Free Markets, Free People


Congress throws fuel on a raging currency war fire

In case you missed it, there’s a currency war going on. It may not be the sexiest thing in the world to talk about, but it is important to understand. Probably the most important thing to understand is, in the midst of all this financial upheaval, it’s not healthy for anyone. In fact that best thing right now would be to back off and let things chill for a bit.

That’s why the US Congress passed a bill calling China a “currency manipulator.” So much for cool heads. Blame it on election year politics and the need to seem to be sticking up for America … even if what you’re really doing is adding more heat to an already ferociously hot situation.

The baseline here is the US believes the Chinese yuan is undervalued by about 25%. And it has been on China’s case for some time to get them to revalue their currency upward. That would make US exports more competitive against China.

But, there’s more to the story than just that.

First thing to know is because of the horrific global financial climate, “Japan, Brazil, Peru and countries all over the world are trying to beggar thy neighbor (just as happened during the 1930s) and gain a leg up for their exports by cheapening their currencies,” according to The Market Oracle. So we have any number of countries trying to boost exports at the expense of their currencies.

You have to then dial it back to June of this year to understand the second part that makes this so complex.  June 19th specifically. Jack Perkowski explains:

That is the day that China, by far the world’s largest currency trader, announced that it would no longer peg the yuan to the U.S. dollar, but would instead peg it to a basket of currencies. What China’s announcement meant in practice is that at the margin, beginning on June 19, China would tilt its purchases in favor of buying assets denominated in the euro, the Japanese yen, the British pound or some other major currency, rather than those denominated in the U.S. dollar. When an investor with $2.5 trillion of buying power makes such a statement, markets tend to listen.

Here is what has happened since.

As of the September month-end, the euro has increased in value by 10.3% against the U.S. dollar since June 19, the pound by 6.3%, and the yen by 7.8%. In fact China’s purchases of yen-denominated securities has heightened trade tensions between Japan and China to the point where the Japanese have complained publicly that China is effectively pricing Japanese products out of the market with its yen purchases, threatening to derail Japan’s economic recovery.

In the broadest measure possible, the United States Dollar Index (“USDX”) has declined by over 9.6% percent since June 19. The USDX measures the value of the US dollar against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swiss franc and the Swedish krona — exactly the currencies that China is most likely including in its own basket and which are now appreciating as a result. The USDX began in March 1973 with a value of 100.000 and has since traded as high as the mid-160s. At its current level of 78.691, the USDX is approaching its 33-year low of 70.698, which was reached on March 16, 2008.

On the one hand you have countries everywhere trying to cheapen their currencies to sell their exports (China wants theirs to stay right where it is) in order to boost GDP growth. And on the other you have China’s move away from pegging the yuan to the US dollar to pegging it to a basket of other currencies, and driving those currencies higher and making their exports less competitive.

Unpegging from the US dollar has also driven the dollar down relative to those  other currencies but still much higher than the yuan, which has only appreciated 2%.

Back to the point about the bill just passed by Congress. It doesn’t really help:

But the former U.S. trade representative, Susan Schwab, says that – while there’s a very real problem in terms of China artificially keeping the renminbi low, this isn’t the way to solve anything. Schwab calls it "a signal-sending exercise during an election season". She says that the bill won’t really do anything, even if the Senate passes it and it is signed into law. Schwab says it "makes no sense", won’t solve any problems, will escalate tensions, and will only divert attention from the real trade problems between the U.S. and China.

In fact the “election signals” may blow up in our face:

Indeed, Schwab warns that other countries might decide that this U.S. bill means that it’s open season for addressing currency manipulation, and that other countries believe that the U.S. is manipulating our currency. She says there could be a "boomerang effect" from the legislation.

All we’d need now to kill our recovery as weak as it is, is to have a full blown, open season, take no prisoners currency war where the dollar would be weakened even more than it is now. And that’s especially true if the “quantum easing” (printing more money) the Fed has been hinting about is about to take place.

