China and Foreign Exchange
China has pegged the exchange rate of their currency in dollars to a below-market level. In order to enforce this price control, the central bank must be willing to purchase any amount of dollars offered at the official rate. After a number of years, they have, as reported by the China Daily, accumulated over $1 trillion of so-called "reserves".
The willingness of the central bank of China to accumulate large amounts of dollar reserves and "invest" them in US government debt has been a major reason that US inflation has been low relative to the amount of money creation. The inflation has been exported to China.
As economists Nouriel Roubini and Brad Setser have written, there are not enough domestic savings in China to fund their purchases in dollars. The Bank of China is monetizing the difference, driving a credit boom in China (see Setser's paper on bad debt in the Chinese banking system).
The exchange rate control makes their exports cheaper to Americans than they otherwise would be, and their imports more expensive. While Chinese importers may show an accounting profit in terms of their local currency, their government accumulates large amounts of dollar-denominated claims, which realistically can not be converted into dollars worth anywhere near their current purchasing power. The central bank will ultimately take a large loss on its currency position, which will be born by the people of China either in terms of inflation, higher costs for exports, or taxation.
These assets could in theory be used to intervene in the foreign exchange market, should their currency become overvalued and they wished to maintain the over-valuation. But realistically, they have far more reserves than they could ever use for this purpose. The linked China Daily article discusses a shift in thinking that is ocurring within the central bank as to what to do with these reserves:
- "How to manage such a huge reserve is a big challenge," said Yi Xianrong, a research fellow at the Institute of Finance Research under the Chinese Academy of Social Science. "The crux of the problem is that you have to keep the value stable or increasing," Yi said.
The ballooning foreign reserves, many economist say, is a major reason behind the loose money supply. This is because the central bank has to issue additional money to mop up the excess US dollars in the market, resulting in excessive liquidity in the banking system.
And the fluctuating foreign exchange rate also poses a huge risk, economists say.
In a bid to minimize such risks, the central bank should diversify its existing US dollar-dominated foreign reserves structure, and increase its holdings of euros or other major international currencies, said Li Yongsen, a finance professor at Renmin University of China.
The central bank, he said, could also buy more state bonds issued by other major economies and decrease holdings of US Treasury bills.
"It's better to spread the risks, and not put all your eggs in one basket," Li said. The professor also suggested that the country might consider using the huge foreign reserves to purchase some strategic resource reserves such as oil.
To the extent that China uses their dollars to purchase real things, rather than hold US debt, the US$ inflation originating from the Fed would no longer be shunted into the Chinese economy.
Comments (56)
RogerM
For a less hysterical view of the trade deficit, try this: "Living with Global Imbalances: A Contrarian View by Richard N. Cooper". To get the pdf version go to http://www.iie.com/publications/pubs_author.cfm?ResearchTypeID=2#319 then scroll down to the author.
Unfortunately, Nouriel Roubini and Brad Setser are stuck in the mercantile era, where most economists who analyze trade deficits reside. The authors write "The US is currently financing itself by selling low-yielding dollar debt, which offers foreign investors little protection against a future fall in the dollar."
The idea that Americans are borrowing from foreigners in order to sustain our gluttony makes sense only if you ignore time, because American consumers don't borrow from China; we pay cash. We purchase from China because they're willing to sell to us at a loss by keeping their FX artificially low. All the better for us. Later, Chinese use their cash to buy stocks and bonds in the US because they would rather save than consume. Conflating the two actions is similar to the way mainstream economists eliminate time from the capital structure.
In addition, no statistical correlation whatsoever exists between the trade deficit and exchange rates. I've tried to find one for years and it simply doesn't exist. In fact, I just read a new financial econ book this week, hoping for guidance on currencies. After studying years of research into exchange rates, the authors concluded that no existing model can predict exchange rate. In other words, no economist on the planet knows what causes exchange rates to change. If they don't know that, then there is no way that they can say that trade deficits will eventually force the dollar down against Chinese currency.
I'm surprised that Mises.org would promote articles that clearly violate Austrian economic principles. I curious as to the reason. Everyone who believes what these authors write need to go back and re-read Adam Smith, Mises, and especially Bastiat.
Published: October 30, 2006 2:00 PM
David White
So with the real inflation rate now running at least 7% -- http://www.safehaven.com/article-5917.htm -- when China starts to reduce its dollar holdings (by buying fewer US bonds), inflation will really take off.
Leading to a hyperinflationary recession/depression?
Published: October 30, 2006 2:01 PM
David White
RogerM:
"American consumers don't borrow from China; we pay cash."
No, American consumers use their homes as ATMs and max out their credit cards to finance their purchases of Chinese goods. Result? Together with our exploding government debt, the US is now the world's largest debtor nation and indeed the largest debtor nation in human history.
So as the housing bubble bursts and the Fed begins to cut the Fed Funds Rate in the hope of stemming the tide, the dollar will fall until the Chinese have had enough and pull the plug, resulting in a bond market collapse and the onset of economic Armageddon.
Published: October 30, 2006 2:14 PM
M E Hoffer
RogerM,
With this: "We purchase from China because they're willing to sell to us at a loss by keeping their FX artificially low. All the better for us."
How does the hollowing-out of the US manufacturing base in the long-run best interest of the US?
Are we not, merely, addicting ourselves to a Supply that is by no means secure?
Not only do these "cheap" Chinese Imports serve as a pallative to aid in the digestion, short-run, of the ever increasing costs of our Gov't, but also serve to weaken our ability to perservere in the face of changing circumstance. This is "all the better for us" ?
Published: October 30, 2006 2:24 PM
RogerM
David:"No, American consumers use their homes as ATMs and max out their credit cards to finance their purchases of Chinese goods."
That's true. But China is not our biggest trading partner. Canada and Mexico are. So why aren't those nations stacking up dollars? Because they let their currencies float and so don't need to intervene to buy dollars from their citizens.
But your conclusion doesn't follow from the above. The exploding government debt is caused by lingering Keynesian thinking among politicians, along with misinterpretations of the Laffer curve, not to mention the love of spending other people's money.
