I Yuan to be a Loan

The battle between the United States and China over currency seems horribly academic, but it goes to the heart of America's future buying power and our economic stability. With Chinese labor costs low and the Chinese currency – the Yuan – on a "forced parity" with the dollar (forced by Chinese central planners who have resisted allowing the Yuan to float and find its own value), prices of Chinese manufactured goods have been and will be attractive to U.S. buyers. So we will export more dollars as we import Chinese-made goods. And because of the labor value differential, there aren't a lot of U.S. made products that are selling like hotcakes in the local Chinese marketplace (too expensive). The result: an horrific trade imbalance favoring China of "net" between $40 and $60 billion per month (i.e., we pay $40-$60 billion a month more in Chinese imports to the US. than U.S. exports to China).

At first blush, you'd think that we would want a strong currency ("strong" tends to = "good" in most folks' minds); in fact we think of a weak currency as suitcases full of cash needed to buy a cup of coffee in banana republics. And while it's true that such extreme dilution of value (ultimate inflation) is unconsciously disruptive, devaluing a currency has some serious benefits if done at the right levels. If the Yuan were stronger, for example, U.S. exports would be concomitantly cheaper in China (i.e., each Yuan buys more), thus spurring more U.S. exports… and with a weaker dollar, Americans won't be as anxious to buy so many Chinese products that are now priced higher just based on the currency shift. The balance of payments wouldn't tilt as hard in favor of China, and the big economic reset we are all talking about – where Asia takes on a more significant role in the global economy – would be more accurately reflected. Golden Lining: Fewer jobs exported to China and more American jobs to make new goods that Chinese can now afford to buy. Sure, we're sacrificing somewhat by not having as many cheap goods to buy, but there is this U.S.-long-term-economy thang we should all be worried about.

It's relatively easier for the U.S. to devalue. Poor Europe has countries that desperately need to devalue – like Spain, Portugal, Greece, etc. – to reflect a relatively overpriced labor and assets generated by a weak economy (or else values have to continue to crash and folks have to slash their salaries, which is really hard to swallow)… but they can't because their currency is part of a pan-European currency (the euro) that also reflects relatively successful economies like Germany and France who don't need to devalue. At least as Americans, we are all pretty much in the same boat. And we need to have more boats filled with U.S. goods floating to China and fewer floating from China to the U.S.!

While direct Obama administration entreaties to China to allow the Yuan to rise against the dollar have all but failed (tiny little movement, but hey….), our Federal Reserve Chairman has perhaps accomplished the feat through a complex back door. The January 24^th DailyFinance.com tells us how: "Last fall, [Chairman Ben Bernanke] announced a program of quantitative easing -- a federal bond-buying program [where the Fed was buying up some impaired assets to clean up some toxic balance sheet assets] -- which was targeted, he said, at raising U.S. inflation to head off possible deflation…. But in reality, it had a completely different result: Money poured out of the U.S. and flowed into China. According to Adam Wolfe, research analyst at Roubini Global Economics, the amount of so-called hot money entering China reached $1 billion a day in 2010.

"Coming on top of China's massive trade surplus, those inflows presented a dilemma for the Bank of China. In order to maintain its exchange rate with the U.S. dollar, which was fixed after 2008, the Chinese government bought dollars from exporters and banks and printed local Yuan for each dollar it purchased… But last fall, the supply of Yuan skyrocketed, increasing by 19.7% in December, Wolfe says. Increasing the money supply causes prices to increase as more money chases fewer products. Chinese inflation had ramped up 4.9% in November, compared with the same month in 2009." China's growth started spinning out of control, up to 9.8% per annum, way higher than central planners wanted.

So what's a nation to do?! Slam on the brakes! How? "It has just two ways to limit prices: impose price controls or raise the value of the Yuan, which reduces the price of imports. Price controls rarely work for more than a short time because people find ways around them, such as the black market [something the Chinese locals are very good at]… It now seems likely the Chinese will opt for raising the Yuan's value. Since last June, the currency has appreciated about 3.5%, or an annual rate of about 7%. When you add inflation, that's 12%. Wolfe says he expects the same level of appreciation for 2011, while [other economists predict] the Yuan rising by at least 10%." DailyFinance.com. If I've kept you remotely awake for this explanation, even I am impressed… but the bottom line with all this: more jobs will stay at home as the balance of trade tilts back towards more reasonable.

I'm Peter Dekom, and strategic weakness has its advantages… at the right time and in the right place.