Here Comes the Chinese Yuan

What evidence have I got that the United States has mis-used its responsibility as the provider of the reserve currency of the world?

Look at the morning papers.

“Singapore Aims to be Renminbi Trade Hub,” in the Financial Times (http://www.ft.com/cms/s/0/64bac520-6a4f-11e0-a464-00144feab49a.html#axzz1JsjXsOj5).

“China Speeds Yuan Push,” in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052748704740204576272802457892870.html?mod=ITP_pageone_0&mg=reno-wsj)

In the first article we learn that Singapore has moved to become the first overseas center for trading the renminbi.  It was learned that Beijing will designate a Chinese bank to clear renminbi trades thereby allowing banks in Singapore direct access to the Chinese currency. 

In the second article we learn that China’s central bank is changing its rules so as to make it easier to bring funds raised offshore back onto the Chinese mainland.  This would mean that companies and governments could fund bonds and the purchase of goods in Hong Kong and the Chinese could move those monies around both into China and out to the rest of the world.

Although there seems to be no rush to make the Chinese currency fully convertible into other currencies, most analysts see this as just another step toward the Chinese currency playing a larger and larger role in world trade and finance. 

In the Financial Times article the authors claim that “The People’s Bank of China is pushing for a greater role for the renminbi in global trade and investment to reduce China’s almost total reliance on the US dollar.”

As is typical of Chinese strategy, there is no real hurry to achieve full convertibility and global position for their currency.  The move is slow and steady, building toward inevitability.  We need to remember this as the slow, patient, ascension of China proceeds in the twenty-first century.

No other country has really threatened the position of the United States dollar as a reserve currency since World War II.  This has been of great benefit to the United States and has allowed the US government to get away with a lot of things in international financial markets that it could not have done if it had not had the world’s reserve currency. 

Still, the failure of the United States to act in a fully responsible way relative to its providing the world’s reserve currency seems to finally be catching up with it. 

Beginning in the 1960s, the United States government began fifty years of credit inflation.  The first victim of this prolificacy was the international gold standard, which ended on August 15, 1971 when president Richard Nixon announced that the value of the dollar would now be floated in the foreign exchange markets. 

The second victim was the purchasing power of the United States dollar.  A dollar that could purchase a dollar’s worth of goods and services in 1960 could only purchase about fifteen cents worth of goods and services in 2011.  That is, the purchasing power of the dollar declined by 85 percent during this fifty year time period!

The third victim was the value of the United States dollar in the foreign exchange markets.  Since the United States dollar was floated, the value of the dollar against the currencies of other major trading partners has declined by about 35 percent.  It has declined by even more against the currencies of other countries the US trades with. 

The United States has profited greatly over the past fifty years or so by having its currency serve as the reserve currency of the world.  Treasury Secretary Geithner drew on this fact the other day when he claimed that the world was still very comfortable buying US Treasury securities. 

Yet the confidence of the world Geithner claimed for the purchase of US Treasury securities is sadly tarnished by the performance of the United States dollar in world foreign exchange markets.  The United States has benefitted from its position as the supplier of the reserve currency, but it has abused its responsibility of being the supplier of this reserve currency by following a path for fifty years of fiscal and monetary policy that undermined the value of the currency.

Now, there is a rising star in the world that threatens the position of the United States dollar.  As I remarked above, the Chinese currency still has a long way to go to dethrone the United States dollar.  What we must notice, however, is that the fault lines seem to be forming.

It will be interesting to see what the leaders of the United States government do as this situation becomes clearer. 

You Can't Lead Out Of Weakness: The IMF Meetings

With each international meeting it is becoming more and more obvious, the United States is dealing from a weakened hand.

The New York Times makes it very clear: “Despite loud calls from the United States; and more muted appeals by Europe, Japan and other countries, the annual meeting of the International Monetary Fund did not succeed in placing significant pressure on China to allow a prompt and meaningful rise in the value of its currency.” (See “Financial Leaders Decline to Press China on Currency,” http://www.nytimes.com/2010/10/10/business/global/10imf.html?_r=1&ref=todayspaper.)

