The Yuan Dilemma: Hammers, Nails and Ridiculous Policy at the U.S. Treasury Department
"When the only tool you have is a hammer, you will see every problem as a nail."
--Abraham Maslow, Psychologist
The world, and most specifically the U.S., is pushing China for reform on many fronts. So far, China has resisted outside meddling as any country would. Will a global slow down speed up China's reforms as a matter of necessity or will we see the unthinkable happen at some point; that being a trade war? While that seems to be a low probability scenario today, the world dynamics are very imbalanced and will likely get worse.
This week I see where Brazil is the latest country to voice concerns about China's economic policies. Brazil's trade surplus with China has disappeared and enthusiasm for trade with China is turning to concern about China's mercantilist export practices. Many in Brazil are now supposing trade with China will continue along the lines of raw material exports exchanged for finished good imports. This is not what Brazil had envisioned. Similarly, the European Union has already taken an aggressive stance with China and the U.S. has finally slapped China with import tariffs after ridiculously attempting to negotiate intellectual property, economic, American business ownership, trade and Yuan reforms for years on end. The time for talk was before China was supported as a member of the WTO. It is obvious China understands nothing, if not action. Why so? China's internal problems including chronically weak domestic job growth is more important than accommodating the rest of the world through potentially destabilizing change. While the wheels of social consensus turn very slowly, I believe we are moving towards a scenario where China may become an pariah across liberal economies unless their own economic policies undergo significant liberalization. Policies which, ironically, would positively impact the Chinese and global imbalances but surely contribute to the demise of Chinese communism.
As I've written, the current account surplus in China shows many similarities to that of the U.S. industrialization pre-1929. It appears the U.S. was willing to fund exports at nearly any cost to drive domestic growth similar to that of China today. Eventually, the U.S. suffered disproportionately for such a policy. The Great Depression in the U.S. was substantially worse than much of the world. There is some reason to assume much of that was because of disproportionate export related industries. Sound familiar? In hind sight, central bankers blame such economic malaise on tight money policies of the Federal Reserve. They may be right. But, there is a part of me which believes central bankers are confusing a little bit of correlation with causation. In other words, historical revisioning is a dangerous and unreliable method of determining causation but remains a common practice of economists. Faulty science. To be fair, economics cannot be tested in the lab but rather is tested in the real world through fiddling and fudging with the world being its test environment. Feeble attempts to model human behavior with computational analytics is far from matter of fact and an example of murky science. Post 1929, when the Federal Reserve began stimulating through loose money and the government attempted to create jobs through social spending, the U.S. economy remained mired in a tremendous funk until World War II. Similarly, today, government spending and loose monetary policies have left the U.S. economy in a state of malaise post the 2000 stock market crash. Why would one consider the malaise of post 1929 to be any different when China's industrialization bubble breaks? To the contrary, as I've written, I would fully expect China to experience their own funk of some sorts as every major economy has at some point in their industrial development.
We really are in somewhat of chartered waters with such an enormous economy impacting the global economy. The last time the world was impacted similarly could be compared to the U.S. industrialization leading up to 1929. That was not a positive experience or positive outcome for anyone. Correlation or causation? We'll find out at some point.
The U.S. Treasury Department's response to trade imbalances is comparably ridiculous. Jaw boning about a Yuan revaluation or a free floating currency is like trying to kill an ant with a ton of dynamite. Or, when the only tool you have is a hammer..... In other words, Secretary Paulson would have more of an impact going on a fishing expedition with Chinese officials than being publicly shamed by said officials in the Yuan debacle. As the needs of China to add somewhere north of 8 million jobs a year to keep the unemployment rate from increasing, the need to drive more and more exports in order to maintain employment will become enormous comparative to global economics. That means China's imbalance with the world could grow significantly larger if unchecked. Without domestic reform required to consume much of this economic output, raise domestic wealth, increase demand and wages, the world and China are likely headed for a day of economic reckoning very few are talking about. Global leaders are already getting an ear full from a populace which has not generally benefited from globalization and the buzz has the potential to turn into a roar at some point. Why? Because the trend of the general populace suffering through globalization will not improve until emerging economic powers adopt serious reform or the world economies launch into a new period of business innovation. Which will come first? Reform or innovation? Yuan revaluation as a policy is using a hammer to drive the proverbial all encompassing nail.
Finally, I am very dubious of the theory associated with currency revaluation as it pertains to balance of payments and economic re-balancing. It requires an elasticity of imports and, more importantly, exports that I don't believe exists in the world today. This comes back to my supposition that the trade imbalances are partially a result of an unattractive export mix of products that has led to its creation. "Gross Imbalances" as I wrote about a few weeks ago. Since the dollar peaked seven years ago, the only thing the j-curve seems to stand for is "j=joke". Was the strong dollar and associated U.S. economic expansion and wealth of the 1990s some how inferior to the weak dollar stagnation and malaise of the last seven years? In other words, what has a substantially weaker dollar brought to the imbalances dilemma? Something is probably going to break at some point and there is likely nothing anyone can do to stop it. In the end I view that break as an opportunity but when and how it happens and the negative consequences will be felt by most everyone across the globe. Human nature is to ignore problems until they become crisis. Plug human nature into a computer and model its economic impact. Devaluing the dollar, in particular, or revaluing the Yuan, could actually exacerbate the imbalances by reducing the dollar value of American exports while doing nothing to stem the flow of what would be more expensive imports. Wouldn't that be nice?