The federal deficit, and federal spending in general is a real problem, but being a debtor nations is not. All it means is that foreigners would rather invest in the US than anywhere else, and that's a good thing! Hysterical economists worry that we won't be able to pay the interest on the debt, but that will happen only if debt grows faster than our economy, and it won't. Foreing investment actually boosts the economy by creating new businesses and improving productivity.
"So as the housing bubble bursts and the Fed begins to cut the Fed Funds Rate in the hope of stemming the tide, the dollar will fall until the Chinese have had enough and pull the plug, resulting in a bond market collapse and the onset of economic Armageddon."
If that were true, you could become as rich as George Soros in the next year by shorting the US dollar. But I can guarantee you from personal research and much reading that no relationship exists between US interest rates and the exchange rate. Every financial economist in the country has searched for that relationship for 50 years and it simply doesn't exist, in spite of what the textbooks say.
A few years ago, economists predicted dire consequences for the US if our trade deficit passed the 5% of GDP red line. That was about 3 years ago. Now it's at 7% and climbing. Some expect it to reach 10% in the next few years. Where are the disasters that everyone predicted? They didn't happen because as Bastiat wrote, trade deficits don't matter, never have, never will.
Hysterical economists who think they matter are the gravest threat we face, because stupid politicians listen to them and then pass laws that destroy the economy, as they did in the 1930's.
Published: October 30, 2006 2:40 PM
Björn Lundahl
The Emperor's New Clothes
People are led to believe that trade restrictions between regions or countries “create jobs at home”, which they certainly do not. If people had the opposite belief that “free trade” between regions or countries “creates jobs at home”, that would also be an incorrect belief. Trade restrictions or free trade does not cause unemployment or cause employment in a region or country. Trade restrictions only lower the standard of living, hamper competition and restrict liberty. If for instance, the USA imposes tariffs on Chinese textiles, the Dollar will appreciate against the Chinese Yuan (the value of the Dollar will increase relatively to the Chinese Yuan). This depreciation (decrease in value) of the Chinese Yuan against the Dollar, in this example, is caused by a smaller demand for Chinese textiles and therefore a smaller demand for Americans to buy the Chinese Yuan. Because of this change in exchange rates, prices of goods from the USA to China will be generally higher and prices of goods from China to the USA will be generally lower (apart from textiles). As you can imagine, this will increase employment in the American textile sector, but decrease employment in other sectors. At the whole, unemployment will not change but trade between the regions will be lower. Specialization, competition and living standards in the USA will be hampered. The tariffs will only serve special interest that is the textile manufacturers and their employees. Surely, most people around the world wants their representatives to serve the common good and the common man and not special interests!
Someone might complain that the Chinese are intervening in the exchange markets to keep their currency artificially low and that they are not letting market forces to appreciate their currency, and therefore my statement about free trade, in this case, is not applicable. Free trade, someone might think, is presupposed by freely fluctuating currencies with no Government intervention (also called clean floating exchange rates). Certainly I do not want Governments to intervene in exchange markets, but actually it is the Chinese that are in this case the losers and the Americans are the winners. Americans should be glad that China is suppressing the rise of its currency, and the Chinese people should be mad about it. When market prices indicate that, for example, a project is unprofitable; investors naturally stop investing in such a project. Otherwise, factors of production such as land, capital, and labour would be wasted. Every government manipulation of market prices is a step toward economic breakdown and chaos. Land, capital, and labour that are invested in the exporting business in China because of a suppressed currency, have changed the economic structure in China and are mal investments, unprofitable for the nation to undertake, and the Americans are getting something free. Americans don't need to export anything to pay for this "extra importation of Chinese products”. To make my statement more obvious, we could consider that if the Chinese currency would be suppressed to no value at all (which would not be possible to realize), the Chinese would be working for nothing and the Americans would get goods and services from China for free (which is, naturally unprofitable for China to undertake), then the market forces in the USA (if market forces would not be hindered by the Government) would reallocate land, capital and labour for other uses and to those fields which the Chinese are not able to compete (even if the Chinese were working and exporting to full capacity, that will not, by far, be enough to satisfy all that Americans want, in other words, their GNP (or capacity) is by far, too small). The increases in production which mentioned reallocation of recourses leads to are an extra bonus the Americans receive. The Americans should applaud this and the Chinese people should revolt!
If you want to know more about floating exchange rates, go to; http://www.hooverdigest.org/974/friedman.html
Productivity and trade will flourish more intensively with one currency* than with several different currencies, and even with one currency, market forces will smoothen out any imbalances between regions, cities or countries. We do not worry, for example, about the balance of payments between London and Manchester, Berlin and Munich, Paris and Bordeaux or Stockholm and Göteborg etc. If, for example, London exports more to Manchester than Manchester exports to London, the demand for goods and services will be greater in London relatively to their supply, and also relatively to the situation in Manchester. Because of this, prices will go up in London and therefore will exports from London to Manchester contract, as well as, imports from Manchester to London will expand. This happens all the time and we do not even know about it and therefore do not worry about it. Governments do create problems all the time.
If we really want increased competition, why not adopt free trade between nations. Why does the USA and the EU not follow that path? The reason is that they do not want increased competition.
For an example, I quote from answers.com;
“In the United States, the decade from the mid-1980s to the mid-1990s saw import quotas placed on textiles, agricultural products, automobiles, sugar, beef, bananas, and even underwear—among other things. In a single session of Congress in 1985, more than three hundred protectionist bills were introduced as U.S. industries began voicing concern over foreign competition”.
Go to;
http://www.answers.com/import+quotas?gwp=11&ver=2.0.1.458&method=3
Only Governments can be so silly to reject great offers and bargains. Individuals doing the same thing would be considered mad.
The essence with above statement is that Governments hinders competition, lower our standard of living, promote special interests and they make excuses for this with faulty theories and propaganda.
Björn Lundahl
Göteborg Sweden
* A gold standard. See also “What Has Government Done to Our Money?” by Murray N. Rothbard.
http://mises.org/money.asp
Published: October 30, 2006 2:41 PM
RogerM
Bjorn:"Only Governments can be so silly to reject great offers and bargains. Individuals doing the same thing would be considered mad."
Right on! By keeping their currency aritifially low, the Chinese are paying us to take their products! Has anyone figured out why Americans want oil to be cheap by sweaters and toys from China to be expensive? I can't!
