``As no one can purchase the produce of another except with his own produce, as the amount for which we can buy is equal to that which we can produce, the more we can produce the more we can purchase.” John Say to Thomas Malthus
The second cyclical variable that should drive the markets over the short to medium term could be the Yuan factor.
For those reading the international scene the Chinese currency the yuan has hugged the limelight of late. That’s because prominent personalities associated with leftist politics have stridently assailed the Chinese government for allegedly perpetuating what they claim as “global imbalances”. It’s a spurious populist claim though, specifically meant to divert the public’s attention from their failed policies.
Nevertheless some variables are proving to be very compelling to suggest for a Yuan appreciation (see figure 5)
Figure 5: Danske Research: Implications of the Rising Yuan
The money printed by China’s central bank, the People’s Bank of China, utilized to accumulate foreign exchange has been generating unwieldy inflation and bubble-like pricing activities in the housing markets. This hoard has reached $2.4 trillion in foreign exchange reserves as of 2009.
China has attempted several times since last late year to arm twist several industries to stem credit expansion which has led to inflation. Lately she has threatened to nullify loans granted to local governments and has similarly instructed 78 state owned enterprises (SOE) to quit the real estate market leaving 16 SOE property developers.
And economic overheating presents as a real risk. There has been an acute shortage of labor where factory wages have risen by as much 20% as the inland now competes with the coastal areas and reduced migration in search of jobs.
We are now witnessing a classic adjustment in trade balances as taught in classical economics. As Adam Smith once wrote, ``When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation.”[1] (emphasis added)
In short, this leaves the Chinese government little or no option but to allow its currency to rise as a safety valve against a runaway inflation.
As shown in Figure 5, left window, USD-China’s yuan currency forward has been trending downwards which shows how the markets today have been factoring in the rise of the yuan. The right corner shows how adjustments were made in 2005 to reflect the advances in inflation. So yes, the Chinese policymakers in 2005 have responded to such scenario, and is likely to apply the same soon.
This means political pressure or no political pressure, China’s yuan will need to appreciate soon, simply because the economic pressures have been endogenously seething which will require for policy adjustments.
This leads us to the next issue which deals with why the cry for protectionism is spurious and the potential impact of the rise of the China’s yuan.
Mercantilism is a form of economic nationalism, which has long been rebuked by Adam Smith in his magnum opus, the Wealth of Nations. Mercantilism today has served as a basis for calls of protectionism.
Here we will unmask the partisanship of protectionist overtures against China.
First, the fallacy of the notion that trade is a zero sum game.
For the myopic protectionists who sees the world as confined to the equation GDP= C (Consumption) + I (Investments) + G (Government spending) + X - M (Exports-Imports), the mathematical operation involved in the equation which subtracts exports from imports engender a negative connotation for imports on economic growth. Hence, the bias or slant against imports for exports.
For instance, as I walked out of the pizza house following a hearty meal, I realized that the Pizza house, which earned the money I spent on, incurred a trade surplus. This left me with lesser money in my wallet, which accounts as my trade deficit. Although after the delectable meal, I also realized that my need for nourishment has been satisfied, unfortunately this has not been represented for in the GDP equation.
If I continue going to the same pizza house because I enjoyed the food, the ambiance, the services, the pretty youthful waitress or for many other reasons, the Pizza house will continue to incur surpluses while my wallet gets drained by deficits.
In the view of mercantilists whom tunnels on the flow of money only, but not the impact of or the satisfaction attained from the voluntary exchange, I would demand from the government that the Pizza house ‘balance its trade’ with me, by forcing them to take my services as a stock market agent, even if the owner isn’t inclined to deal with stock markets. If this sounds nonsensical, that’s exactly how the protectionists think.
If all the entities that I spent money on will be required to take on my services, from which rule applies to everyone, do you think the economy will prosper? Apparently not, that’s because people will probably stop trading with each other legally and do it behind the scenes.
In the above case, the pizza house will refuse me as a customer, that’s because they don’t need my services, even if I need them. In essence, forcing the people to buy or sell beyond their self-interests will cause a restriction of activities.
And be reminded that it is the individual that conducts trade. Whether it is done through personal, or through various forms of enterprises (proprietorships, partnerships or corporations), trade balances are incurred as individuals but only represented as enterprises or as states or nations.
