I got no requests for charts (and I will ask again at the end of this post) so I decided today to comment about the potential longer-term reasons that the Peoples’ Bank of China executed a Yuan devaluation versus the United States Dollar. This action might actually be the beginning of a decoupling move to secure the future of the currency, and not a desperate attempt to shore up what recently has been a sputtering Chinese economy. Many of you may add me to the ‘wingnut’ classification of bloggers on this topic, but I think some careful consideration should be made about this topic. This attention is cogent given how the world seems destined to follow that old 1980s IMF model of “devalue and export” it used to rescue the then emerging and third-world markets from their mounting debt. That debt and fiscal deficit in many cases caused crushing currency inflation problems. I have commented in the past about the race to zero currency value in this post as well as others in the past.
Take a look at this chart. It is a trade weighted valuation of the Yuan versus the dollar over the last 10 years. That 3.6% devaluation in the context of the chart really doesn’t look that severe does it? The truth is, it isn’t really. The Yuan has quietly (and under the stepwise “market maker” adjustment of value the the Peoples’ Bank of China (PBOC) has administered) INCREASED in value steadily against the U.S. Dollar in that time frame. That strategy is described in this article from The Economist.
Why then, did the PBOC decide to make such an adjustment? The author of this article states:
“Instead, another event seems the main trigger for the central bank’s actions. Later this year the IMF will decide whether to include the yuan in the select group of currencies it uses to calculate the SDR, its unit of account. Inclusion would amount to declaring the yuan a global reserve currency. Just last week the fund hinted that the yuan is still too heavily controlled. For the PBOC, getting into the special drawing rights (SDR) has never been just about prestige. Rather, it has been using this objective as a means to push for reforms that remove some of the policy distortions still hobbling the economy. Introducing a truly floating exchange rate is an essential part of its programme.”
Taken in its longer term context, China is attempting in the best way it knows how to prepare to become one of the world’s reserve currencies. The PBOC at some point would want its currency to freely float as other major currencies. That condition would require a sterner test of China’s financial reserves (including gold). That situation would likely also require increased transparency in the reporting of economic growth. China’s economic data has come into question many times, particularly in the last 3 years.
I don’t think there is much question that China DOES face a slowdown, as car sales are slumping (Ford is predicting the first slowdown in Chinese sales since 1990), and that industrial production seems to be flattening, so there is a real chance that a Chinese (and perhaps even world) economic slowdown is at hand, given the declines oil, copper, and other key commodity prices of late.
However, I think Peter Schiff may actually have a point about the U.S. Federal Reserve’s dilemma with zero interest rates. To keep equity and real estate prices afloat, it has no choice but to stand pat (watch the video associated with this article). This past week, gold rose both in U.S. Dollar terms AND Yuan terms, as other currencies turned down.
What we could be witnessing, given in relative terms a small devaluation in the Yuan, a first attempt for PBOC and China to decouple itself slowly from a U.S. Dollar peg. When still working a slower growing economy ( at or just below 6% GDP growth of late), why not devalue to some degree to gain and edge in exports to other countries AND to the US? If the Yuan can gain reserves through SDR and by expanding their gold reserves, China will eventually be in a better position over time to float the currency freely. What the US has to be worried about longer term is that a decoupling from the dollar would mean a lack of interest in buying our debt, which is priced at unrealistically low levels of interest for other nations to be interested in. Our mortgage market and stock market valuations are dependent upon low rates as our GDP continues to grind at growth rates that are lower than the 3 to 3.5% rates of the last 3 centuries. If we cannot finance the burgeoning welfare state we continuously create, then our currency will become worth much less than other currencies on a value-to-economic-growth basis. That situation would put our financing costs over the edge. When one realizes that we have 200 trillion U.S. dollars worth of unfunded liabilities to cover, the financing costs would indeed cripple our economy. The American standard of living would dramatically decrease, and decrease rapidly.
The United States Federal government needs to fully assess these issues and not let world market events dictate our policies. A 30-year vacuum of leadership, statesmanship, and over-regulation of market forces have led us to this point. Americans can still take control of this situation if they choose to learn the economic lessons of history. Our leaders need to steer a path of fiscal restraint and fiscal responsibility. If we don’t reduce debt and dependency, then will become the willing victims of change that will sweep away what was once the economic juggernaut of the earth. The future is right here and right now, as this 1 year old video suggests. Fiscal responsibility and economic freedom are the tickets for the bus. Trust me, it is better to take a ride on the bus, than to be hit by the bus.
The United States can still be the economic leader, but without fiscal responsibility and economic independence, it and not China, will end up being the emperor with no clothes.
OK folks, no requests for charts? Then there are no charts ( at least not this week). As I get the survey together, I will begin to fully understand what you want. In the meantime, however, if you want me to take a look at something, leave a comment in the post and I will dig into it.
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