For the last several years, the U.S. has been pressuring the Peoples Republic of China to allow her currency to appreciate against the dollar. The plea has been delivered personally and repeatedly by the President, our Secretary of State and the Treasury Secretary. It has been rejected by every Chinese leader – out of hand – at every level, sometimes with responses that countries whose economies are in turmoil shouldn’t be telling countries with longer term sustainable growth what to do (and I’m being polite in my paraphrase). China’s renminbi (also called the yuan) has floated in lockstep with the dollar, assuring local Chinese manufacturers that dollar devaluation wouldn’t reduce the level of exports to the United States; the balance of payments – although slightly moderated in the meltdown – still tilt very heavily towards China ($227 billion in 2009 but accelerated in the first half of this year; we also have a huge imbalance with Germany, Japan and Saudi Arabia). Foreign leaders have also pushed China to allow its currency to appreciate, requests that have fallen on deaf ears.
The dollar has been appreciating against the battered “Greece is collapsing and Spain is right behind” euro, which has trimmed the margins America exporters were expecting from selling their products overseas. But please do not mistake that appreciation for a positive sign on the stability of the dollar. It’s like two drunks at a bar, an American who is clearly soused but a European who cannot even stand up, and the American thinking he is sober by comparison! The giant BRIC countries (Brazil, Russia, India and China) are the real economic powerhouses in the world today; two, Brazil and Russia, have massive natural resources (particularly oil) with relatively educated populations, and the other two have built up massive currency reserves from cheap manufactures or massive service outsourcing.
The massive debt created in both Europe and the United States – both public and private – combined with the staggering fall in the value of the assets supporting that debt, has crippled those economies. And sooner or later, inflation is going to hit, even as the governments of the debtor nations struggle to maintain lower interest rates in order not to trigger a further economic collapse in the marginal signs of recovery that have surfaced of late. It will not take much to plunge our economies back down the slope of additional severe contraction. At some point, governments with humongous debt are going to have to attract lenders by raising interest rates or fall into the old world Latin American habit of increasing money supply (so-called “M-1”… most folks call that “printing money”). While inflation at that level may create a false appreciation of assets (like homes) that could push markets from being deep underwater and generate unjustified taxable appreciation for the government, people on fixed incomes and companies trying to raise capital for growth will really be slammed.
But the U.S. government has a vested interest in stemming the flow of money outside of the U.S. to pay for imports. We’ve already seen how just the price of oil is impairing growth – and we are going to be drilling in fragile ecosystems because most of the easy oil has already been tapped (the catastrophe in the Gulf isn’t the first such tragedy nor will it be the last) – but reducing imports in general is a priority, just as making U.S. exports more attractive to international buyers is a vital part of any hope of near-term recovery. The Los Angeles Times (June 20th): “If U.S. consumers can abstain from a "shop till you drop" lifestyle, their savings rate will grow and their debt loads will shrink. Those trends could strengthen the country's long-term economic health but also could cause more short-term pain in the form of slower job and wage growth.”
At the heart of reform has been the refusal of the Peoples Republic to allow its currency to float. But that position has always been viewed as unsustainable for the Chinese, making them completely reliant on overseas markets for growth. The PRC has had its share of economic woes – primarily in the oversold real estate market (see my Breaking China blog) – but what is developing within its borders – a growing middle class with a rising standard of living and rapidly expanding consumer buying power – offers a market to continue China’s growth while creating a more stable and satisfied constituency; Chinese consumers are the new hot market for Chinese goods.
Back 2005, China allowed its currency to appreciate over three years against the dollar (21%), and as world leaders prepared to gather at the end of June in Canada (for the Group of 8 and the Group of 20 summit meetings) to consider economic issues, China has finally signaled a willingness to allow the renminbi to appreciate: “China’s central bank announced on [June 19th] that it would allow greater flexibility in the value of the country’s currency, in the clearest sign yet that China will allow the renminbi to appreciate gradually against the dollar… The central bank, the People’s Bank of China, said that the Chinese economy was strengthening after the global financial crisis and that it was ‘desirable to proceed further with reform’ of the currency...” New York Times (June 19th).
But China is also pressuring the world to get off of the dollar as the global reserve currency, substituting instead a “special drawing right” currency blended bundle (reflecting the major currencies of the world including the dollar, euro and renminbi). This would naturally place further downward pressures on the value of the dollar as it would no longer be the sole reference currency in global pricing. China holds over two trillion dollars of U.S. national debt; this puts us in the role of supplicants and China in the driver’s seat. Our main bargaining power over China is how we impact the value of their dollar holdings (but think what would happen to the dollar if China decided to dump its dollar holdings!), the dependence of China on American consumer demand and the level of China’s investments and holdings in American assets and corporations. Being on your knees for longer periods of time is painful.
Don’t forget, however, to many, especially those in Europe where the falling currency value makes their products appear cheaper to us, Americans are the consumers of last resort. They’re looking to our bad spending habits to get them on the road to recovery, just as we are looking to global consumers to help us. And if we put up trade barriers to stem this trade imbalance (or use taxes to incentivize consumption of local manufactures), the resulting trade wars and retaliations will decimate our export business – present and future. The LA Times: “Mark Weisbrot, co-director of the Center for Economic and Policy Research, sees an overvalued dollar as a central cause of America's economic woes…In theory, he said, the administration can take aggressive steps to drive down the value of the dollar. But Weisbrot doesn't expect that to happen, because of resistance from Wall Street, U.S.-based multinational companies and White House economic advisors.” Whether we adjust now or simply allow the markets to correct over time as the U.S. standard of living plummets for most Americans, time will re-balance it all; I’d rather take the more obvious and easier road, but… there are a whole lot of special interests who will fight that tooth and nail.
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