Published: October 30, 2006 2:54 PM
David White
RogerM:
"The federal deficit, and federal spending in general is a real problem, but being a debtor nations is not. All it means is that foreigners would rather invest in the US than anywhere else, and that's a good thing!"
The Chinese presently have no choice but to invest in the US (government, that is, as they aren't allowed to purchase real assets) because if they didn't, the bond market would have already collapsed, sending interest rates soaring and the economy down the toilet.
You seem to forget as well that no fiat currency has stood the test of time (or even close) and that the dollar has lost over 95% of its value since the creation of the Federal Reserve. (In fact, the dollar, as constitutionally mandated, no longer exists.)
This is why there is no such thing as free trade today. Instead, Globalization is really Dollarization, at least until the worthlessness of this paper tiger succumbs to economic reality.
Will a gold standard then reclaim in rightful place in the scheme of things, as Björn Lundahl recommends? I don't know, but if and when gold becomes a Nash Equilibrium -- http://www.safehaven.com/article-5205.htm -- I don't want to be sitting on the sidelines without any.
Published: October 30, 2006 2:59 PM
Mark Brabson
If the nations of the world had stayed on the gold standard, we wouldn't need to worry about trade rates, since dollars/francs/pounds would all convert at the fixed ratio of their weights.
What we need is REAL money, i.e. gold or silver, absolute free trade, and reduced government spending. In the absence of that, bleating about whether the trade deficit matters or not is immaterial.
Published: October 30, 2006 3:09 PM
adi
Will we see commodity prices going up fast if the Chinese will start to accumulate vast reserves of materials as they planned?
RogerM made few comments about determinants of exchange rates. Mises himself was wrong about the exchange rate movements (his theory seems to be a variant of Gustav Cassel's purchasing power parity theorem). I know that Cassel presented his theory in Economic Journal 1916,but was Mises earlier?
Though common sense would indicate that the trade flows between countries are major determinants of exchange rates, but this might be a wrong idea.
Published: October 30, 2006 3:21 PM
RogerM
David, You make some good points in the last post. The Chinese are stuck in mercantilism like most economists in that they think they must have a trade surplus in order to grow their economy. As long as they think that, they'll subsidize our purchase of their products by keeping their exchange rate low. In order to keep their exchange rate low, they have to purchase dollars from Chinese citizens. So as long as they think like that, they'll have a huge surplus of dollars.
But the Chinese have put themselves in a difficult position. If they try to unload their dollars, they'll have to do it slowly in order to keep the price from plummeting. But who will they sell the dollars to? That's why I don't expect a crash. Besides, their low exchange rate keeps new dollars coming in like a flood. The only way they can stop the flood is to let their currency appreciate, which they refuse to do. So if they dumped their $ Trillion tomorrow, they would have another $ Trillion by year end.
I don't see the big inflation (German style) coming until the federal debt becomes so large that we can't make the interest payments. At that point, I believe people will find high inflation more acceptable than higher taxes and we'll try to cheat our lenders by destroying the value of the principle.
Published: October 30, 2006 3:23 PM
Björn Lundahl
Mark Brabson
“If the nations of the world had stayed on the gold standard, we wouldn't need to worry about trade rates, since dollars/francs/pounds would all convert at the fixed ratio of their weights”.
A gold standard without the dollars, francs and pounds would be even better!
I quote from the book “What Has Government Done to Our Money?” by Murray Rothbard:
5. The Monetary Unit
“In the first place, most tangible physical goods are traded in terms of weight. Weight is the distinctive unit of a tangible commodity, and so trading takes place in terms of units like tons, pounds, ounces, grains, grams, etc. Gold is no exception. Gold, like other commodities, will be traded in units of weight”.
http://mises.org/money/2s5.asp
Björn Lundahl
Published: October 30, 2006 3:44 PM
David White
RogerM:
"But the Chinese have put themselves in a difficult position. If they try to unload their dollars, they'll have to do it slowly in order to keep the price from plummeting. But who will they sell the dollars to? That's why I don't expect a crash."
The corruption of money has put the entire WORLD in a difficult position, and in fact an impossible one. But in any case, examine your logic here: You have so much of something that it can't be unloaded without a price collapse. So continuing to accumulate it -- at an ever-increasing rate, no less -- will PREVENT the collapse?
Answer: No, it will only make the collapse that much worse.
Published: October 30, 2006 3:50 PM
Björn Lundahl
Don Robertson
“And that's how the Chinese think about these things too. They're taking care of their business with good common sense”.
“And, you can count on China too”.
How do you know that? Do you think that they have taken care of their business with good common sense for the last 50 years or so?
Björn Lundahl
Published: October 30, 2006 3:58 PM
Mark Brabson
Björn Lundahl:
Agreed. At one time of course, these various currency units were actually units of weight, i.e. dollar=1/20 ounce of gold.
I pretty much share Murray Rothbard's view of monetary policy.
Published: October 30, 2006 4:05 PM
Raymond Keller
RogerM: First, you write:
"In addition, no statistical correlation whatsoever exists between the trade deficit and exchange rates. I've tried to find one for years and it simply doesn't exist."
Then you write:
"I'm surprised that Mises.org would promote articles that clearly violate Austrian economic principles."
As any Austrian will tell you, one of the gravest sins a real economist can commmit, from an Austrian perspective, is to look for "statistical correlations"
The one violating Austrian economic principles is you.
As for the gist of Blumen's arguments , Hans Sennholz (the 84 year old Austrian economist, who attended Mises' NYU seminar)makes pretty much the same point in a new column (http://www.sennholz.com/unstableworld.html):
"A few critics believe that the U.S. trade deficits may be the greatest threat to the economic order. Yet the deficits have neither impaired the U.S. dollar nor undermined the position of the United States as the primary economic engine and power. Many observers, therefore, question and disclaim the dangers of American balance-of-payments deficits. They not only cast doubt on official statistics that may exaggerate the case, but also point to the stable rates of exchange which all participants maintain voluntarily. Stability, after all, benefits everyone.
