedly relationships with America are on a deteriorating path. Rather than indulging in state piracy on the high seas, fears that the US could blockade Chinas imports would possibly be achieved by American action to prevent Western corporate commodity suppliers from supplying commodities in the same manner as America controls with whom the global banking system transacts.
China has already agreed import targets for American soya and maize, only partially delivered, due one presumes, to waiting for this years harvest. She has been buying soya from other cheaper sources, such as Brazil, but it is too early to say China is holding back on American imports as part of a trade negotiation strategy. It is the timing of Chinas policy to enact more aggressive purchases that is interesting: it coincided with or swiftly followed the Feds monetary policy change in late-March embarking on an infinitely inflationary course. Figure 1 points to this relevance.
The pecked line divides 2020 into two parts. First, we experienced the intensifying deflationary sentiment leading to the Feds rate cut to zero on 16 March, and then its promise of unlimited inflation in the FOMC statement which followed on 23 March. The second part is the inflationary period that commenced at that time as a consequence of those moves. The S&P 500 index then reversed its earlier fall of 33% and started its dramatic move into new high ground, and the dollars trade weighted index peaked, losing about 10% since then. Gold took the hint and rose 40%, while commodities turned higher as well, gaining a more moderate 20% so far. The gold/silver ratio collapsed from 125 to 72 currently, as the monetary qualities of silver resumed an importance. The S&P GCSI commodity index was initially suppressed by the WTI futures contract delivery debacle in April, but crude oils recovery has resumed. Both gold and commodities are clearly adjusting to a world of accelerating monetary inflation, where bad news on the economic front will accelerate it even more.
If Chinas decision to increase the rate of importation for commodities and raw materials did occur at that time, it is very likely that rather than solely based on geopolitical reasons, the decision was driven by Chinas reading of prospects for the dollar. When all commodity prices are rising, there can only be one answer, and that is the currency common to them all is losing purchasing power. And from its timing that is what appears to be at least partially behind Chinas decision to accelerate purchases of a wide range of industrial and agricultural materials.
With a reasonable level of commodity stockpiles before 23 March, China might have taken the more relaxed view of buying additional imported commodities as and when needed. But the one stockpile she has in enormous quantities is of dollars, of which about forty per cent is invested in US Treasuries and agency debt. A short trillion or so has been loaned to trading partners, predominantly in sub-Saharan Africa and South America, as well as partners in the land and sea silk roads. The indebtedness to China of her commodity suppliers makes further protection from American interference more difficult perhaps, supporting the thesis of China dumping dollars. Furthermore, we should add it is possible that China has hedged some of her dollar exposure anyway. If so, against what is not known but important commodities such as copper would make sense.
That China owns and is owed massive amounts of dollars confirms her primary interest was in a stable dollar. In March she will have found that position no longer tenable. She has cleared the decks with the Global Times front-page article, which assumes America will continue to escalate trade and financial tensions, thereby ignoring Chinas warning.
The likelihood that she has now abandoned a stable dollar policy has been missed by the mainstream commentary cited at the beginning of this article, yet the consequences for the dollar will be far-reaching. China is only the first nation using dollars for its external purchases to take the view it should get out of dollars as money and into something tangible. Others, initially perhaps other members of the Shanghai Cooperation Organisation, seem bound to follow.
The switch from a deflationary outlook to one of indefinite monetary inflation commits the Fed to purchase US Treasuries without limit. For this to be achieved will require the continued suppression of the cost of the governments funding, which in turn will assume that the consequences for prices are strictly limited, and that existing holders of US Treasuries do not turn into net sellers in unmanageable quantities. If the Fed is to succeed in its monetary objectives it will be required to absorb these sales as well, which could be on a scale to ultimately defeat the Feds funding efforts.
According to the latest US Treasury TIC figures, out of a total foreign ownership of $7.09 trillion US Treasuries, China owns $1.073 trillion of which according to the Global Times $300bn will definitely be sold.[iv] But then there is the other matter of $227bn in agency debt, and $189bn in equities, which added to the remaining $800bn Treasuries after Chinas planned sales tells us that there is a further amount of $1.2 trillion of securities that will be on the market if China sells all of its US bonds in an extreme case, like a military conflict. When an important holder begins to liquidate, others are sure to follow.
Until recently, the US Governments funding has not presented a problem, because the trade deficit has not been translated into a balance of payments deficit. Foreign exporters and their governments have held onto and even added to their dollars, which is how they have ended up with $20.534 trillion in securities, together with additional cash at end-June as well as T-bills and commercial bills totalling a further $6.227 trillion.
