United States USD Policy is Misguided

I begain writing this about a week ago, and am beginning to see some media reports supporting my argument below, thankfully. Hopefuly, these opposing opinions to current US Policy are not too late.

Recent media reports indicate a growing strain between US-Sino relations over the Chinese policy on currency valuation. The fervor of Chinese currency manipulation is once again bubbling within the United States.

The US, or at least those proponents of this agenda believe China’s cheap currency is artificially low and therefore is creating unnatural imbalances in global reserves and global trade.

In layman’s terms these folks think the shit we import from China is too cheap, giving Chinese manufacturers an unfair pricing advantage in global trade. As a result, dollars flow (as well as the currencies of other developed countries) into China and just stay there.

The logic being espoused now is that in order to correct these imbalances the Chinese should be letting their currency appreciate (at least against the dollar) by as much as 20-40% as of recent reports. This is a large movement as it pertains to currencies, and normally would be something that might happen naturally over the course of years, if not the better part of a decade.

Recent reports claim that a growing consensus of US policy makers want to see this kind of movement in the Chinese currency over a far shorter time frame.

For more than two decades US consumers have benefited directly and indirectly from a relatively weak Renminbi (Yuan). We were able to consume more Chinese imported / manufactured goods for less money. Indirectly this helped to keep inflation in check, and benefited industries who were able to capitalize on China’s relentless demand for natural resources and those companies who were able to arbitrage the cheap cost of Chinese labor.

Now that US unemployment stands as high as it has been in over a generation, America seems abruptly convinced that part of our troubles have arisen from the fact that our finished goods cannot compete with the prices of Chinese finished goods and therefore China is “keeping a good man down”. Funny we don’t consider our legacy cost structures part of the problem.

If not absurd, the evangelical approach supporting a rapid rise in the Renminbi is at least short sighted, and may actually dangerous for the US.

The end result of a rapid rise in the Renminbi (RMB) against the US Dollar would certainly help US manufacturers compete better on price in the global market place, this would particularly benefit our durable goods industries like cars that are assembled here. However increasing the purchasing power of the Chinese consumer dramatically and quickly seems to me might have other adverse consequences.

For one, despite continued commentary that inflation is not an issue, anyone who does grocery shopping in the United States can tell you otherwise. Food prices have not benefited from the deflationary recession that took home prices and the prices of other durable goods down. As per-capita purchasing power increase for the Chinese consumer, we here at home will be competing with them more heavily for grains, dairy and protein which will surely drive up global prices.

The same scenario that is described for food would also apply ubiquitously across all commodities and natural resources. In fact a fast rise in Chinese purchasing power might incentivize stockpiling, creating additional pressure on the prices of all natural resources.

In addition a stronger RMB relative to the USD specifically implies not only an increase in the relative purchasing power for the Chinese but concurrently a relative decrease on the purchasing power for Americans, a major double whammy. In the areas where we compete to consume natural resources this could have dramatic, adverse and even rapid consequences.

The direct impact would be modest to severe rise in price driven inflation, particularly for “headline” CPI. Core CPI would be less impacted in the near term as it excludes food and energy prices. I won’t explore how the government gooses these numbers anyway.

The political agenda out of Washington is currently misguided, if not dangerous. An article today appearing in Bloomberg alludes to this as well. In the article Nobel-Prize winning economist Robert Mundell says that U.S. legislation to press China to raise the value of the yuan [RMB] would be a “disaster” and fail to narrow the trade deficit between the two nations. He goes on to say:

The bill “would create a very damaging thing to the world economy and the stability of Asia,” Mundell said. “This would have a wounding effect on the stability of international relations. There’s never been any precedent in economic history where a country through any legal system was forced to appreciate its currency relative to another country.”

“It’s not going to have much of a dent in the U.S. deficit,” he said. “America has had a huge deficit since the 1980s. None of that is going to change if China changes its exchange rate.”

Policy makers should try to keep the currencies within a range to prevent “huge swings” in the price of raw materials such as oil, he said.