"This economist, nevertheless, is convinced that a correction is unavoidable. All markets function to adjust and readjust any maladjustment. They are burdened and strained by the growing mountain of debt which raises the question of American ability to meet its obligations. If there ever should be any doubt about the stability of the American economy, the world-wide demand for U.S. dollars would decline, which would cause the dollar exchange rate to plummet. American imports would decline, dampening the surge of consumption and slowing the very growth engines of export countries such as Japan, China, and many others. The whole world would feel the American instability. A weaker dollar and rising import prices also would accelerate the inflation rate which would pressure the Federal Reserve to raise interest rates. Higher rates would slow the American economy and boost the rate of unemployment."
Published: October 30, 2006 4:27 PM
RogerM
David, So how will the collapse come about? Will the Chinese suddenly convert to Austrian economics, realize their folly, and dump the dollars? They can dump the dollars only if they get tired of selling to us. For without changing their mercantilist policy, the dollars they dump will suddenly be replaced by new ones.
But for argument sake, let's pretend that the Chinese suddenly decide to dump $1 Trillion in US gov debt. Interest rates in the US would sky rocket and shut down the US economy. Americans couldn't purchase any more Chinese imports and China's economy would plunge into a deep depression. I think the Chinese aren't that stupid. That's why I don't see a crash. They have a tiger by the tail and for the foreseeable future, it's safer for them to hang on than turn loose.
The best thing for the Chinese to do is gradually raise their exchange rate until it can float. It would be interesting to learn why the Chinese don't buy gold. One reason might be that they don't earn interest on gold. But then you have to ask would they ever get tired of holding gold? Can you have too much gold in the treasury?
Published: October 30, 2006 4:39 PM
RogerM
Raymond:"As any Austrian will tell you, one of the gravest sins a real economist can commmit, from an Austrian perspective, is to look for "statistical correlations...The one violating Austrian economic principles is you."
When I mentioned Austrian principles, I was thinking of Bastiat's condemnation of trade statistics and worry about deficits, and Mises promotion of free trade. I'm not aware of Mises, Hayek or Rothbard promoting any connection between trade deficits and exchange rates, but I'm certain they would find the utter lack of correlation at least interesting.
With all due respect to Mr. Sennholz, I disagree with some of his conclusions: He writes "If there ever should be any doubt about the stability of the American economy, the world-wide demand for U.S. dollars would decline, which would cause the dollar exchange rate to plummet." The stability of the US economy is relative to the rest of the world. Foreigners would have to be convinced that the US economy is more unstable than other places in which they could invest. As stupid as US monetary and fiscal policy is, it's still better than that in most other places in the world. That's why foreigners want to invest here. In addition to buying our debt, they also invest here directly; the US is the largest recipient of FDI in the world today. Maybe you could suggest other countries that are better to invest in? Besides, debt should be viewed as a % of GDP. If GDP continues to grow faster than we accumulate debt, the mountain can grow quite large in absolute terms.
How would foreigners lose faith in the stability of the US? We would have to default on our debt like Brazil or Argentina. But I don't see that happening. I think the Fed will inflate the debt away rather than default.
Finally, Mr. Sennholz assumes a direct relationship between US debt held by foreigners and the exchange rate. I don't see that relationship described in any of the classic Austrian writers, and it certainly doesn't exist statistically. If it did, I would model it and play the FX futures market and become rich. Austrians don't like empirical analysis, I know, but they like history and promoted the study of economic history. However, you won't find in recent history any connection between the amount of our foreign debt and the exchange rates.
Sennholz wrote "A weaker dollar and rising import prices also would accelerate the inflation rate which would pressure the Federal Reserve to raise interest rates." That's pure neo-classical, not Austrian! Monetary policy causes inflation, not rising import prices. Rising import prices are the effect of monetary inflation.
Published: October 30, 2006 5:05 PM
David White
RogerM:
First of all, I appreciate your acknowledgment that the trillion dollars China hold constitutes debt -- i.e., it's not investment in the US economy but an ongoing bail-out of the US government.
Second, the fact that China can't dump its enormous dollar holdings is precisely the point, as both governments are held hostage by the arrangement, never mind that it must inevitably end. Thus, the question so far as China is concerned is whether an Asian trade bloc can make up the difference when (not if) the US house of cards finally collapses, indications being that it can -- http://www.safehaven.com/article-6177.htm. So it's just a matter of time before China starts reducing its purchase of US bonds and the endgame is on.
As for why China doesn't buy gold, there's simply no way its central bank can do so in anywhere near the quantity it needs to without sending the price of gold to the moon, even though that's where it will ultimately go. Even so, can they or any other central bank or individual, have "too much gold"?
No, because, as a Nash equilibrium arises amid the collapse of the greatest financial fraud in the history of the world, "an ideal financial strategy for everyone on Earth is to buy as much gold and silver as they can, as soon as possible."
Published: October 30, 2006 5:12 PM
M E Hoffer
David,
I concur. And, in the meantime, the craven among us are only too happy, rubbing their hands in glee, with "Everyday Low Prices" on virtual baubles and beads, while the heart of our, once, Manufacturing Superiority is transplanted, West, to the Far East.
Published: October 30, 2006 6:02 PM
N. Joseph Potts
RogerM:
First of all, Blumen's post wasn't about the American trade deficit - it was about the Chinese trade surplus, and mostly its effect on China, not the US. He was describing/analyzing CHINESE policy, not American, which is what I often notice Americans getting hysterical about. Blumen isn't Chinese, and I didn't notice him getting hysterical on China's behalf.
Secondly, the Mises Institute is NOT "promoting" such an article or viewpoint. What you're responding to here is a posting on a blog. As a poster, *I* take responsibility for the position expressed or implied. I think that's how blogs work generally.
Published: October 30, 2006 7:15 PM
M E Hoffer
"Every media prediction concerning China's rise only echoes what was chorused about Japan three-four decades ago. So what?"
China's financial markets And their currency aren't nearly as open as Japan's were/are.
It's a mistake, Japan's, that China won't make anytime soon. Their, China's, fall will have come from a different vector, if there's to be one at all.
Published: October 30, 2006 7:24 PM
Björn Lundahl
Don Robertson
“Every media prediction concerning China's rise only echoes what was chorused about Japan three-four decades ago”.
