Today’s post is all about Why was it done? And What will be the effect?. But first, let’s recap what just happened…
In the past year, the exchange rate between the Chinese Yuan Renminbi and the US dollar has drifted between 6.75 and 6.95 ¥/$. But this morning, it shifted. The Yuan was intentionally devalued by the Chinese government to punish (or perhaps to provoke) the Trump administration.
Let’s start with a little recent history—narrated with a big dose of editorial sarcasm…
Trump is not happy with China’s economic growth, leadership in 5G infrastructure, success in launching satellites, building new airliners, and of course their construction of islands off their own coast. (Do you suppose that the Chinese would make a fuss over construction projects in the Gulf of Mexico, even if it served a military purpose?!)
And so, Trump held rallies and press conferences. This is what he does best. He mumbled some trumped up complaints about an uneven playing field, and he slapped a series of escalating tariffs on Chinese imports.
Naturally, the Chinese retaliated by limiting their purchases of soybeans and pork, and they asked their own companies to scale back the purchase of US food, materials and machine equipment.
This led to a tit-for-tat. That’s not a surprise. A negative outcome was virtually guaranteed by the US president. Eventually, Trump followed through with even higher tariffs on even more goods, because that’s exactly what he said he would do—And since the Chinese didn’t cave to his demands, he became worried about sounding tough and saving face.
Mr. Trump claims that the Chinese government pays these high tariffs, rather than US consumers. And he doesn’t seem to realize that when no one is willing to pay, it retards commerce. When no one is buying, it is no longer a debate about who pays. Import tariffs don’t protect workers or industry, they simply thwart trade.
Yesterday, in the wake of increasing tariffs by the Trump administration, China devalued its currency, announcing an exchange rate of 7 ¥/$. This is not too radical. In fact, it is in line with recent history. After all, even a communist regime is limited in how much they can bend the exchange rate against another major currency. If they try to manipulate more than a little (or for more than a short period), they risk three undesired results:
- It bounces back with a vengeance
- Citizens lose buying power and they become enraged. Eventually, they revolt or begin using other currencies. Governments hate losing control over currency.
- The government goes bankrupt. After all, you cannot really manipulate the results of massive capitalist forces.
But the devaluation irks Mr. Trump. Having a sparing partner who keeps getting up off the floor, is stronger than you, and who claims the high moral ground is really infuriating. It gets under Trump’s orange skin—especially since he likes to hug the American flag at rallies.
Of course, manipulating currency is not unique to the Chinese. Although Trump probably doesn’t recognize or acknowledge it, America regularly tweaks interest rates through an obscure and mysterious agency called the Federal Reserve. That same agency licenses banks to create imaginary money out of thin air and loan it to real businesses for a profit, under a system called Fractional Reserve lending.
Lately, I have cross-published some of my favorite answers as a Q&A writer for Quora. Here are two answers that were posted this afternoon. In the second answer, we’ll get into America’s unique and precarious position as bearer of the reserve.
What is bad for the US is our continuing trade deficit and our willingness to print currency to continue massive consumption in view of our withering industrial base. That is, we export far less than than we import from China. And the only thing we give them in exchange is paper promises.
We love to consume Chinese products, and we give back few tangible goods beyond soybean & pork, Hollywood movies and jumbo jets (and to our allies: weapon systems). These are legitimate industries, but they do not match the economic power of clothes, toys, computers, car parts, mobile phones, TVs, 5G infrastructure, etc, etc, etc.
Even most of our high-tech chips (an industry that we still dominate) are manufactured in Asia, Israel and Europe.
The reason the US retaliates against Chinese currency controls or tariffs with panic and/or sanctions is because individuals who do not understand economics (or wish to placate nationalistic sentiment) fear that a weak Yuan will continue to promote cheap exports into the US and an inability for US companies to get a fair price for their exports.
What they fail to understand is that a ‘fair price’ ultimately tracks back to what a nation produces and ships out to balance its consumption. Currency manipulation is an illusion* and sanctions cannot fix this.
And don’t even get me started about Huawei… The US is demonizing an innovative value leader in the next generation of communications infrastructure and gadgets for the sole purpose of diverting attention from its own failings and to buy short term advantage. The argument that Huawei’s ties to a communist government would lead the company to spy on western users is not only a red herring, it flies in the face of economic reality.
2. Question #2:
Why did US designate China
as a “currency manipulator?”
The US took this meaningless step because some individuals in the US government are arrogant, whiny, little brats that do not truly understand the nature of free market economics. They are reacting to declining US productivity and exports—or, perhaps their advisers don’t understand the self-balancing nature of capital markets.
The relationship between two global currencies cannot be manipulated apart from very short intervals. This short term manipulation is driven by short-sighted motives—and it ultimately backfires when assessed against the original goals.
If you depress the value of something by creating an “official” exchange rate, you would quickly bankrupt the government that made such a goofy proclamation. That’s why these announcements rarely produce lasting results. Economists recognize that when you closely track the outcome (with other factors normalized), results are almost always in opposition to original goals.