We know the relationship between trade and deficit nations demand for recycled monetary capital, because the relationship between the deficits and net savings form an accounting identity, summed up by the following equation:
(Imports - Exports) ≡ (Investment - Savings) + (Government Spending - Taxes)
The trade deficit is equal to the excess of private sector investment over savings, plus the excess of government spending over tax revenue. In basic English, if expenditures in the domestic economy exceed the incomes produced in it, the excess expenditures will be met by an excess of imports over exports. This is further confirmed by Says law, which tells us we produce in order to consume. If we decrease our savings and the government increases its spending, there will be less domestic production available relative to enhanced consumption. The balance will be made up by imports, giving rise to a trade deficit.
It follows that a decline in the currency can only be deferred for as long as importers are prepared to increase their holdings, in this case of US dollars, instead of selling them.
So far, we have not adequately addressed the impact on monetary policy, and how it affects prices in the context of trade imbalances and capital flows. We know from the relationship of the budget deficit with the trade deficit that other things being equal the rapid increase in the US budget deficit will lead to an equally dramatic increase in the trade deficit. This is not something the US Government is prepared to tolerate, and China would become even more of a whipping boy with regard to trade.
In terms of capital flows, China is disposing of dollars and buying commodities just at the moment the USs budget and trade deficits are spiralling out of control. At the same time, she is adjusting her economic policies away from reliance on export surpluses to enhancing living standards for its population by promoting infrastructure spending and domestic consumption. By encouraging consumers to spend rather than save, the accounting identity discussed above tells us that Chinas trade surpluses will tend to diminish, and consequently exchange rate policies will move from suppressing the renminbi exchange rate to make exports artificially profitable.
We can see this effect in Figure 2. Given the time between a central government directive and its implementation, the turn in the yuans trend in May seems about right in the context of a change of commodity purchasing policies initiated by central government a month or two before.
In the case of the US, the accounting identity which explains how the twin deficits arise informs us that in the absence of the balance of payments surplus which America has enjoyed heretofore we must consider new territory. If foreign importers dump their dollars there are two broad outcomes. Either the quantity of dollars in circulation contracts as the exchange stabilisation fund intervenes to support the exchange rate, thereby taking them out of circulation. Or they are bought by domestic buyers, at the expense of the exchange rate but remaining in circulation. It should now be apparent that attempts to maintain the exchange rate and accelerate monetary stimulation, which is the Feds post-March policy, are bound to fail.
Whether America decides to increase tariffs or ban Chinese imports altogether is immaterial to the outcome. The problem is rapidly becoming one of increasing quantities of inflationary money chasing a reducing quantity of American produced goods while imports are tariffed or blocked. And domestic production is also hampered by coronavirus lockdowns and the desire of bankers to decrease lending risk to the non-financial sector.
Anything the US Government does in an attempt to reduce the trade deficit without reducing the budget deficit is bound to lead to additional price inflation, or put another way, a reduction in the dollars purchasing power. We dont know for sure, but it is reasonable to assume the planners in Beijing will have worked at least some of this out for themselves. If so, Americas exorbitant monetary privilege will no longer be at Chinas expense.
It is increasingly difficult to see how a cliff-edge for the dollar can be avoided. Decades of benefiting from Part 1 of Triffins dilemma, whereby it is incumbent on the provider of a reserve currency to run deficits in order to ensure adequate currency is available for that role, is coming to an end. Those who cite Triffin tend to ignore the stated outcome; that Part 2 is the inevitable crisis that arises from Part 1. And with over 130% of current US GDP represented by dollars and securities in foreign hands, Triffins cliff-edge beckons.
If China is to prosper in a post-dollar world it must be ready to adapt its mercantile model accordingly. The evidence is that it planned a long time ago for this eventuality. Its Marxist roots from the time of Mao informed Chinas economists and planners that capitalism would end inevitably with the destruction of western currencies.
Since those days, Chinas economists have adapted their views towards the macroeconomic neo-Keynesianism of Western governments. While this is a natural process, the extent to which their earlier Marxian philosophy has been changed is not clear. And while this leaves a potentially dangerous lack of theoretical understanding of money and credit, we can only assume Western currencies are still viewed as inferior to metallic money.