Yes, China is heading towards being rich and powerful. No doubts about that. But that is for the reason that their economy is more and more market oriented and, of course, hard work. Economic growth has occurred despite of the fact that they have been pegging their exchange rate. That the Chinese Government has been pegging the exchange rate is a proof of that it is not very wise and that it is not “taking care of its business with good common sense”. Still, a Government can do a lot of waste and economic growth will for other reasons, occur any way.
Björn Lundahl
Published: October 31, 2006 1:37 AM
billwald
Prior to WW1 we had "real" money but the problem is the pronouns. Half the population lived in poverty. Post WW2 produced freak conditions in the USofA and the economy is reverting to the norm with a 70% working class, maybe 25% middle class and 5% rich people. Before WW2 the middle class had servants.
Second, the books are always in balance. The only thing China can do with US dollars is spend them in the USofA as tourists buying services, buying debt, buying goods, or buying businesses or land.
Published: October 31, 2006 12:31 PM
Nick Bradley
A few points:
1. I'm not too concerned about the US dollar and rapid growth in the money supply. Why? because every other country in the world is increasing their money supply at an even faster rate! If the European Central Bank or the Bank of Japan starts buying commodities, then I would be worried. Or, if a major oil-producing ountry started selling oil for gold and created a commodity-backed currency (is a pan-arab gold dinar standard a possibility), I would be worried.
2. If China does indeed have an artifically-low exchange rate, it is akin to the PRC writing a check to the American consumer in the form f cheaper goods. However, I am not so sure that the Yuan is undervalued. In fact, it may be overvalued. I wrote a graduate paper on the subject last year. Basically, if it weren't for stringent controls on capital controls in the PRC, there would be a mass exodus of wealth from China into foreign investments. Why? Because (1) interest rates in China are extremely low, (2) corporate profits in China are very low, and (3) investments in China recieve poor returns ON AVERAGE.
So, perhaps the PRC keeps its yuan artifically pegged at a low level so it can keep currency controls on its people without paying the price.
Published: October 31, 2006 12:47 PM
M E Hoffer
NB,
Are you not dismissing the pernicious effects, of Chinese monetary/political policy, on the US Manufacturing Sector?
Published: October 31, 2006 1:03 PM
Nick Bradley
MEH,
You are aware that global manufacturing jobs decline every year, don't you?
Low-end, unskilled manufacturing is moving into the third world, where labor is cheap; that is unavoidable. High-end, skilled labor is being more and more automated every day.
I don't know where people get it in their head that wealth can only come from manufacturing.
As the division of labor expands globally, we will get our goods from somewhere else.
Published: October 31, 2006 1:17 PM
M E Hoffer
NB,
Were it so simple that "Manufacturing", in any of its forms, was merely taking advantage of "comparative values" for labor inputs.
Sadly, the Financial Price signals that emanate from the current schema are grossly distorted, hardly functioning.
You posit: "I don't know where people get it in their head that wealth can only come from manufacturing."
Would you show me the sustainable wealth building that is incumbent in other sphere? Please exclude Farming/Agriculture and Resource Mining.
Published: October 31, 2006 2:29 PM
Björn Lundahl
To hide behind a state
If China wants to find out true market prices, it should promptly deregulate and denationalize all aspects of its economy. We can all speculate on what the right value of the Yuan is, but only free markets can tell. Governments are no substitutes for the free market, but are the problem. If Government bureaucrats are good in their foresight and at speculating, they could make fortunes with their own money in a free market.
In a free market China, prices of factors of production would be adjusted to a level which makes investments profitable.
Foreign investors would happily invest tremendously in a free market China. In a developing country like China with all of its hard working and disciplined work force, business opportunities would be enormous.
Björn Lundahl
Göteborg, Sweden
Published: October 31, 2006 4:18 PM
Björn Lundahl
China, Hong Kong and Sweden
China is still a very poor country. Productivity is very low so wages are, therefore, also very low. Productivity and wages goes hand in hand. For an example, go to; http://www.rieti.go.jp/en/china/02083001.html. Once, a long time ago, I was in Hong Kong*, and wages there were among the highest in Asia. Real wages increased about 10% per year, for the reason that productivity per hour work increased that much. Unions were very weak and had no influence, but wages increased anyway, because of competition between employers. As productivity increases, cost per employee gets lower and, therefore, the demand for labour increases and wages goes up. Productivity goes up for the reason that increased savings leads to ever higher capital investments per employee. That is the recipe for high wages and all Western countries have gone through that process.
Wages and living standards in China are higher than ever, but compared to the western countries, extremely low. In poor countries the average worker wants to work more hours than the average workers wants to do in the Western countries. Why? Isn’t that obvious? If your wage barely can support your family, life will be easier if you can work and earn more. We must remember that. Japan, Taiwan, South Korea, Hong Kong and Singapore once were very poor countries and today are better off, China also, will in the future, be richer and the living standard higher. Working hours will then be a lot shorter. There is no “short cut” for a higher standard of living and for a shorter working week. Many companies are “forced” by market forces to invest in countries like China. Consumers have a tendency to buy the cheapest goods and if they are not produced in those countries where they are produced for the lowest costs, they can’t compete. It is no point in accusing businesses for being greedy, they are, but so are we consumers.
Today, Hong Kong is even richer than Sweden. Hong Kong has accomplished in a much shorter time a higher GNP per capita and also a higher life expectancy than Sweden. The Swedish economic growth rate was also higher relatively to other countries when the economy was more free market oriented in the period before 1970. Sweden has also avoided two world wars.
For some information about Hong Kong, go to;
http://www.answers.com/hong+kong?gwp=11&ver=2.0.1.458&method=3
And for some information about Sweden, go to;
http://www.answers.com/sweden?gwp=11&ver=2.0.1.458&method=3
Free enterprise in action, just look at all those symbols of creativity and wealth, I really feel sorry for the people in the People’s Republic of China, go to;
http://my.tdctrade.com/photolib/hk/0100063L.jpg
If China, 50 years ago, had chosen the same path which it is now following, living standards in today’s China would probably be about the same as it is in Hong Kong. The Communist religion was really encouraging long working days and low wages in China.
Björn Lundahl
Göteborg Sweden
• Hong Kong is a free port with no tariffs and exchange controls and is probably the most free market oriented region in the world.