In short, trade is exchange, where people conduct exchanges in order to fulfill a desire. The difference between local trade and trade with foreign enterprise is matter of classification. But the rudiments are the same, it is meant to satisfy some desires.
Hence, trade is not merely an accounting entry. It deals with human satisfaction.
In addition, trade balances do not include the sale of financial assets, as Robert Murphy writes, ``When economists compute the trade balance (or more accurately the current account), they don't include the sale of financial assets. So if foreign investors want to spend more (once we convert to a common denominator) on American assets than US investors want to spend on foreign assets, the trade balance is negative. The capital-account surplus is counterbalanced by a current-account deficit.”[2]
Once again Adam Smith[3], ``To import the gold and silver which may be wanted, into the countries which have no mines, is, no doubt, a part of the business of foreign commerce. It is, however, a most insignificant part of it.” (emphasis added)
Second, money isn’t wealth; inflation isn’t a Philosopher’s stone.
For instance current ploy of protectionists today is to arrive at a comparison of benefits. In such an instance, they distort the data to produce the account of which country is more dependent on trade. From here they argue, that by imposing trade restrictions, whatever vacuum left by closing the trading doors might be covered by money from central banks.
In other words, government can be relied to print money to produce jobs and investments. Had this logic been true then people don’t need to work at all, since the government can just print money.
Since voluntary exchange is aimed at satisfying human desires, then the role of money is essentially just as a medium of exchange.
And as medium of exchange, the valuation of a monetary unit, according to Ludwig von Mises, depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money.[4]
In other words inflating away out of protectionism will not achieve the desired prosperity.
What inflation will do is to vastly reduce the purchasing power of a nation which would redound to an erosion of wealth.
It is another absurdity to suggest that inflation won’t transpire because of output gaps. England has shown resilient inflation in spite of the similarities of condition with the US. To assume that the US is beyond the scope of the laws of scarcity is no more than living in a fantasy land.
Instead, it must be reminded that wealth is attained by accumulating capital, again Adam Smith ``The wealth of the country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds.”[5] (emphasis added)
Third, Protectionism Is Mutually Assured Destruction (MAD).
It is naive to believe that protectionism applied to China will not spillover to other countries. Such intellectual weenies fail to learn from the lessons of the Smoot Hawley act during the Great Depression.
To consider, should the US government engage in reckless inflation to finance the said gaps from protectionism with China, as the other holders of US treasuries realize of the scale of indirect default applied to their assets, many, if not all of them, will be panic sellers of US sovereign papers. And Americans will probably impose capital controls to curtail the exodus, and the ensuing capital controls would result to political counteractions.
And as reminder, the US is so dependent on oil that it imports 65% of what it consumes.[6] Guess who suffers more from a MAD policy?
According to Ludwg von Mises, ``The philosophy of protectionism is a philosophy of war. The wars of our age are not at variance with popular economic doctrines; they are, on the contrary, the inescapable result of consistent application of these doctrines.”[7]
Fourth, it is a myth that the appreciating Yuan and depreciating US dollar would expand US competitiveness while derail Chinese growth.
Pieter Bottelier and Uri Dadush writes in the International Herald Tribune, ``The immediate effect of renminbi appreciation will be to raise prices for U.S. consumers. A 25 percent revaluation of the renminbi, which some economists have said is needed, would — if not offset by a reduction in China’s prices — add $75 billion to the U.S. import bill. And since the United States imports three times as much from China as it exports there, higher U.S. exports to China would not nearly offset the welfare loss to U.S. consumers from higher Chinese prices.
``In the end, though some U.S. firms would gain and some export jobs would be created, the U.S. consumer would be the loser.”[8]
Fifth, fix currencies do not automatically equate to arbitrary currency manipulation, that’s because there is no free markets in currency, today. All governments control or somehow manipulate respective currencies to a certain degree.
The US dollar is pegged to 23 nations according to wikipedia.org. By definition of the protectionists, all 23 nations are also currency manipulators.
The Wall Street Journal hits the nail on the head,
``At the core of this argument is a basic misunderstanding of monetary policy. There is no free market in currencies, as there is in wheat or bananas. Currencies trade in global markets, but their supply is controlled by a cartel of central banks, which have a monopoly on money creation. The Federal Reserve controls the global supply of dollars and thus has far more influence over the greenback's value than any other single actor.