--Abraham Maslow, Psychologist
The world, and most specifically the U.S., is pushing China for reform on many fronts. So far, China has resisted outside meddling as any country would. Will a global slow down speed up China's reforms as a matter of necessity or will we see the unthinkable happen at some point; that being a trade war? While that seems to be a low probability scenario today, the world dynamics are very imbalanced and will likely get worse.
This week I see where Brazil is the latest country to voice concerns about China's economic policies. Brazil's trade surplus with China has disappeared and enthusiasm for trade with China is turning to concern about China's mercantilist export practices. Many in Brazil are now supposing trade with China will continue along the lines of raw material exports exchanged for finished good imports. This is not what Brazil had envisioned. Similarly, the European Union has already taken an aggressive stance with China and the U.S. has finally slapped China with import tariffs after ridiculously attempting to negotiate intellectual property, economic, American business ownership, trade and Yuan reforms for years on end. The time for talk was before China was supported as a member of the WTO. It is obvious China understands nothing, if not action. Why so? China's internal problems including chronically weak domestic job growth is more important than accommodating the rest of the world through potentially destabilizing change. While the wheels of social consensus turn very slowly, I believe we are moving towards a scenario where China may become an pariah across liberal economies unless their own economic policies undergo significant liberalization. Policies which, ironically, would positively impact the Chinese and global imbalances but surely contribute to the demise of Chinese communism.
As I've written, the current account surplus in China shows many similarities to that of the U.S. industrialization pre-1929. It appears the U.S. was willing to fund exports at nearly any cost to drive domestic growth similar to that of China today. Eventually, the U.S. suffered disproportionately for such a policy. The Great Depression in the U.S. was substantially worse than much of the world. There is some reason to assume much of that was because of disproportionate export related industries. Sound familiar? In hind sight, central bankers blame such economic malaise on tight money policies of the Federal Reserve. They may be right. But, there is a part of me which believes central bankers are confusing a little bit of correlation with causation. In other words, historical revisioning is a dangerous and unreliable method of determining causation but remains a common practice of economists. Faulty science. To be fair, economics cannot be tested in the lab but rather is tested in the real world through fiddling and fudging with the world being its test environment. Feeble attempts to model human behavior with computational analytics is far from matter of fact and an example of murky science. Post 1929, when the Federal Reserve began stimulating through loose money and the government attempted to create jobs through social spending, the U.S. economy remained mired in a tremendous funk until World War II. Similarly, today, government spending and loose monetary policies have left the U.S. economy in a state of malaise post the 2000 stock market crash. Why would one consider the malaise of post 1929 to be any different when China's industrialization bubble breaks? To the contrary, as I've written, I would fully expect China to experience their own funk of some sorts as every major economy has at some point in their industrial development.
We really are in somewhat of chartered waters with such an enormous economy impacting the global economy. The last time the world was impacted similarly could be compared to the U.S. industrialization leading up to 1929. That was not a positive experience or positive outcome for anyone. Correlation or causation? We'll find out at some point.
The U.S. Treasury Department's response to trade imbalances is comparably ridiculous. Jaw boning about a Yuan revaluation or a free floating currency is like trying to kill an ant with a ton of dynamite. Or, when the only tool you have is a hammer..... In other words, Secretary Paulson would have more of an impact going on a fishing expedition with Chinese officials than being publicly shamed by said officials in the Yuan debacle. As the needs of China to add somewhere north of 8 million jobs a year to keep the unemployment rate from increasing, the need to drive more and more exports in order to maintain employment will become enormous comparative to global economics. That means China's imbalance with the world could grow significantly larger if unchecked. Without domestic reform required to consume much of this economic output, raise domestic wealth, increase demand and wages, the world and China are likely headed for a day of economic reckoning very few are talking about. Global leaders are already getting an ear full from a populace which has not generally benefited from globalization and the buzz has the potential to turn into a roar at some point. Why? Because the trend of the general populace suffering through globalization will not improve until emerging economic powers adopt serious reform or the world economies launch into a new period of business innovation. Which will come first? Reform or innovation? Yuan revaluation as a policy is using a hammer to drive the proverbial all encompassing nail.
Finally, I am very dubious of the theory associated with currency revaluation as it pertains to balance of payments and economic re-balancing. It requires an elasticity of imports and, more importantly, exports that I don't believe exists in the world today. This comes back to my supposition that the trade imbalances are partially a result of an unattractive export mix of products that has led to its creation. "Gross Imbalances" as I wrote about a few weeks ago. Since the dollar peaked seven years ago, the only thing the j-curve seems to stand for is "j=joke". Was the strong dollar and associated U.S. economic expansion and wealth of the 1990s some how inferior to the weak dollar stagnation and malaise of the last seven years? In other words, what has a substantially weaker dollar brought to the imbalances dilemma? Something is probably going to break at some point and there is likely nothing anyone can do to stop it. In the end I view that break as an opportunity but when and how it happens and the negative consequences will be felt by most everyone across the globe. Human nature is to ignore problems until they become crisis. Plug human nature into a computer and model its economic impact. Devaluing the dollar, in particular, or revaluing the Yuan, could actually exacerbate the imbalances by reducing the dollar value of American exports while doing nothing to stem the flow of what would be more expensive imports. Wouldn't that be nice?
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