Published: October 31, 2006 4:51 PM
happylee
1 trillion? What a coincidence! I have some prime real estate for sale, at slightly more than 1 trillion, but I am willing to come down in the spirit of Sino-US relations. It stretches over the east river from Manhatten to Brooklyn. Very stylish design. For 1 Trillion it's yours, and I will throw in a limited edition beanie bear.
Or, on a serious note, the Chinese could spend the trillion to build a memorial to the hundreds of millions of its citizens who were killed during Mao's time.
Published: October 31, 2006 5:21 PM
Peter
Prior to WW1 we had "real" money but the problem is the pronouns. Half the population lived in poverty.
This is probably the 1000th time I've seen this from you, billwald; I don't understand why you keep saying it. Are you suggesting some sort of causal relationship?
Published: November 1, 2006 4:30 AM
Björn Lundahl
Don Robertson
“Every media prediction concerning China's rise only echoes what was chorused about Japan three-four decades ago”.
Have you changed your mind?
No one can with certainty predict the future, but I think it is quite probable that China will, if it follows the same path which it is now following towards a freer market, be a success story. Even today you can see tremendous economic results and China is very successful.
Japan, Taiwan, Singapore and South Korea have all of them been very successful.
For example, compare North Korea with South Korea.
In North Korea GDP - per capita: purchasing power parity - $1,700 (2004 est.)
http://www.answers.com/topic/north-korea
In South Korea GDP - per capita: purchasing power parity - $19,200 (2004 est.)
http://www.answers.com/south+korea?gwp=11&ver=2.0.1.458&method=3
Quite a difference!
Björn Lundahl
Published: November 1, 2006 6:26 AM
Nick Bradley
Has anybody put thought into how hard it would be for the PRC to go to a gold standard?
The Chinese money supply is at about 35 trillion Yuan, or about 4.5 trillion dollars.
Many believe that China would never sell off it's $1 trillion dollars in USD holdings because the price would start dropping as they sold it, reducing the value of remaining dollars.
But what if they started selling dollars and buying gold? The size of the gold market isn't that large, with the total amount of gold mined in human history standing at around 4 billion ounces, or 2.5 trillion dollars worth of gold, China would see rapid appreciation in their gold holdings while the value of their dollars would decrease. The Chinese wouldn't lose a dime of value, and would probably even grow the value of their foreign reserves.
And I would think that other nations would follow suit. China's second largest trading partner, Japan, would probably follow suit and start selling off their dollars and buying gold. There would almost be a panic selling of the dollar and a rush into gold. But the funny thing is that the first central bank to buy gold first would be the biggest winner.
Published: November 1, 2006 6:50 AM
Mark Brabson
Between Mao and the Gang of Four, pretty much anybody in mainland China who might have been sympathetic to Austrian views is at the bottom of some mass grave somewhere, with a bullet hole in the base of their skull.
Published: November 1, 2006 8:58 AM
Nick Bradley
Mark Brabson,
Although there may not be many Austrians in China, that does not mean the Chinese regime won't sample from the Austrian Buffet to achieve their ends. For example, going to a gold standard (or a partial gold standard) would immediately shift the global balance of power from the West to the East. Prudent investors around the world would put their money in the world's only hard currency, and the current plague of malinvestment in China would come to a screeching halt. The Japanese would have to remonetize (into gold) shortly thereafter, followed by other Asian states.
On another note, why do people keep insisting that the Yuan is undervalued? If anything, it is overvalued.
Since we're dealing with fiat currencies, no method is very accurate when it comes to determining the "fair value" of a currency. The PPP method is highly inaccurate (does not take into account lower inputs for production).
I feel a quick way to look at whether a nation's currency is overpriced or not is by looking at the ratio of the money supply to GDP. The US has a nominal GDP of $12.5 trillion and the money supply is around $9 trillion; an M3:GDP ration of 75%. In China, however, the PRC's GDP (including HK and Macao) is around $2.5 trillion. But, they have a money supply around $4.5 trillion; that would make for a Chinese M3:GDP ratio of 180%. Sounds over-inflated to me.
Published: November 1, 2006 9:42 AM
M E Hoffer
NB,
From myself: "You posit: "I don't know where people get it in their head that wealth can only come from manufacturing."
Would you show me the sustainable wealth building that is incumbent in (any) other sphere? Please exclude Farming/Agriculture and Resource Mining.
Any answer? Or, is it just that that's fact of it? Manufacturing is the Key to Wealth(?).
Published: November 1, 2006 9:58 AM
Nick Bradley
M. E. Hoffer,
Much wealth comes from value-added economic activity, such as services.
How much is produced in Hong Kong? I may be mistaken, but don't they gain most of their wealth from SERVICES, such as the shipping trade, banking, consulting, etc. etc.?
Furthermore, looking at the situation as "us vs. them", you're just propagating marcantilist worldviews further and further. What difference does it make to a Californian whether their clothing was manufactured at a textile mill in North Carolina or Vietnam? Not a damn bit of difference to me. An expanded division of labor is an expanded division of labor.
If you want to talk about manufacturing policy, look no further than tax codes and regulations. Those two factors drive the cost of manufacturing in the US up far higher than they would be in a free market. Take a look at Ireland, where manufacturers have flocked to the Emerald Isle since slashing corporate taxes. The US Government LOSES money on corporate tax policy anyway, revealing for what it is: a corporatist system of control over private industry; tax income from corporate taxes and corporate welfare are pretty close in size, and if you add in the hundreds of billions of dollars wasted in corporate compliance with the tax code, it's a no-brainer.
Published: November 1, 2006 11:52 AM
Dan Coleman
I agree, Nick. The moment trade becomes us vs. them with legal implications, both "us" and "them" lose.
"Manufacturing" is a loose category at best and certainly not something that is a foundation for special treatment and laws.
Published: November 1, 2006 12:01 PM
M E Hoffer
NB, and, by extension: DC,
"Were it so simple that "Manufacturing", in any of its forms, was merely taking advantage of "comparative values" for labor inputs.
Sadly, the Financial Price signals that emanate from the current schema are grossly distorted, hardly functioning."