The euro-dollar fluctuation “is a terrible thing for the world economy,” Mundell said. “We’ve never been in this unstable position in the entire currency history of 3,000 years.”

I agree with Mundell. What he doesn’t say directly but he alludes to is that US policy smacks of protectionism, and at a time and with a trading partner that could undermine the global recovery. A protectionist policy agenda with China could easily and quickly escalate to stimulate a new geopolitical divisiveness that in its worst form could lead to war(s).

This week in fact the House of Representatives is voting on a China trade tariff that would inflate the cost of more Chinese goods imported into the US. This comes after a handful of other trade tariff disputes since Obama took office on things such as tires and gift boxes. In retaliation earlier this year China proposed a tariff on US chicken going into China.

There is no good that can result from an escalation of trade tariffs, a system that was mostly dismantled through globalization. It is only a matter of time before the US/China trade was draws allies inspired to align their home interests by protecting their own major industries.

At home in the US, the result would further squeeze the middle-class American budget that Obama so adimantly wants to protect. It’s not the wealthy that rely on cheap products from China Mr. Obama, its the men and women who are trying to stretch every dollar.

My alarmist comments are not unfounded by anyone who knows a little bit of history and has a little bit of vision. But the future of human survival will depend on social order. A major imbalance in global resource production and consumption (particularly in food and energy) could tip a boat that has been running evenly for more than half a century. If you want to consider what happens when people cannot eat, consider the Middle East and Africa where poverty rates and lawlessness run hand in hand.

What makes this policy misstep so dangerous in my opinion is that it is driven not by rational thinking that can be tested and rebuffed, but instead by dogmatic Middle-Class zealotry. The administration in its effort to return middle-class Americans to work, may incite the worst bout of protectionism seen since before World War II, an action that could certainly inspire a new Cold War, and as mentioned before possibly a real one. I am not a Republican, nor do I consider myself to be overly conservative, but I think they have got this RMB agenda all wrong.

I believe the Obama Administration has done a tremendous job with what was left behind by the Bush Administration. However, I see forcing China on its currency as having the potential to undermine everything accomplished thus far, and with the potential to recreate a level of global instability far in excess of what was left behind by the Bush Administration.

It seems to me that a better agenda for the administration would be to focus on USD stability instead on RMB parity. The vast majority of the World’s commodities are priced in USD. In addition, US corporations are faced with the onerous task of calculating their currency exposures on a regular basis. Even small and medium sized business who may not have significant overseas sales are victims of price instability caused by commodity fluctuations. Consider the chart below.

DXY: US Dollar Index Spot Summary - USDI Chart 2006-2010

DXY: US Dollar Index Spot Summary - USDI Chart 2006-2010

The USD index has made moves of 10-15% three times now in the last two years. This is unprecedented volatility in the world’s largest reserve currency. The USD Index has spiked when fear spiked, and sank when fear subsided. The US currency has effectively become the beneficiary/victim of the global risk on/risk off trade. With equity and bond markets now chasing highs, the dollar is again heading downward.

At some point, however, I suspect unless we stabilize our currency, it will begin to lose its place as the preferred store of value. Not to mention what this volatility has done to commodity prices effecting everything from food and fuel, to industrial goods. Companies who bare the brunt of controlling costs or raising prices are force to make decisions today that may be totally obsolete a few months from now, based on currency movements alone. Regardless of the structural imbalances between China and the US, and despite objective (or subjective) relative valuations of the RMB vs the USD, I have to believe that price stability predicated by US Dollar stability is the more immediate issue rather than the RMB/USD exchange ratio.

In a world of uncertainty and unprecedented volatility, we need stability. We are so focused on China’s proported currency manipulation when the truth is we ought to be more concerned over our own.

Remember China has about four times the population as the US. The more the RMB appreciates, the greater the increase in 1.2 billion people’s purchasing power. Are we really sure we want to force that agenda? Seems idiotic to me.

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