What no one seems to want to admit is now is not the time for any country to be revaluing its currency upward. The US is demanding of China what it wouldn’t do itself.  Until the financial crisis has passed, these demands that China push the value of the yuan up should be on hold. Then, as Zachary Karabell explains, it is in China’s best interest to see the value of the yuan eventually increase:

China has been revaluing its currency, nearly 20% between 2005 and 2008 and now nearly 3% since June when the government resumed that policy having shelved it during the midst of the global financial crisis. It is in the domestic interest of the Chinese government to raise the value of their currency because they are focused on building up on internal, domestic consumption market. They have no wish to be dependent long-term of the vagaries and whims of American consumers, and higher purchasing power for Chinese consumers is the answer. They are not revaluing quickly enough to suit an America stuck in second gear and looking for someone to blame, but revaluing they are.

And there’s the bottom line – the US recovery isn’t going as well as we’d like it and as seems to be the penchant among US politicians, they have to have someone else to blame for the problem.

Solution: throw gas on a raging fire. I sure hope China has cooler heads at the helm.

~McQ

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29 Responses to Congress throws fuel on a raging currency war fire

  • China News has been reporting that there are a large number of unemployed (or more precisely “never employed”) young workers in China.  They expect there to only be 1 job for every 2 new graduating students. Yikes !!  This with a reported 15% annual growth.  Yikes Yikes !!  These new “redeployable human resources” apparently are now in “ant hills” around many of the major cities in China.

    • I wonder if these are a result of (as Instapundit calls the “college bubble”) over production of highly educated workers.
      (I’ve see stories that there are more engineering professors in China than there are engineers in the US).

    • One issue is that the factories need workers, not salesmen. Supposedly, its now easy to hire any number of white collar staff, but blue collar staff (of the cheap kind) is harder to find.

  • First thing to know is because of the horrific global financial climate, “Japan, Brazil, Peru and countries all over the world are trying to beggar thy neighbor (just as happened during the 1930s) and gain a leg up for their exports by cheapening their currencies,” according to The Market Oracle. So we have any number of countries trying to boost exports at the expense of their currencies.

    And this is different from our falling dollar, how?

    • Our dollar falls according to a free market. Yes, we intervene when we mess with interest rates, etc., but I don’t think we actually intervene and buy/sell dollars (could be wrong there.) We certainly do not have currency controls like China, or sterilize every export by requiring all foreign exchange to be handled by the central government which invests in US treasuries and mortgage backed securities with the funds.
      Highlights:
      Asian offering of credit with their export dollars led to US interest rates being a full 1% lower than they would have been without such credit being offered. That means we borrow more than we would normally, and housing goes up due to low interest rate.
      25% of US consumer credit comes from overseas.
      Every Chinese citizen owns roughly US$ 800 of US housing debt. Does anyone think they would normally have spent that money on housing debt rather than CAT earth movers or airplanes, or soy beans without the government forcing such “investments?

  • The funny thing is that the US does manipulate its currency.  The congress-critters will deny it saying that the Fed is in charge of the currency and is independent of the government.  And anybody with two brain cells to rub together knows that is bull.
    Nit-picking:  it is ‘quantitative easing’ not ‘quantum easing’.

    • “Nit-picking:  it is ‘quantitative easing’ not ‘quantum easing’.”

      Ah, damn, you’ve detected evidence of “the Erb in the machine”.

    • If that is true, then why not have the Fed simply set the exchange rate like China does?
      Why do we see USDEUR bouncing all over the place while the Yuan moves explicitly on Beijing’s orders?
      We control the currency like curlers control the stone with brooms. The Chinese control the currency like driving a car.

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    Three horrifying facts about US deficits:
    #1: The US Fed is now the second largest owner of US Treasuries.
    Such monetization of the debt is currency manipulation.
    Facts 2 and 3
    #2:  “There are only about $550 billion of Treasuries outstanding with a remaining maturity of greater than 10 years.”
    #3: The US will Default on its Debt
    http://www.gainspainscapital.com/index.php?option=com_content&view=article&id=168:three-horrifying-facts-about-the-us-debt-situation&catid=41:currencies&Itemid=72

    • The US is buying treasuries to prevent collapse of the treasuries market.  If anything that action keeps the US dollar high.