=
"look no further than tax codes and regulations. Those two factors drive the cost of manufacturing in the US up far higher than they would be in a free market."
I'm not sure where, either of you, got the idea that I'm propounding some type of "legalistic solution"(read: "Protectionism") to out current trade conumdrum.
To me it's fairly simple. We, as the source of ultimate Demand, make the conscious decision to maintain a baseline of Manufacturing proclivity for, at the very minimum, the maintaince of the ability to "defend" ourselves. Or, we'll forever be supplicant to the potential ill-will of "our Suppliers". Literally, no better than a Crack-Ho.
NB, none of the "value-added" "services", that you mention, exist without the Heartbeat of Manufacturing. It's been the case throughout the History of Man's experience with "civilization", and there isn't Any Question about it.
There was a quote, fairly recently, in the right-hand sidebar from LvM, to paraphrase: "We must accept things as they are, as opposed to how we wish them to be."
In that vein, dealing from weakness--the (growing)inability to Supply intregral pieces of our (predicated)Economy--is, at best, Folly.
Further, the idea(s) that "Free Trade" with Mercantilists or some type of "Trade-based" M.A.D. has stripped the Globe of its animosities, belong in the same Eco-Fi section that one would find JMK's GT.
Published: November 1, 2006 1:29 PM
RogerM
ME Hoffer:"We, as the source of ultimate Demand, make the conscious decision to maintain a baseline of Manufacturing proclivity for, at the very minimum, the maintaince of the ability to "defend" ourselves."
How would we do that?
Published: November 1, 2006 1:32 PM
M E Hoffer
RogerM,
The simple answer, to start with: By understanding the nature of the trade-deficit(s) we create/ are creating.
And, by extension, the Nature of those we trade with.
Published: November 1, 2006 1:54 PM
Nick Bradley
M E Hoffer,
"We, as the source of ultimate Demand, make the conscious decision to maintain a baseline of Manufacturing proclivity for, at the very minimum, the maintaince of the ability to "defend" ourselves. Or, we'll forever be supplicant to the potential ill-will of "our Suppliers". Literally, no better than a Crack-Ho."
-- You Sound Like Alexander Hamilton. You are arguing that a limited amount of autarky is essential, no? What is this baseline? It has to be completely arbitrary.
Tell me, how is Connecticut the wealthiest US state when it doesn't manufacture much of anything? Don't they need an essential manufacturing base or else they will be no better than "whores"? Connecticut, Main, Vermont, and new Hampshire comprise about 5% of the US population and don't produce much; yet they are successful. The US is about 5% of the global population. Is there any difference?
How about a reducto ad absurdum argument? Should I, as an individual, have to maintain an essential ability to manufacture to survive? Must I be able to build a kitchen table and construct a toaster to be successful? Absolutely not! Wy shouldn't it be? After all, it is said that nation-states act in a state of anarchy with each other anyway.
My point about corporate taxes/regulation and manufacturing is this: Even if ALL manufacturing jobs left the US and we THEN eliminated corporate taxes, manufacturing jobs would come back. To claim otherwise would be supporting the fallacy of predatory pricing, but on a much grander scale. And if you look at it, poor US industrial policy is just accelerating what technology is already doing: getting workers out of low-intensive manufacturing and into something else.
I have in fact read that even China is losing manufacturing jobs! Can you believe that? It's actually a source of great social unrest in Central and Northeast China, away from the boom in Nanjing and Shanghai; millions of unemployed factory workers are protesting!
Published: November 1, 2006 2:59 PM
RogerM
ME, Once we understand the nature of the trade deficit and those we're trading with, then what?
Not that achieving that understanding is easy. Most econs believe that we Americans are greedy hedonistic gluttons burning our furniture to keep warm and eating our seed corn, in other words, sacrificing our children's future for our present digusting pleasure. Is that how you see it?
Published: November 1, 2006 3:08 PM
Nick Bradley
RogerM,
I do believe that present-day Americans have a high time preference, especially baby boomers, don't you? Americans want it now; damn the consequences.
Of course, this can be laid at the feet of the state, with inflation, taxation, and regulation loweing the value of future goods.
Published: November 1, 2006 3:22 PM
billwald
If the ability to do business in an economy depends upon the possession of gold then the efficiency and equity of the economic system depends upon the distribution and circulation of gold. A gold ownership economic system in which half the population historically never had any gold is neither efficient not equitable.
Our present economic system is based on credit and IOUs. Most people have access to credit and can generate IOUs. A person who uses credit to obtain tools and make sound investments will do just fine. A person who uses credit to obtain toys will crash. Breaks my heart.
Published: November 1, 2006 7:20 PM
M E Hoffer
NB,
I suppose that whether sounding like A. Hamilton is true apostasy, or not, will soon be adjudicated. Past that, "a limited amount of autarky is essential", Yes, of course, it is. It is, surely, the best Insurance against the vagaries of the Unknowable, the Future. Relying on strangers, whether next door, in the next time zone, or across the (next) Ocean, is, by greater degree, respectively, ever more fool-hardy. It is, merely, the chimera of "stability" and delusions of "hyper-powerness" that give rise to conceits such as you, and a great many others, are parroting.
The "wealth" accumulations you point to, HK and CT, are nothing, certainly not nearly as much, without the manufacture of hard goods.
On a different thread, nearby, you note, and rightly so, the intergeneration delamination of the American Society by the hand of SocSec. I wonder how it is that you so properly see the deleterious effects of that illusion and yet, do not seem to utilize equal vision in spying the threats pregnant in similiar mirages.
RogerM,
You ask if I: "believe that we Americans are greedy hedonistic gluttons burning our furniture to keep warm and eating our seed corn, in other words, sacrificing our children's future for our present digusting pleasure." (?)
I'd simply say we've been inattentive And misled.
In the course of so doing/being, we've consumed many Tomorrows in exchange for some rather forgettable Yesterdays. Is the room bare? The silo empty? Hardly. Are we building greater strength? more capable of ensuring our Liberty? I'll just say: We should be.
Published: November 1, 2006 10:36 PM
RogerM
ME Hoffer,
So what action do you propose to change things? Education or legislation?
Published: November 2, 2006 8:19 AM
Nick Bradley
MEH,
So how much autarky is necessary. What arbitrary amount wil you pick?