``A fixed exchange rate is also not some nefarious economic practice rare in human affairs. From the end of World War II through the early 1970s, most global currency rates were fixed under the Bretton-Woods monetary system created by Lord Keynes and Harry Dexter White. That system fell apart with the U.S.-inspired inflation of the 1970s, and much of the world moved to "floating rates."
``But numerous countries continue to peg their currencies to the dollar, and with the establishment of the euro most of Europe decided to move to a fixed-rate system. The reason isn't to get some trade advantage against their neighbors but to gain the economic benefits of stable exchange rates—and in some cases a more stable monetary policy. A stable exchange rate eliminates a major source of uncertainty for investment decisions and trade and capital flows.”[9]
In short, the labelling of manipulation is a matter of political convenience than truth.
The real problem has been China’s non convertibility and capital controls.
Again the Wall street Journal, ``China's real problem isn't its peg to the dollar but the yuan's lack of convertibility to other currencies and capital controls. These controls have blunted the yuan's development as a tradable currency, which means private markets can't recycle the flow of dollars into China from its large trade surplus.” [10]
Finally, as we have long argued US trade deficits are a function of the US dollar standard.
The more the world engages in global trade, the bigger the need for US dollar to finance this trade, since it is the de facto, reserve currency of the world, where transactions are quoted, paid and settled through US dollars.
Hence, until the US dollar is replaced with another alternative it is a fairy tale to believe that a strong yuan would rebalance the global economy. What would occur instead would be more distribution of surpluses around the world, but US deficits will continue to swell as the global economy expands.
Although there are more to discuss including the transition to the information age or China’s internal economic structure we will leave this discussion here.
But for those wishing that April 15th to be the fateful day where the US tags China as currency manipulator, good luck to you. Prediction markets, google trends or market indicators haven’t been pointing to such direction.
The appreciation of the Yuan will allow for cheaper imports and essentially reduce dependence to lend money to the US. This means that China would have more bandwith to employ resources for its own development, depending again on the degree of economic freedom embraced by China. And the impact is likely to be seismic.
Peter Schiff rightly argues, ``Absent Treasury-bond purchases, the value of the Chinese currency would rise sharply, causing goods prices to tumble in China. This long-delayed increase in purchasing power for everyday Chinese will unleash pent-up demand in what is already the largest middle class in the world. Chinese factories would retool in order to produce goods for their own citizens to consume. In RMB terms, commodity prices would plunge, making it easier for China to produce all kinds of stuff, such as automobiles, while also making it cheaper for the Chinese to buy gas. Millions will trade in bikes for cars, and Chinese oil imports will swell.”[11]
This means that there could indeed be temporary uncertainties from expectations of the Yuan appreciation, which will depend on the degree of the allowable strengthening of the Chinese currency.
As a caveat, while the Japanese Yen firmed over the past decades, the Japanese haven’t been transformed into a US consumer type of compulsive shopper or oniomania. Hence, habits or forms of addiction in a society should apply. In short, no society is homogeneous.
Figure 6: Danske Research: Strong Stock Markets And Commodities Post Yuan’s Revaluation
Nevertheless, if history would serve as precedent of the future, then the uncertainty from a revaluation is likely to be short-lived (see figure 6). And the impact from a revitalized yuan has could be tremendously salutary in terms of stocks, Asian currencies and commodities.
Finally another word of caution, every expert I know expects the Yuan to appreciate, while this is the most likely the political outcome, we can’t rule out policy errors. This means that inflation can go berserk, if China refuses to budge, perhaps out of the recalcitrance to bow to political pressure.
A bubble bust or a hyperinflation in China would cause massive outflows and reverse all these expectations [even without protectionism].
For protectionists, I suggest for you to just mind your own business as nature will force the hand of economic imbalances.
[1] Smith, Adam Wealth of Nations, Book IV, Chapter 1 wikisource.org
[2] Murphy, Robert; Trade Deficits and Fiat Currencies, Mises.org
[3] Ibid
[4] Mises, Ludwig von; Stabilization of the Monetary Unit
[5] Smith, Adam Wealth of Nations, Book IV, Chapter 1 wikisource.org
[6] See The Delusion Of The Mercantilist Miracle
[7] Mises, Ludwig von Human Action, The Conflicts of Our Age, Human Action, oil.lbertyfund.org
[8] Pieter Bottelier Uri Dadush The Myths About China's Currency
[9] Wall Street Journal, The Yuan Scapegoat
[10] Ibid
[11] Schiff, Peter Paul Krugman Versus Reality