It was Deng Xiaoping who led China following Maos death until 1989 and authorised monetary policy. And it was he who set Chinas policy on gold and silver. On 15 June 1983 the State Council passed regulations handing the state monopoly of the management of the nations gold and silver and all related activities, with the exception of mining, to the Peoples Bank of China. Ownership of both metals by individuals and any other organisation remained unlawful until the establishment of the Shanghai Gold Exchange in 2002, since when it is estimated on the basis of withdrawals from the SGEs vaults that publicly owned gold has accumulated to over 15,000 tonnes.
Since then, China has moved gradually but surely to gain control over physical gold markets and to become the worlds largest miners, both in China and through the acquisition of foreign mines. The Shanghai Gold Exchange dominates physical markets both directly and through ties with other Asian gold exchanges. Joining these dots leaves one dot concealed from us; and that is the true extent of physical gold owned by the Chinese state.
We can assume that China started from a position of some gold ownership when the 1983 regulations were enacted. The fact that precious metals other than gold and silver were excluded is in accordance with the Chinese view of gold and silver as monetary metals. And the permission for the general population to buy gold and silver on the establishment of the Shanghai Gold Exchange in 2002 suggests that in the nineteen years since 1983 the state had accumulated sufficient gold and silver for its anticipated needs.
In Dengs time, foreign exchange activity at the Peoples bank was frenetic, with inward capital flows as foreign corporations established manufacturing operations in China. From the 1990s, while these flows continued, they were more than compensated by growing trade surpluses. Taking into account these flows and the contemporary bear market in gold prices, it is possible (though not provable) that the state accumulated as much as 20,000 tonnes.
Whatever the actual amount, little or none of this is declared as monetary gold. A strict policy of no gold exports has been enforced ever since with the sole exception of limited quantities for the Hong Kong jewellery trade, which ends up being bought and reimported by day-trippers from the Mainland.
Even though state economists have increasingly used neo-Keynesian policies to artificially stimulate Chinas economy, we should be in no doubt about Chinas Plan B. It is not for nothing that she has deliberately taken control of physical gold and even run advertising campaigns through state media, following the Lehman crisis, urging her people to acquire it.
We cannot yet say when, how or if China will introduce gold-backing to ensure the yuan survives intact the problems faced by the dollar. But for now, with the new policy of a rising yuan illustrated in Figure 2 above, the impact on domestic costs for imported raw materials will be reduced and we can expect the yuan/dollar rate to continue to increase accordingly.
Chinas threat to dump US Treasuries in an extreme case, like a military conflict is an important development for the dollar. It was a clear shot across Americas bows, and will have been seen in that context by the American administration. We have yet to see a response.
A firm plank of American monetary policy has been to suppress the price effects of monetary inflation. In the case of commodity prices, this has been achieved through the expansion of derivative substitutes acting as artificial supply. For the moment, the deteriorating outlook for the global economy persuades the macroeconomic establishment that demand for industrial commodities and raw materials will ameliorate, leading to lower prices. But this view does not take into account the changing purchasing power of the dollar.
At some point the threat to the dollar will be taken seriously. But before then, the political imperative in the run up to the presidential election is likely to continue and even intensify pressure on China. But Chinas renewed determination to dump both dollar denominated bonds and dollars is a developing crisis for America and the Feds monetary policy. We can expect further threats to materialise from the Americans to Chinas ownership of US Treasuries and agency bonds. It is a situation that could threaten to escalate rapidly out of control before China has disposed of the bulk of her dollar-denominated bonds.
The certain victim will be the dollar. And as the dollar sinks, China will be blamed and tensions are bound to escalate between China and her Asian partners on one side, and America and her security partners on the other. The start of this additional crisis was the turning point last March, when the Fed publicly stated its inflation credentials. With nearly $3 trillion in its reserves, it is not surprising that China is acting to protect herself.
With so much dollar debt and dollars in foreign ownership, it is hard to see how a substantial fall in the dollars purchasing power can be avoided and the Feds funding of the budget deficit badly disrupted.
Yet another gold bug publication talking its book.
Baloney, juan is higher now than 5 years ago, the bonds they hold a good bonds at higher interest rates, US will buy back all bonds, CCP is talking about 20% of their holds, ain’t squat. Just CCP prop!
RE: Yet another gold bug publication talking its book.
OK, can you tell us if you disagree with this article or not, and if so, why?
Be a damn shame if all those Chinese Generals lost their mansions and luxury cars.
