China’s currency is 35% cheaper (if not more) than it was in 1993. Is a protectionist backlash in the cards?
Earlier this month, Tudor Investment Corp. sent an interesting piece of research to clients. The gist — China’s currency is undervalued in a very big way.
According to measures based on productivity and purchasing power parity, or PPP, the Chinese renminbi (RMB) is 35% to 72% cheaper than it was in 1993.
How many things can you think of that have gotten at least a third cheaper, and possibly more than two-thirds cheaper, over the past 18 years? Apart from technology and data storage costs, there isn’t a whole lot.
And yet, if Tudor’s research is sound, that’s how much China’s currency has dropped relative to the buck.
Tudor sees this devaluation as “a major, if not the primary, contributing factor to the nearly 6 million lost jobs suffered in the United States’ manufacturing sector.”
U.S. manufacturing employees, in other words, have been subject to a job-grabbing “currency war” that has gone on for nearly two decades. A cheaper currency means cheaper exports and higher sales, at a cost to higher-priced exporters who can’t compete.
There is further argument that China devaluation has fed America’s debt woes. How? In at least four ways:
- By keeping its exports cheap, China encouraged Americans to import more “stuff” on credit.
- By causing millions of U.S. manufacturing jobs to disappear, China caused an invisible reduction in U.S. government revenue — taxes never collected on wages never earned.
- By recycling U.S. dollars back into Treasury bonds, China encouraged even greater leverage in the borrow-and-spend cycle, their bond buying having kept long-term interest rates low.
- By acting as lead manipulator, China forced other Asian countries in the region to follow suit, giving them the non-choice of devaluing like the dragon or losing competitiveness.
(This isn’t the first time I’ve talked about China’s currency. Sign up for Taipan Daily to receive all my investment commentary.)
This is the old “Bretton Woods II” story your editor has written about in past years. China, along with other Asian exporters and Middle East oil exporters, created a new vendor finance-type relationship with the West.
The West bought tons of “stuff” (and oil)… the creditors took the flow of dollars and plowed it back into Treasury bonds… and via those Treasury purchases America’s long-term rates were kept low, fueling mortgage leverage and private equity leverage and every other form of cheap money vice.
It had the feel of a giant party while it lasted. China was booming, America was booming, housing and equities were booming. The price of oil was skyrocketing but nobody cared (at least pre-2008 anyway). It was a case of leverage on top of leverage — creditors gone crazy and debtors gone wild.
But whose fault is it all really? The problem with blaming China for America’s spending excesses is that it’s akin to blaming the bartender when a drunk goes on a binge. Was it really the bartender’s fault? Or was it the guy consuming the alcohol? And yet — what if the bartender knew his patron had a problem, and kept slinging out gin and tonics as fast as he could?
Your editor is a fan of free markets and free trade. Protectionist thoughts do not come easily. But currency manipulation is one of those topics where simple answers do not apply.
For example: Can it really be called “free trade” if one country is pushing down its currency at the competitive expense of another? Is it really a “free market” if private sector manufacturers are forced to compete with government-enabled challengers?
These questions are easy to deal with when everything is going well — you just ignore them. Nobody cares much about ramping debt levels when the party’s in full swing. Just make up some stuff about a “global savings glut” and let the leverage roll.
After the party ends, however, things can get messy. When the reality of carpet stains and destroyed furniture comes about — if not worse — that’s when voices rise as blame gets passed around.
As of this writing, there is still an abundance of blind hope that the U.S. economy will recover nicely. So far there has been no forced reckoning, no painful deleveraging, and no need on the part of the authorities to admit how they screwed up. For many, the Federal Reserve’s “extend and pretend” policies are (thus far) seen as a success. To the extent that China copied the West’s easy-money ways, its actions are painted with the same brush.
But for America, the reality of persistent unemployment looms. Tens of millions of Americans remain on food stamps — the hidden underbelly the stock market says nothing of. And the proposed solutions to the problem are laughable.
Just recently knucklehead chatter of “QE3” (quantitative easing 3) has started up, resolving the unemployment problem if deemed that QE2 was not enough.
But QE3 will not work any better than QE2 did — especially if the real jobs problem is a permanent loss of competitiveness through mercantilistic currency policies. At some point the Federal Reserve will be seen as a bunch of ineffectual jokers — once people wake up to the stagflation nightmare Bernanke is creating.
When that bitter realization hits, there will be new demands to deal with America’s unemployment problem — furious demands, more stringent and vocal than before. This will lead back around to the China devaluation issue, and a likely protectionist backlash.
All the more reason, then, to be prepared for a rude shock in the months ahead. If the mercantilist foundations of the Asian miracle are challenged head on — with increasingly harsh words and harsh measures exchanged — the “Bernanke Put” could again become background noise as global growth stalls.
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About the Author
Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor of the free financial market news e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.
Aside from his career in the financial industry, Justice enjoys playing chess and poker; he enjoys scuba diving, snowboarding, hiking and traveling. The Cliffs of Moher in Ireland and Fox Glacier in New Zealand are two of his favorite places in the world, especially for hiking. What he loves most about traveling is the scenery and the friendly locals.