Monday, June 21, 2010



The big news over the weekend, the weekend that, not at all coincidentally, preceded the weekend on which the G-20 meets in Toronto, was the decision by China to return to a “managed floating exchange rate” for its currency with two names. Don’t kid yourself; this return on the part of the Chinese to the approach to the renminbi/yuan that prevailed until 2005 does not mark “…the beginning of a new era,” as Li Daokui, a member of the Chinese central bank’s monetary policy committee put it. What we saw over the weekend was not a major shift in Chinese currency policy but, rather, a feint toward the G-20 and such economic illiterati as Senator Chuck Schumer and a small move to contain a domestic inflation rate that is getting out of control. China simply cannot let the yuan appreciate to a market clearing level.

The reason that the Chinese cannot let the renminbi appreciate appreciably has little to do with the balance of trade, the focus of discussion of the “experts” in the wake of the weekend’s moves. While I realize that life takes place at the margin, even big changes in exchange rates are not going to have a noticeable impact on the obvious advantages those who manufacture or assemble in China have over their counterparts in Europe or North America With, for example, Chinese autoworkers recently having received a raise to about $1.20 an hour, and working in factories that would not look at all out of place in Lansing, Marysville, Oshawa, Stuttgart, Munich, or Hiroshima, it isn’t the value of their currency that gives the Chinese a big advantage in trade. Further, since those who manufacture or assemble in China, whether domestic or foreign, import a substantial portion (in the case of car manufacturing, nearly half) of their parts, a stronger yuan will have some salubrious effects on the overall terms of trade. No, the “terms of trade,” properly understood, are not going to be affected much by a strengthening of the yuan.

The real reason that the Chinese cannot allow the yuan to appreciate, and the dollar to depreciate, is not an income statement reason (terms of trade), but, rather, a balance sheet reason, i.e., the nearly $1 trillion in dollar denominated assets held by the Chinese central bank and other Chinese entities. A sharp appreciation in the yuan against the dollar would have substantial consequences for Chinese wealth. That is why this weekend’s “big news” is not as big as it appears.

One could argue, with a great deal of justification, that one cannot put the genie back in the bottle, that once the yuan starts to move the pressure, and not only from speculators, but also from other natural market forces, will be irresistible. But the Chinese have a lot of money and a lot of brains, the former of which we gave them, and thus the ability to fight even market forces for protracted periods of time. Doubtless one of the tacks the Chinese will take in the “managed floating exchange rate” regime will be further, and probably heightened, browbeating of the U.S., to defend the value of its currency by applying both fiscal and monetary discipline, concepts that have become increasingly foreign on these shores as we have increasingly come under the influence of “experts” who have never made a legitimate dollar but who insist that the principles involved in actually making a living (frugality, sobriety, budgeting, restraint, reflection) are hopelessly dated relics of a benighted era. Though we won’t like being lectured by the Chinese on principles we once practiced but have long since forgotten, this further license for Chinese hectoring will be one of the beneficial byproducts of the sort of floating yuan. Since we can’t discipline ourselves, we need these lectures on fiscal and monetary sanity, especially when delivered by people with an assortment of cudgels that can be used to drive those lessons home.

So to the extent that the yuan floats, we will be subject to more lectures and punishments designed to get us to do what adults, sorely lacking in modern America, and especially in its public sector, should know to do without constant browbeating.

In former centuries, western colonialists forced the Chinese, often Chinese with far more mental horsepower than their colonial masters, to do menial tasks like pulling rickshaws (a term, by the way, which is a western bastardization of “jinrikisha”). In the post western binge world, the Chinese will be forcing us to do tasks that, while not necessarily menial, should have been obvious to us for years. Some will say this is poetic justice, but calling the newly turned tables by that term ignores an important difference. The colonialists forced the Chinese to do their bidding by force of superior arms. We, on the other hand, put the Chinese in charge by our own unrestrained spending and borrowing. To paraphrase a guy who shared the philosophy the Chinese still nominally, but laughingly, embrace, we, in this instance, bought the rope with which the Chinese can hang , or, hopefully, teach, us.

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