They park their money in Treasury and Agency bonds not because they like Americans, but because there's no place else to put it that won't cost them a bundle of money getting in and out.
The Chinese are chasing a chimera. They want an appreciating currency without also running trade deficits. That's the equivalent of trying to create a perpetual motion machine. It's something only people brought up on Marxist cant or an exaggerated belief in their own abilities could believe.
Reserve currency status isn't the reason the US became the world's largest economy. The causation runs in the opposite direction. The US dollar became the world's major reserve currency only almost 50 years after the US became the #1 economy in the world. It took on this burden (which essentially requires the US, previously a trade surplus country, to run trade deficits for as long as its currency is the major reserve currency) to help the Free World's economies to recover in the wake of WWII. The rest of the Free World is no longer on the verge of starvation. It's time someone else took on the costs of being the major reserve currency. The near zero interest rates on offer today are the Federal Reserve's way of saying that it is time for some other currency to start taking up the responsibility for running the large trade deficits that come with major reserve currency status.
The dollar is one of several reserve currencies, forming ~60% of the reserves of the world's national treasuries. The euro is ~20%. The principal reason the euro's only ~20%? EU member countries are responsible for their own bonds. Nobody wants Greek bonds and the potential haircuts in the event of default. There's an excellent Quora response that laid out the reasons why reserve currency status isn't all it's cut out to be:
First off, let’s get rid of one misconception that you seem to share with dozens of other people on Quora. The dollar is not “the world’s reserve currency.” It is “the world’s major reserve currency.” Any currency can be held as a reserve currency. There are no laws about this and it’s up to each country to decide what they want to hold, of course. Nobody declared that each country has to hold the bulk of its foreign exchange reserves in USD, it’s just the result of individual decisions by each country.
As far as we know, the dollar accounts for 63% of reserves, EUR is 20%, and then there are the rest. Take a look at the IMF’s breakdown of reserves by currency at http://data.imf.org/?sk=E6A5F467...
So why is USD the world’s major reserve currency? Why have most countries elected to hold the bulk of their reserves in USD? To fulfill this role, a country has to have:
- large, liquid financial markets capable of taking huge investments (there are currently at least $6.3tn – that’s trillion dollars -- in reserves held in USD, and probably closer to $7.2tn);
- a reputation for safety and rule of law, so that other countries are willing to invest billions and billions of dollars in that country’s government securities; and
- a willingness to run current account deficits indefinitely, since that’s the counterpart of a financial account surplus. (I’ll explain this later)
I think you’ll find that at the moment, there is only the US that fits all three criteria, and I don’t see any other country volunteering to take its place any time soon. What other country’s bond market could take even half that amount? As far as I know, only Japan, and they have shown zero interest – in fact significant negative interest – in having their currency play this role. (Negative interest = they discourage people from doing this.) The Chinese government bond market is also large and growing, but of course China has an estimated $1tn or more in USD reserves – where can it put that money besides USD?
On the contrary, most countries fight to prevent their currency from being held as a major reserve currency, since that causes the currency to appreciate, dampens growth, and causes unemployment. That’s what all this “currency wars” talk is about. Here’s why:
In order to accumulate foreign exchange reserves, central banks buy assets (mostly government bonds) denominated in the currencies of other countries. In this case, we have foreign central banks buying billions and billions of dollars worth of US government securities. This causes the US to run a financial account surplus. (A financial account surplus means foreigners buy more USD-denominated assets than US-based investors buy in foreign assets.)
If the US runs a financial account surplus, by definition it has to run a current account deficit, unless the government intervenes heavily. The current account is mostly made up of trade in goods & services. (That’s because money coming in has to equal money going out.)
So the fact that the USD is the world’s major reserve currency is one of the main reasons why the country has run a current account deficit for most of the last 30 years. (This by the way is known as the Triffin dilemma
— a dilemma identified in the 1960s by the economist Robert Triffin, who realized that any country that dominated world FX reserves would have a consistent current account deficit that would gradually undermine the value of that currency.)
To put it in simpler terms, if the USD weren’t the world’s major reserve currency, probably its value would have fallen, US exports would be more competitive, and more people in the US would have jobs making goods for exports. On the other hand, probably fewer people in China, Germany and Mexico would have jobs making things for export to the US. Do you think that’s a good thing or a bad thing? Probably your view on this depends on whether you work in a factory in the US or China.