Chinese currency doesn’t need to be devalued, because the Chinese have been so incredibly productive over the past 30 years. They are producing so many high quality shoes, toys, computers, car parts, underwear and construction materials, that other nations are becoming lazy. Their currency has a low value, because they continue to ship huge quantities of low-price products to us and are willing to continue accumulating dollars. That is, throughout an enormous trade imbalance, they trust our ability to repay.*
This is why China’s Yuan is ‘cheap’. It is not because of anything that the US government does as a reaction to transient political or economic issues.
Likewise, attempting to ban a country from selling products internationally below what it costs in the domestic market is a useless and counterproductive law, even from the perspective of the consumer nation.
There is rarely a justifiable and rational “manipulation”—or more accurately, action—imposed by consumer nations on its trading partners (other than figuring out how to reboot their own industries!)
For every rule of thumb, there is an exception. I can think of a few punitive actions that are justifiable, because they protect things that cannot protect themselves in a free market: The use of prison labor, child labor, slave labor or any production that poses a health hazard (for workers or buyers) or that harms the global environment.
The problem with these practices is not they create an unfair marketplace. Rather, they represent morally and universally condemned activities that kill or subjugate. And so, pressure and uniform restrictions from outside nations helps to quarantine a practice and ultimately make it unprofitable. But economic pressure applied by coalitions or trading blocks for any other reason is destined to fail. You just can’t fly against the headwind of widely disbursed, free market, capitalist economics.
With respect to currency “manipulation”, monopoly trading blocks or underpricing, sanctions are not only ineffective, they are unnecessary. If we allow the economic activity to play itself out in a free, fluid and unregulated manner, these things not only work themselves out, they actually backfire on the manipulator!
* When I refer to America’s “ability to repay” (i.e. for all the things that we have consumed without exchanging products of equal value), I am not referring to handing the Chinese more and more green pieces of paper with portraits of dead presidents. Dollars can be created out of thin air by transient politicians who continuously raise the debt ceiling. This can lead to a collapse in value and the Chinese know this.
Rather, I am referring to the confidence that our trading partners have demonstrated (at least until very recently), that we will eventually restore the vigor and volume of our manufacturing industries—and also be willing to use most of these newly restored resources to work for them and not just to generate products for consumers back home.
Will nations, institutions and large pension funds continue to prop up the dollar at a time when industry is dying, exports are scant, and legislators keep raising debt—kicking the can down the road?
This unfounded trust in the great nation that triumphed in world wars and the space race cannot last forever. What will signal the turning point?
The signal has already been lit. This year, it’s just a flicker, but in the next two years, it may well ignite the tinder that leads to a global forest fire.
The reason that the US can get away with kicking the can so far down the road, is because the US dollar has been the de facto reserve currency for most international deals, even when neither party to a transaction is in the US or serving US interests. The use is milking a convenient truth: He who controls the reserve currency needn’t balance his books—not for a long while!
Very large contracts for ships, airplanes, oil, wheat, weapons and pork bellies are typically quoted and guaranteed in US dollars or dollar equivalents. This is not required by law, of course, but it arises from the fact that buyers and sellers do not trust the forward inflation of each others’ currencies. Since the US dollar tends to inflate very slowly, they agree to use dollars to settle their affairs.
This clearing house effect leads to an enormous US advantage and it is fed even by nations that despise America.
A few years ago, it seemed that the Chinese Yuan might take the mantle from the US dollar as de facto reserve currency. Even currencies of UAE or Qatar seemed like they might supersede US influence, because of their status as a banking hub or massive energy exporter. But this left many nations uncomfortable, because the Chinese government—though capitalist—is still communist. Energy and banking economies have shown signs of instability, and of course, the middle-east is constantly a source and target of terrorist activity.
All of these factors lead commercial interests to wonder if currencies backed by these nations will last for the decades of a big trade deal and if they will be sufficiently protected from manipulation or inflation by future kings or monetary Czars?
Sure Bitcoin is new; it’s controversial and it is requires a very different way of understanding money. But it is unquestionably fair, democratic, trustworthy and immutable. Nothing else even comes close.
Gradually, economists, banks, enterprises and governments are coming to the conclusion that the choice of a reserve currency is an issue of trust. And what can be more trustworthy than math and crowd-sourced bookkeeping?
What about volatility?
In the end, it’s not about volatility. Even today, payment processors will protect any vendor who accepts bitcoin, but wishes to convert revenue into local currency.
As Bitcoin becomes ubiquitous (not as an investment—but as a payment instrument, and ultimately as the value itself— it will also become stable. Ten years from now, if you observe a massive spike or dip in the dollar exchange rate, you will not wonder “What happened to Bitcoin today”? Rather, you will wonder what happened to the US dollar. That’s because you will be using bitcoin to pay for a head of lettuce, a new car or a vacation cruise, and the vendors will honor their current prices in bitcoin.