The Great Sino-American Currency War

The economic relationship between the United States and China is often described as being “co-dependent.” The Chinese lend America money, and the Americans buy Chinese goods. If the Americans stopped buying Chinese goods, then people in China would lose their jobs, and if the Chinese stopped lending to America, then Americans couldn’t consume Chinese goods, and around and around as the story goes.

It is a complete mirage. Right now, the Chinese are dedicating a large portion of their economy (land, labor and capital) to produce cheap, depreciating consumer goods to sell to the United States. We pay for these goods with American dollars, and China’s domestic exporters have so far been happy to accept these dollars in exchange for their products.

These dollars flow back to China through those exporters, but the Chinese companies that end up with these dollars have a bit of a problem: They are paid in dollars, but their outflows (wages, supplies, taxes and dividends to their owners) are largely priced in the Chinese yuan, so they need to exchange their dollars for the locally accepted currency. Rather than force their exporters to sell their dollars on the international currency exchanges, the Chinese central bank has been content to buy dollars from their own exporters.

This has led to two problems from the Chinese perspective: It causes massive inflation in China (floating between 6 and 8 percent lately) as the Chinese central bank prints yuan to buy all these dollars (when you hear politicians talk about the Chinese “suppressing their currency,“ this is what they are talking about); and, it has left the Chinese with a reserve of American dollars totaling something like $3 trillion in cash, accounts, and US Treasuries. They have thus far been happy to acquire this massive stockpile because the American dollar has enjoyed the status of the world reserve currency, leading it to be considered a trustworthy store of value.

This situation is about to change. The Chinese are about to figure out that they have acquired a stockpile of money that they will not be able to easily spend. Right now, about the only things the Chinese can easily buy with their dollars is oil and US Treasuries, and some in the United States actually think that this is a sustainable economic model (the Chinese work hard, sell things to us for money, and then lend it to us so we can spend it).

The only reason we were able to run the trade deficits which facilitated the assembly of these massive dollar reserves around the world was because the dollar was considered a reserve currency. China, Russia and Japan have had to export goods in order to import other goods, because other countries were largely unwilling to hold massive reserves of these currencies. Germany, with the largest trade surplus in the world and not enough arable land to feed its own populace, has had to export things of high value in order to purchase what it couldn’t produce at home.

In response to this, we have been told that the ongoing devaluation of the dollar will begin the long process of reversing our trade deficit, as it will make our exports more affordable and more attractive to other countries. It hasn’t worked – our trade deficit is growing as of August 2011, not shrinking. Devaluing the dollar has, rather than make our goods cheaper for foreigners, actually raised the prices foreigners already holding dollars need to pay for American goods. If India devalued the rupee, then the Japanese yen will buy more rupees and Indian goods will be more attractive to holders of yen because of the exchange rate. Since the dollar is held in reserves around the world , foreign customers end up paying the same higher prices as we do when our currency loses value, because they hold our currency already.

Eventually this will all come to an end. The financial authorities in China are going to stop printing yuan to buy all these dollars, and China’s exporters will have to sell their dollars on the international exchanges. When that happens, the decline in the dollar’s value will accelerate, and the value of the yuan will begin to rise. Many Americans will be priced out of Chinese goods, and because the United States has little to offer China in trade except agricultural commodities, prices for food will rise even farther in the United States, as the Chinese try to divest themselves of the dollar by purchasing something of value to them – food – not more US Treasuries that pay interest in the form of more American dollars that China can‘t spend.

But, without the American consumer, won’t there be massive unemployment in China? I don’t believe so. There might be a brief recession in China, as their economy re-balances from producing cheap goods for America to producing things for China’s domestic markets, as well as for countries like Germany – with the world’s largest trade surplus and a trade surplus with China individually. China’s economy will recover and grow, assuming the Chinese government doesn’t screw it all up by continuing to rob their own people with inflation, as they try to suppress their own currency further.

It isn’t clear if anybody can actually win this currency conflict; the American people will have a massive recession as our bubble economy based on spending borrowed money continues its collapse, and the Chinese populace will have spent the last 20 years working hard, saving money and enduring inflation so their government could amass a pile of foreign money and bonds that are being rendered worthless.

Although, if the dollar collapses the Chinese government will be at the reigns of the new global superpower; and in return American politicians got to spend money on social programs, wars and bike trails without raising taxes. So, if you happen to be either a Chinese foreign ministry official or a 15-term member of Congress, then it really is a win-win situation. If you are a Chinese factory worker or an American looking for work, then the arrangement looks rather less appealing.

Image © ktsdesign – Fotolia.com

About the Author

Mr. Waechter is an attorney and a recent graduate of Drake University.

 

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