While some people have said that the use of the dollar as the world’s major reserve currency is an “exorbitant privilege,” other people argue that it’s actually an “exorbitant burden” for just this reason. See this article by Prof. Michael Pettis, An Exorbitant Burden or this one on his blog, The Titillating and Terrifying Collapse of the Dollar...Again
So we can see that:
- The USD is not going to lose its position as the world’s major reserve currency any time soon, for a variety of reasons, the simplest of which is that there is no possible alternative under the current monetary system;
- It’s virtually inconceivable that it could lose its position as a reserve currency totally; and
- It might be a good thing for the US economy – or at least the average US worker – if it did lose that position. As several people here have pointed out, GBP used to be the world’s major reserve currency. It’s now a relatively small part of global reserve (4.5%). Yet life seems to go on OK in Britain.
Footnote: By the way, let me explain a bit why the euro can’t fulfill this role. The problem with the euro is that there are no eurozone bonds, there are only national bonds (i.e., bonds issued by the individual countries). Now remember, why does a country issue bonds? Because it has a budget deficit. Therefore, the largest national bond markets are going to be those of the countries with the largest government deficits. These are precisely the countries whose bonds you don’t want to buy. So within the eurozone, the biggest bond market is the perennially fiscally challenged Italy (EUR 2.4tn outstanding), followed by France (EUR 2.09tn). By comparison, there’s only EUR 1.3tn in German bonds outstanding, not far above the EUR 1.23tn for much smaller Spain (49mn people vs 81mn. So the problem with the euro is not the lack of EUR-denominated assets, it’s the lack of attractive, trustworthy EUR-denominated assets.
No matter how indebted the US government gets, at the end of the day the US Treasury and the Fed are going to work together to avoid defaulting. Not necessarily so with the euro, as we’ve seen with Greece — the ECB and the other EU countries won’t necessarily bail out Italy if it can’t pay its bills.
The Swiss definitely don't want their franc to be a reserve currency. In the 1970's, they imposed a 41% tax on Swiss franc accounts opened by foreign depositors. Today, they have a central bank rate of -0.75%, meaning countries that want to hold their reserves in Swiss francs must pay the Swiss central bank for the privilege.
Maybe we can buy them back at $.10 on the dollar...
“That’s the equivalent of trying to create a perpetual motion machine.”
Like the Fed?
Selling a Book,
I can’t follow this
Post much less 20 pages
For Fifty bucks.
Fug get about it!
[Like the Fed?]
America is the #1 purchaser in the world. We are a country of consumers and we buy a ton of products. The communist Chinese may be evil but they’re not stupid. Kill the dollar and Americans stop consuming. No consuming and Chinese businesses get hit hard. If they wanted to crash our economy, they should have done it during the height of the American COVID shutdown.
For 20 years I’ve been hearing gold bugs promise that metals were about to go through the roof and it still hasn’t happened. But they sure love panic buyers that resemble preppers.
LOL -- China's debt problem is much larger than ours. Plus this 'plan' will leave China with essentially no export markets due to a surging Yuan and falling dollar. China's productive capacity is far in excess of domestic demand, despite the CCP's endless loans to bankrupt enterprises to maintain employment.
Here's a more likely scenario: the CCP takes a gamble on a short war to justify the internal reforms necessary for its own economy, hoping (at best) for the easy acquisition of Taiwan and at worst a stalemate that allows the CCP to utterly destroy any internal opposition and make the needed chnages to its internal markets.
Trump, if pushed far enough, could use executive authority to render the bonds worthless. If he announced even the possibility of such the bonds would become unsalable as buyers would be concerned they could be stuck holding the bag.
This action, if taken, would render the rest of the outstanding bonds a little bit more trustworthy...this due to the slight lessening of US debt.
The US Dollar strengthens during a global recession, just like it did during the last one. Gold bugs need to understand basic economics when it comes to the world's debt-based money supply.
China is a factory nation - nothing more. Its economy will crash and burn if we stop buying their junk. Their only hope would be to increase sales to the other BRIC nations. Russia will have no interest, and India hates them. Brazil is ticked about the Chinese virus.
China is in a world of hurt - not the United States, or the US Dollar.
If China did that, China would have no influence over US policy. The US could completely be independent upon China.
China will have to sell at an additional discount. Its bonds are already out there.
A pro China puff piece.
It’s rather simple choice at this time.
Who do you trust.
Riiiiiiiiiiiight. Either that, or Xi will be late for dinner because he's got to finish delivering the news to his paper route on Mars.
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