With the yuan now set to appreciate, will US policymakers rue the day?

“Hey look, I know lot’s of folks in China. They think we are the dumbest son of a bitches in the world. They think our representatives don’t know what they’re doing. They laugh at us behind our back. They’re taking money out (of the US economy) and then they loan it to us.”

The Donald advocates a tariff on Chinese imports to raise revenue, decrease the trade deficit, and bring back manufacturing jobs to “places like North Carolina and Alabama”. China is not a free trade country. It is very hit and miss when it comes to American companies having success entering China’s marketplace. This would be an argument for Trump’s tariff. However, China still enjoys a steep absolute advantage in the manufacturing sector. In other words, they can produce more of a good at a lower absolute cost than America. Is this because their labor is inherently more efficient? No, but it is because they work longer, have fewer environmental and safety regulations, and don’t have the health care and pension costs of union-laden American counterparts.

The Chinese are expected to let the yuan rise 2-3%, and made the announcement right before the G20 meeting in Toronto this weekend where they were going to be on the hot seat. This move will minimize the scrutiny and perhaps even garner some praise in Canada. Will a 2-3% rise in the cost of Chinese goods really mean much to America in the way of job creation? It seems like a stretch to me. Your cheap Blu-Ray player from Wal-Mart will go from $89.99 to $92.69. I don’t see that bridging the gap between the real problem in US manufacturing, labor costs, and creating many jobs.

So it’s entirely possible that a higher yuan will create few jobs here (all of which would be very delayed) and in return we all pay more for Chinese goods. Sweet deal. More troubling is that China has kept the yuan pegged to the dollar by purchasing extraordinary amounts of US Treasuries, which finance the US government’s spending sprees. If the yuan ever truly floats, China won’t need to buy our debt in such great quantities. In order to spur demand for our debt we would have to raise interest rates on U.S. Treasuries. This would make it even more difficult to pay off the deficit and increase borrowing costs for credit-seeking Americans and businesses.

A burgeoning yuan on the global stage could eventually make the dollar lose value. This would jack up the price of imports from around the world, including oil.

So let’s all be careful of what we wish for when it comes to the yuan. And let it be known that Tim Geithner, in particular, has been pushing for this since he was the president of the New York Federal Reserve Bank.

Trump says the Chinese have been laughing at us behind our backs. Beyond the fact that’s exactly what it feels like everytime Geithner makes the sojourn East, let’s hope the joke’s not on America when it comes to the yuan.

Your run-of-the-mill G8, G20 or IMF summit.

In restoring economic harmony, leaders and central planners hope to balance fund flows, surpluses and savings rates across nations. By doing so, they feel they can restore a collective parody through balanced, sustainable growth, and minimize the run (or retreat) on particular currencies. The concerns seem to be as follows:

1) “Too much” money is flowing into emerging economies, and will cause the currencies of those nations to inflate

2) Countries like China, that run surpluses, have export-led growth and high savings rates, will further distort current account balances in other nations

In general, money flows into countries where investors believe they will earn their required rate of return. Emerging countries offer value and growth opportunities, with affordable labor costs. The IMF telling investors not to invest capital in emerging countries, and instead invest in more expensive nations, is like telling your mother to skip over the cheaper refrigerator at Costco, and instead buy at a 15% premium from Mom & Pop Appliance. Money flows places for a reason.

Current account balances equal a country’s trade balance, plus net interest and dividends, and foreign aid.

The G20 hopes to rally member nations to set national policy goals ranging up to 5 years. Their theory is that with these economic blueprints, countries would interact with one another in the most efficient means possible, and a sustainable growth would be achieved for all. Metrics for these five-year plans could include growth rate, balance of payments, budget deficits, and employment, but nothing has been decided. (2)

This is fairly problematic. Does any country really know what their economy will look like in five years (unless you’re a dictating oil-exporter)? Of course not; economic agents perpetually change and adapt to a tsunami of market conditions (including government policy). And furthermore, nobody knows what breakthroughs will be made, or new industries created (not to mention new bubbles popped).

The men, the myth, the legends...

For China, it probably won’t mean a whole lot.

China produces products and sells them to other countries, and then saves their money. Economically, China is playing from a position of power, despite increased debt spending as of late, mostly on infrastructure, manufacturing and real estate. Given the fact China holds roughly $800 billion in US Treasurys (5), and they fret on a daily basis about US fiscal policy, it’s quite a stretch to believe they will repeat the same mistakes.

But Federal Reserve Chairman Ben Bernanke urged China to change their ways, and increase their consumption, in a speech made on October 19th. Said Bernanke:

“Another set of lessons that Asian economies took from the crisis of the 1990s may be more problematic. Because strong export markets helped Asia recover from that crisis, and because many countries in the region were badly hurt by sharp reversals in capital flows, the crisis strengthened Asia’s commitment to export-led growth, backed up with large current account surpluses and mounting foreign exchange reserves. In many respects, that model has served Asia well, contributing to the rapid growth rates in the region over the past decade. In fact, it bears repeating that evidence from the world over shows trade openness to be an important source of economic growth. However, too great a reliance on external demand can also pose problems. In particular, trade surpluses achieved through policies that artificially enhance incentives for domestic saving and the production of export goods distort the mix of domestic industries and the allocation of resources, resulting in an economy that is less able to meet the needs of its own citizens in the longer term.” (4)

They all look 16 years old; particularly at an average size of 4-foot-9 and 77 pounds.