My other post was in regards to moral issues. I don't see how manufacturing applies (unemployment would be nonexistent without state unemployment regulations).
I think the HK and CT analogies apply quite fittingly. They do not directly produce goods, but still prosper from their production. Same goes for the US.
Published: November 2, 2006 8:57 AM
M E Hoffer
NB,
You ask: "What arbitrary amount wil you pick?"
Along the lines of: "unemployment would be nonexistent without state unemployment regulations", if we stripped our present schema of much of the State intervention that is perverting it, I'd think everyone's answer would be : More.
To your point, from that different thread: "That strong morals are a natural phenomenon that emerges from the market. I think Hoppe has done a lot in this realm by linking the state's articifial heightening of time preferences with the degeneration of society." I'd quite concur. Though, not only have our "time preferences" been skewed, the whole of the Financial Price signal, emanating from the scheme, has been warped.
Many like to believe that that results, merely, in "Everyday Low Prices", problem is, like the Grasshopper of yore, whose Time Preference Series had been ill-thought, we'll be knocking, pleading, praying at the door of the Ant, the Manufacturer, come Winter.
The same rude potentiality awaits the Shipper who fills his Holds with others Produce(HK), and the Trader who fills his Portfolio with mere Paper(CT). Mandelbrot, beyond his picturesque Fractals, well understood, along with Grantham, the Actuality of "Fat Tails" and their systemic consequences. We should too.
With this: "My other post was in regards to moral issues. I don't see how manufacturing applies."
"That strong morals are a natural phenomenon that emerge from the market." More Market, more morals, more Liberty. More Market, fewer "strangers", more Freedom. More Liberty, more Freedom, more Happiness, less War.
Published: November 2, 2006 10:27 AM
RogerM
The Fed has some interesting research on the relationship between the twin deficits, fiscal and trade at http://www.newyorkfed.org/research/current_issues/ci12-7.html
Basically, they say the link is very weak.
ME, so what's your solution to the problem you see? Are you content with trying to educate people, or do you have some policy prescriptions?
On the idea that a country can't live without manufacturing, I would suggest that moving manufacturing to other countries is nothing more than the globalization of the division of labor. Theoretically, it should be possible, even advantageous, to move all manufacturing out of the US to Asia and have all Americans working in services if doing so is more efficient. In other words, if Asians are better at manufacturing than us, and we're better at services, both of us would be better off doing exclusively what we're best at. Even further, I believe Ricardo showed that even if Asians are better at both manufacturing and services than we are, if within the US we're better at services than manufacturing, we and the Asians will be better off if we concetrate on services and import their manufactured goods.
Published: November 2, 2006 11:04 AM
M E Hoffer
RogerM,
Do us all a favor, please enumerate these vaunted "Services" that will form the Economy you envision.
Published: November 2, 2006 11:37 AM
Björn Lundahl
RogerM
”On the idea that a country can't live without manufacturing, I would suggest that moving manufacturing to other countries is nothing more than the globalization of the division of labor”.
I, completely, agree with you.
Björn Lundahl
Published: November 2, 2006 11:38 AM
RogerM
ME:"Do us all a favor, please enumerate these vaunted "Services" that will form the Economy you envision."
I don't know that I'm doing you a favor, but services include financial, especially accounting, engineering/architecture, shipping/transportation, healthcare, entertainment (excluding football, which is a religion), publishing, R&D, legal, barber shops, education, etc. Can anyone else think of more services?
Published: November 2, 2006 11:45 AM
Dan Coleman
RogerM,
It doesn't matter, really. . .we can name different services all day but the point is that people produce goods and services that satisfy needs. There are plenty of things that will keep any economy afloat minus the manufacturing industry--we can just get manufactured goods from somewhere else. (It is certainly, as you pointed out, merely the furthering of the division of labor to a global scale).
If it turns out that some kind of doomsday arrives and all foreign manufacturers decide to stop producing for us, then the markets will take care of that by redistributing resources back to their most urgent needs. Manufacturing plants will open up in the US, other services will cease to be profitable, innovation will take place, and life will move on.
The only real threat is if the U.S. government decides to get its hands in to *ahem* "fix" the problem. Anything from "saving X industry" to protectionist trade policies to inflation distort price signals. Businesses will have a much harder time figuring out what the most urgent needs are, and recovery will be much slower as capital and investments are wasted on innefficient uses.
On that count, I would perhaps agree (somewhat) with what I think M E Hoffer is trying to say here. (It's hard to tell, as he's not a very clear writer). Should almost every individual business in the U.S. rely on foreign manufacturing for its wealth, and the foreign manufacturers decide to stop their services, our own distorted economy will have a hard time adjusting. And, in fact, the government will likely be spurned to further action by the trouble, increasing the time that it would otherwise take to recover.
However, the problem is not that manufacturing is an industry that is leaving our borders; the issue at hand is how the U.S. government is setting up its citizens (and especially the poor) for hardship in the future.
Published: November 2, 2006 12:08 PM
RogerM
Dan, I agree completely. The real threat to US manufacturing is not China, but taxes and regulation.
But let me drag out my own doomsday scenario. Mark Steyn has written a book called "America Alone" in which he basically asserts that except for Australia, the US stands alone in the world as the defender of Western Civilization, Europe having caved to Islamists. Along those lines, socialism has grown in popularity by huge amounts since the collapse of the USSR. The US and Australia stand as the last bastions of what's left of capitalism in the world, and the rest of the world is increasingly angry at us for holding out against socialism. I fear that the rest of the world, led by Europe, will someday try to isolate us as they did South Africa, allowing no imports or exports. The issue that ignites the the blockade could be global warming.
I developed this fear, possibly irrational, a few years ago when studying the econ history of the Dutch Republic. The first capitalist state, and therefore very wealthy, the rest of Europe hated them something awful. Spain, England and France tried to destroy them in multiple wars but failed. Finally, all of Europe, including their "friends", isolated the Dutch behind high trade barriers. The story isn't tragic, however. The Dutch economy grew very slowly but didn't decline. Meanwhile, England adopted Dutch capitalism and went on to led the industrial revolution.
Published: November 2, 2006 12:50 PM