Comments (16)

• Alex

  Very much enjoyed this article. Hits home very well the point that to analyze effects one must consider all important channels of influence when an event occurs.

  Published: May 5, 2008 10:01 AM

• newson

  wouldn't it just be easier to be clear on semantics and stick rigorously to the austrian definition of inflation?
  that would make it simple to understand that growth in the money supply doesn't preclude the contemporaneous rise and fall of different asset classes. in your scenario, collapsing financial assets accompanied by rising consumer and producer prices.

  Published: May 5, 2008 11:05 AM

• Kel

  Great article Bob. I always think pointing out when one is wrong gives themselves more credibility.

  But I'm still not so sure about your final position on the falling dollar affecting asset prices and not consumer prices. We understand how this could conceivably be, because we witness the stock market rising far more in an average year than we do consumer prices.

  But, if the dollar falls, those who would sell their US assets receive dollars for them. This means they still have a claim on American goods (or assets). It seems to me that when the day comes that they no longer want anything in dollars, they will use their cliam on dollar goods (dollar bills) to purchase these goods (i.e., finally dispose of their dollars). The return of these dollars to America would drive up consumer prices. In short the selling of assets by foreigners would result in money flowing out of US assets and into US consumer prices (the same might happen one day by Americans selling US assets and diverting the money to US consumer goods)

  Published: May 5, 2008 1:19 PM

• olmedo

  politicians like publicise an increase in exports as good news. but, what they dont say is that in a country with massive trade deficits (and little savings) that increase in exports could only come from a decrease in internal consumption manifested in higher internal prices as foriengners are better able to compete for the same amount of internal goods than locals.

  Published: May 5, 2008 2:15 PM

• olmedo

  politicians like publicise an increase in exports as good news. but, what they dont say is that in a country with massive trade deficits (and little savings) that increase in exports could only come from a decrease in internal consumption manifested in higher internal prices as foriengners are better able to compete for the same amount of internal goods than locals.

  Published: May 5, 2008 2:16 PM

• Tom Burger

  At one point Mises talked about the end of the inflationary process. He said that if currency holders ever begin to think that debasement is an official policy that would never end, a "flight to real values" could result. Applying his words to our situation today, it would seem that a "flight to real values" could move the dollar very rapidly toward a value of zero -- even without any additional "helicopter drops" by our merry band of Fed governors. The multiple trillions in foreign hands today ought to be quite sufficient -- if everybody is trying to exchange those dollars for real goods and assets.

  Published: May 5, 2008 2:47 PM

• Raja

  I am unable to understand how having food stamps in China will lead to less savings.

  Having food stamp would allow a household to have surplus Yuan not used to buy food as food stamp provided food.

  Even if all of the surplus household Yuan is used for consumption, how does the savings drop?

  Published: May 5, 2008 8:57 PM

• fundamentalist

  Raja: "Even if all of the surplus household Yuan is used for consumption, how does the savings drop?"

  By increasing government spending, the state saves less, which is a part of national savings. It might also be the case that the food stamps go to the very poorest people who would increase their consumption and not save more.

  Published: May 5, 2008 9:36 PM

• fusgerm

  Good article.

  The Chinese taxpayer is effectively subsidizing both American consumers and American investors.

  The Chinese government is subsidizing the exporters of consumer goods by giving them more yuan in exchange for their dollar-earnings than "fundamentals" (based on relative purchasing power) would justify.

  This leaves the Chinese government with a surfeit of dollars, which it spends on the US financial markets. Its buying of US treasuries and (to a far lesser extent) US shares keeps bond-yields low and also (to a far lesser extent) helps prop up the US stock market.

  When the Chinese government ends the dollar-peg, then the dollar-price of Chinese consumer goods will rise, the reduced demand for US bonds will raise US bond-yields, and the slightly reduced demand for US stocks will make it harder for the US stock market to rise.

  On top of this, the maintenance of the peg has caused the Chinese to amass a vast armory of US treasuries. Any attempt to sell these will exacerbate the rise in bond-yields. The value of the dollar will also be depressed as the Chinese government wades in to the market brandishing the dollars which it receives in exchange.

  No doubt the US treasury is well aware of this, and is planning a bout of hyper-inflation to expropriate its Asian creditors before they catch on.
  

  Published: May 5, 2008 10:51 PM

• newson

  fusgerm says:
  "No doubt the US treasury is well aware of this, and is planning a bout of hyper-inflation to expropriate its Asian creditors before they catch on."

  i find it difficult to believe the asian t-bond buyers don't know exactly what risks they're taking on with negative real yields, as they are now.

  they are prepared to wear this risk to support their own mercantilistic agenda, or for other political reasons known only by the inner circle.

  Published: May 5, 2008 11:08 PM

• fusgerm

  "they are prepared to wear this risk to support their own mercantilistic agenda, or for other political reasons known only by the inner circle."