  • Ahhh rats… sorry about the formatting mess.

  • Pardon my ignorance, but how does a country modify the value of its currency?  Do they destroy some of it (ie, the opposite of devaluation via printing of more)?  Do they just, er, set it aside (ie, take it out of circulation)?

    • A country can control a fiat currency by controlling the supply.  Things like debt monetization, prolonged low interest rates, low reserve requirements can increase the money supply.  Or the government can just outright print more money but this can go badly.  I have some $100 trillion Zimbabwe notes that at the time, 2008, would buy about 3 eggs.  I joke with my friends that I’m a multi-trillionaire!
      Governments can do the opposite to raise the value of their fiat currency.  Raise interest rates, retire debt, raise reserve requirements.

  • Apparently the weakened dollar isn’t weak enough to compensate for the enormous government  cost burden carried by American businesses in the form of taxes and regulatory compliance cost. You’d think that our leaders might want to focus on reducing this burden. One can only hope.

    • The common belief is that the government wants a weaker currency as this would drive up inflation and make paying off its own huge debts easier to do.  The other reason is that a weak dollar makes our exports cheaper overseas and make imports more expensive at home.  This is pretty much mercantilism and that usually ends in war.
      The problem with a perpetually weak dollar is that inflation is a fickle beast and if there is a confidence ending moment in the US dollar then hyper-inflation is the next step.  Other calamities could cause problems, like trade wars, actual fighting wars, defaults…
       

      • The belief is that we need to start producing again.  And we can’t do that while China still has the cost advantage of a 3rd world country but with a 1st world infrastructure.   Primarily form its central planning of its trade relationships which includes manipulating its currency.

        • Their wages are going up. Even if they don’t formally revalue their currency, it will happen via domestic inflation. Personally, I think if they had actually traded instead of sending product to us in exchange for promissory notes that globalization would have been moderated but more durable. Instead, China took steroids.

          • Their wages have a long way to come.  And their wages don’t represent their major cost advantage anymore.

            Our manufacturing infrastructure is so gutted it has gone over the point of no return.  It has a time limit.  Probably a little over 2 decades at the most.

            Meanwhile they still have a substantial wage advantage, now the infrastructure advantage, and the only growing market and use access as a trade tool, and an array of trade barriers both soft and hard.  With the exception of the infrastructure advantage, take away just one of those won’t stop the slide without an active effort to protect domestic manufacture.

      • “The other reason is that a weak dollar makes our exports cheaper overseas and make imports more expensive at home.  This is pretty much mercantilism and that usually ends in war.”
        So, show me the wars we made against Taiwan, Korea, Japan, and China? None so far.
        I would suggest that we wanted those economies (ex-China) to do well after WW II, so we allowed them to do these policies. Plus, they were not that large. Now, with China, its really untenable and dangerous – its not just a trade war, but its affecting credit.

        • Harun,

          Don Boudreaux over at Cafe Hayek would gladly point out that we really shouldn’t complain that those governments are taxing their own citizens in order to supply us with cheap goods. We didn’t go to war with South Korea, Taiwan, China or any other countries because their governments are practically paying US citizens to buy their goods.

          It’s just now that our unemployment is getting high that we start questioning the relationship. But really, US manufacturing isn’t really keyed towards producing low to mid quality, inexpensive items using large amounts of manual labor. We’re all about the robotic production and final assembly using foreign made semi-finished materials now. Starting a currency war those low-cost items from other countries more expensive will do nothing to fix our labor issues.

    • Bingo. This is the hidden part of the government iceberg.

  • we are cheapening our own currency a lot faster than most of the other countries.

  • I don’t believe we have any control over our currency.  Obviously other countries have manipulated their currencies to their advantage for the longest time.

    As our manufactured exports are less of a potential threat, other countries can allow our currency to lower.  Its to their advantage now because there are raw materials they must import so a lower US currency is to their advantage.

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