In any event, central planning on a global scale doesn’t seem to be going anywhere, anytime soon. Groups like the G20 and the IMF will tell us central planners are necessary to avoid the pitfalls of capitalism, future collapse of the financial system and market unpredictability. Intuitively, we know that mixing and matching five-year plans of the world’s largest economies will be extraordinarily inefficient. The individual plans themselves will prove to be utterly inaccurate. There’s a reason that any length of time greater than a year is referred to as the “long-run” in economics: it’s downright unpredictable at that point. Economies are intensely complex, with millions of people and an infinite number of moving parts and conditions.

Somehow, telling economic stalwarts to be more like the US and EU, seems like a laughing matter. Likewise, thinking that a group of central planners will pull the strings on fund flows, to manage currencies and current accounts on a global scale, is just as funny.

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(1) G-20 major economies – Wikipedia.org, retrieved November 8th, 2009, http://en.wikipedia.org/wiki/G-20_major_economies

http://en.wikipedia.org/wiki/G-20_major_economies

(2) G20 to seek progress on world growth scheme – Reuters.com, retrieved November 8th, 2009, http://www.reuters.com/article/topNews/idUSTRE5A13CQ20091103?feedType=RSS&feedName=topNews

(3) G20 leaves door open for fresh pressure on dollar – Reuters.com, retrieved November 10th, 2009, http://www.reuters.com/article/ousivMolt/idUSTRE5A71XS20091108?pageNumber=2&virtualBrandChannel=0

(4) Asia and the Global Financial Crisis – FederalReserve.gov, retrieved November 8th, 2009, http://www.federalreserve.gov/newsevents/speech/bernanke20091019a.htm

(5) MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES – Treasury.gov, retrieved November 11th, 2009, http://www.treas.gov/tic/mfh.txt

Due to popular demand, the “Funny Money” article has become a series. Please read the first installment before venturing on:

Funny Money Part I

Thanks to “Funny Money” Part I we know that U.S. currency is exactly that: funny money. We know who orchestrates the funny money monetary system and who routinely confuses credit with capital. Convenient, isn’t it?

We also know that currency isn’t immortal. Currencies have failed in the past and they will fail in the future. A currency’s health depends on a government’s monetary and fiscal policy.

A government’s monetary policy decides how money will derive its value: by faith in pieces of paper or backed by a physical asset such as gold. The U.S. monetary system utilizes a fiat currency, or money declared by the government to be legal tender. With fiat money, the Treasury and Federal Reserve can control the money supply. They do this by printing new money or by purchasing securities like Treasury Bills on the open market. This is a way to take money sitting in the Federal Reserve coffers and hand it to an investment bank, or in other words, infuse cash into the system. Notice how the word “cash” was used in the previous sentence and not “capital.” The cash isn’t always capital; it’s often credit. Other renowned aliases include debt and Outlaw Pete.

A government’s fiscal policy determines its cash flow. The politicians budget out their desired spending and project their annual revenue from taxes, tariffs, user fees, etc. If the spending outflows exceed the revenue inflows, money has to be borrowed to finance the bloated budget. That’s where China, Japan, and the oil exporting countries come a-knockin’. Some people argue that deficit spending is healthy for an economy from time to time. A compelling case can be made for that. Though the key phrase is “from time to time” and certainly the amount of deficit spending is at the heart of the issue. What cannot be argued is that at some point deficit spending meets diminishing returns. In the eyes of many, the U.S. hit that point a long time ago. The end effect on currency from huge government deficits is unpleasant; the currency’s value is driven into the ground.

The funny money game will end; either by the government and the Federal Reserve stopping the above actions in time or the dollar collapsing. But what shenanigans would ensue if the dollar did collapse? American’s wealth, now standing on its last legs, would be worthless. Products and services would once again derive its value solely from their necessity for survival. We’d all be playing an impromptu game of Survivor; tribes being our local neighborhoods (never before have school boundaries been so imperative). All amateur athletic statuses and regulations would fly out the window. The “Fightin’ Irish” tribe would gladly trade little Billy to the “Axemen” for some livestock. Heck, the Irish would extort the Axemen by busting out Mr. Jennings’ tool collection. They’d be swinging a big stick alright, only the stick would be a garden hoe. Those babies are sharp.

With a failed dollar we’d have far more church-going citizens eager to stockpile communion crackers. And for the altruistic of the local tribes, the communion crackers might end up back in the offering basket.

Agricultural might would flex its muscles and unite a region. Without that pesky need for the agricultural industry to be globally competitive in dollars and cents, Americans would remember how expansive their farm system could be (especially without corn subsidies).