  If this is a risk they were prepared to wear, then they must have got a rude shock when the dollar index broke below 30-year support last year. A less unprofitable way for them to indulge their mercantilist appetite would have been to invest their trade surpluses in equities instead of treasuries. That would have inflation-proofed them to some extent. But it is only in the past year or so that their SWFs have radically shifted their focus.
  

  Published: May 6, 2008 4:35 AM

• DS

  The Chinese are hardly in a position of strength here because their whole house of cards is built on a weak currency and the yuan created with each cycle of exporting cheap consumer goods to the US, trading those dollars for Yuan and using the dollars to buying US treasuries to keep their currency weak. The real problem is China's banking system which is for all intents and purposes insolvent. Not too long ago the proportion of non-performing loans in the banking system was over 50%, and I don't think that number has come down very much. An increase in interest rates and the contraction in the Chinese money supply that would result from a rise in the Yuan would devastate the Chinese banking system, and would set off massive inflation in the US as all those dollars printed over the past 15 years came home for good. This is just like Japan's "zombie" capitalism of the 1990's but in a poor country without a cushion of 50 years of solid economic growth and a real, fully developed industrial economy.

  I don't know what the end game is here but it isn't pretty for either side of the Pacific (it will take down the Japanese as well), which is why both sides are doing everything they can to keep the game going.

  Published: May 6, 2008 8:09 AM

• newson

  fusgerm says:"A less unprofitable way for them to indulge their mercantilist appetite would have been to invest their trade surpluses in equities instead of treasuries."

  in a rational, economic sense, i couldn't agree more. but the politics militate against it. note the furor over the cnooc bid for unocal. withdrawn before the politicians knocked it back. witness the dubai ports world bid, and the white heat that generated.

  here in australia, chinese participation in j-v mining projects has already got populists squealing.

  also, i think you are quite wrong to imagine that the chinese government cares two hoots about value for their taxpayers money. the regime keeps their pals' factories afloat, a weather-eye is kept on unemployment (remember the revolution), and the dance of death continues. i think ds is perfectly right in saying this ends up bad for both parties.

  Published: May 6, 2008 11:17 AM

• fusgerm

  I would say that Unocal was a test case. They had seen Lenovo go through OK, despite the issues of software acquisition. But I think it is only in recent years that it has occurred to them to diversify from treasuries. If they were gifted with really long-range sight then they would have bought their stake in BHP or Rio Tinto back in 2004, when it would have cost them less than a quarter as much.

  The Chinese government is very wealth-conscious - not for the sake of the Chinese taxpayer, but for the aggrandizement of the Chinese State. Look at their obsession with the Olympics, and the recent buildup of military forces, notably the recent revelation of the nuclear submarine base. I think this is more than just sabre-rattling over Taiwan - they want to project a serious military presence. If they are denied the resources they desire at the negotiating table then - probably in a decade or two - they want an option to play their trump card.

  Published: May 6, 2008 5:07 PM

• newson

  to fusgerm:
  i think lenovo is in a different, non-strategic category, not comparable to the unocal and rio tinto/bhp situation. the chinese have been joint-venturing smaller projects here in western australia for years now, and many miners have substantial shareholders from china on their register.

  were the chinese to make a play on bhp billiton, i'd bet on it getting blocked by the foreign investment review board or the treasurer, as happened some years back when shell tried to move on woodside petroleum.

  i think the chinese are wary of provoking nationalistic/xenophobic sentiments - there is substantial resentment over our local manufacturing base having moved to china, and protectionism is warmly embraced by a not insignificant fraction of the voting public.

  i agree that the chinese are very interested in becoming the regional power, but i cannot accept that they don't very well know the terrible prospects of us treasuries. this is just the price they've chosen so as not to antagonize the us, at least not yet. besides, the t-bond market is so huge, compared to the resource company market.

  Published: May 6, 2008 10:20 PM

• Alex

  Kel: "But, if the dollar falls, those who would sell their US assets receive dollars for them. This means they still have a claim on American goods (or assets). It seems to me that when the day comes that they no longer want anything in dollars, they will use their cliam on dollar goods (dollar bills) to purchase these goods (i.e., finally dispose of their dollars). The return of these dollars to America would drive up consumer prices. In short the selling of assets by foreigners would result in money flowing out of US assets and into US consumer prices (the same might happen one day by Americans selling US assets and diverting the money to US consumer goods)"

  But, when the Chinese, or other foreign holders reduce their demand for U.S. Treasuries, this reduces the market price of the bonds and raises the yield. The result is that the attractiveness of holding these bonds increases to other foreign and U.S. investors.

  For the Chinese to suddenly dump U.S. Treasuries would, as everyone says, cause a huge drop in the market value of the U.S. Treasuries, a huge drop in the value of the U.S. $, and a huge drop in the yuan value of the U.S. assets held by the Chinese. This strikes me to involve a lot of foot shooting by the Chinese. It's not clear that it would at all be in their self interest.
  

  Published: May 7, 2008 9:03 AM