In the U.S., agriculture made up only 0.90% of GDP in 2008. GDP in the United States is substantial, though, relative to other nations. In addition, developing countries place greater weight on their agricultural sector because industries like “information technology” haven’t quite flourished yet. For example, 65% of Somalia’s GDP comes from agriculture. (1)

The U.S. brings the heat in individual commodity production. We produce more almonds, blueberries, cow milk, cranberries, grapefruits, maize, sorghum, soybeans, strawberries, string beans, and indigenous cattle, chicken, pig, and turkey meat than any other country. We rank second in apples, cherries, game meat, hen eggs, honey, hops, lettuce, mushrooms, oranges, pistachios, spinach, tomatoes, and walnuts. We rank third in asparagus, avocados, carrots, grapes, hazelnuts, linseed, oats, dry onions, peaches, nectarines, pears, green peas, raspberries, safflower seed, sugar beets, and wheat. We rank fourth in green chilies and peppers, garlic, groundnuts in shell, pumpkins, squash, gourds, tobacco leaves, and watermelons. (2)

I see plenty of options to fulfill the food pyramid guidelines, expediently brought to you by the U.S. Department of Agriculture (USDA)! But seriously, almost all of my favorite foods are in that expansive list. I see beer, wine, chocolate milk, protein powder, strawberry spinach salad, and peach-berry smoothies. When can the agricultural self-sufficiency begin?

It doesn’t stop at a nation’s agricultural might. The United States has an embarrassment of riches in natural resources. I’m not sure what’s more embarrassing, the fact that the U.S. is so resource abundant or the fact we’ve been so reluctant to use them, opting to consume other country’s resources instead. Only estimates begin to project the true reach of U.S. resources as many of them remain unexplored. Within the U.S. boundaries lie coal, copper, lead, molybdenum, phosphates, uranium, bauxite, gold, iron, mercury, nickel, potash, silver, tungsten, zinc, petroleum, natural gas, and timber. The U.S. sits on the world’s largest coal reserves with 491 billion short tons, accounting for 27% of the world’s total. (1)

The climate in the continental United States is moderate across most of the nation. We have the tropical climate covered in Hawaii and Florida. Plenty of moose’s frolic about in the arctic climate in Alaska. We have mountains and valleys as well as vast coastlines and Midwest plains. Wind power can be harvested throughout the west and Midwest as well as solar energy harnessed in the deserts of the southwest (and everywhere else the sun pops out occasionally).

As Barack Obama stated: “We have some beautiful real estate.”

To quantify it even better, here is how the U.S. ranks in various “real estate” resource abundance:

2^nd most water area (only to Canada): 664,707 sq. km.

3^rd most irrigated land (only to India and China): 223,850 sq. km.

3^rd largest country by size (only to Russia and Canada): 9,826,630 sq. km.

4^th total renewable water resources: 3,269 cu. km.

5^th most land area: 9,161,923 sq. km.

6^th most proven natural gas resources: 5,551,000,000,000 cu. meters

10^th coastline: 19,924 km.

11^th most proven oil reserves: 21,760,000,000 barrels (1)

There’s lot of water in that list, a commodity the world will fight for vigorously one day as populations exponentially increase.

If the dollar was to fail the first thing the International Monetary Fund (IMF), United Nations, and G20 would do is attempt to implement a new reserve currency. Whose currency no one knows for sure; it could even be a new currency. That isn’t particularly important after the sunk cost of a failed dollar. Whichever currency was promoted, rest assured it would be a fiat currency, one in which it’s “declared” legal tender by some government body so they can inflate and deflate it at will.

The powers at be will try to press restart on the funny money game. But if the world decided the funny money game would no longer be tolerated, one of two things would happen: an uproar of civil unrest would occur forcing change to a currency backed by a physical asset OR currency wouldn’t be a part of everyday life anymore. If we moved to off the cuff Survivor tribes, the United States could clearly take care of ourselves.

Maybe this is the underlying motivation for the government trashing the dollar. No matter what happens in a non-nuclear world, the U.S. will survive and possibly even flourish. We have military power that can only be rivaled by India and China (those two countries have four to five and a half times as much manpower fit for military service as the U.S.). (1) In our undeniable hubris we test how much money a country like China is willing to loan us. We continue policy that kills the dollar and the value of all the U.S. Treasury Bills sitting in China’s Central Bank. Economists have one universal response: China needs us to buy their products. Maybe they do, maybe they don’t. I’m not educated enough to say in the long run but damnit if we’re not pushing them to the edge. We may need each other now but not in a world of agricultural self-sufficiency. The U.S. will be on its merry way.

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(1) CIA – The World Factbook

https://www.cia.gov/library/publications/the-world-factbook/index.html

(2) Food and Agricultural Organization of the United Nations
Economic and Social Department – The Statistics Division

http://www.fao.org/es/ess/top/topproduction.html?lang=en&country=231&year=2005