The language in the concluding statement of the policy-setting committee of the IMF “was benign.” Everything was postponed to the G-20 meeting in Seoul, South Korea in November.

The United States took a strong position on the value of the Chinese currency and the behavior of the Chinese government with respect to this value. The United States Congress made its will known in late September. Treasury Secretary Geithner also spoke out about the need for action on the part of the Chinese. President Obama has even made mention of the issue.

But, policy-makers are “wary about pressuring China too severely.”

Right now, China seems to hold the cards and no one is willing to move strongly against their position.

Most revealing is the fact that the United States seems to be in no position to press its points with its own actions and does not seem to be strong enough to command support among the other nations that might side with it.

Furthermore, the central bank of the United States, the Federal Reserve System, appears to be on the verge of another round of “quantitative easing”, something that world financial markets have reacted to by selling dollars. The world investment community has not given the United States a very good grade in terms of how its government has managed the monetary and fiscal policy of the country over the past eight years or so and sees these additional efforts as just a continuation of the lack of foresight and discipline and will in its economic policymaking.

If this is the prevailing attitude in the world about the economic policy of the United States, then one can only project further declines in the position of this country in the evolving discussions about world financial arrangements.

The United States has dealt itself a weak hand in world economic affairs. Unless it steps back and re-assesses how it got here and what it needs to do to change the situation, it will just continue to further weaken its position. And, it is very hard for a nation to lead when it is continually hurting itself.

The Long View of China

“Spend enough time with Chinese officials and economists, and you will hear a story about the Japanese yen in the 1980s.” So writes David Leonhardt in “The Long View of China’s Currency” (http://www.nytimes.com/2010/09/22/business/global/22leonhardt.html?ref=business).

A few years ago, I heard something similar, only it went like this, “Spend enough time with Chinese officials and economists and you will hear a story about Russia opening up its economy and suffering large bouts of social chaos.” Here the fear on the part of the Chinese was that opening the economy up too quickly could bring on social unrest similar to that observed in Russia, when Russia began to open up its economy.

One of the best insights given to me has been the one a friend of mine gave about the future of China. He said, “The Chinese believes that they need to move in the direction of a more capitalistic society. They also believe that moving too quickly in this direction could result in societal disruption that could derail their efforts. Furthermore, the Chinese think in decades whereas Americans think within a two- to four-year horizon. Consequently, Americans will become very impatient with what the Chinese are doing.”

Just a side note: Martin Wolf, in explaining how China is achieving its remarkable growth, makes the statement that, China “is, in a sense, the most ‘capitalist’ economy ever.” This is because it is putting so much emphasis upon investment to achieve a 8-10 percent a year growth rate. However, this is a pretty dramatic generalization. (See Wolf’s column, “How china must change if it is to sustain its ascent,” http://www.nytimes.com/2010/09/22/business/global/22leonhardt.html?ref=business.)

Leonhardt makes two important points I would like to give my on. First, he writes that China and the United States aren’t the only two countries in the world producing products. But, “The entire value of the product counts toward the trade deficit between the United States and China.”

China is making itself felt in many, many parts of the world. Again, we see the article this morning, “Chinese Business Gains Foothold in Eastern Europe,” (http://www.nytimes.com/2010/09/22/business/global/22chinaeast.html?ref=todayspaper). And, we are constantly hearing about the initiatives of China in South America, and Africa, and the Middle East. And, this doesn’t fully capture the advances of the Chinese Sovereign Wealth Fund that is even buying physical assets in the United States.

China has a long term plan to obtain supply sources and build influence throughout the world. They are doing this quietly, peacefully, and continuously.

The United States is mired in the current value of the renminbi and the current trade deficit. In the meantime, the strength of the United States economy continues to slide. There have been numerous assessments recently about where the United States stands in the world economy and they have not been very favorable to the relative strength of America’s economic performance.

One of the standard arguments for a rise in the value of a nation’s currency, or, a decline in the value of a nation’s currency is that such movement will correct trade imbalances. This is only true if the relative quality of the goods produced by the countries remains the same.
The international investment community has been especially concerned about the performance of the United States economy and the economic philosophy of the United States government since the 1980s. This concern has been reflected in the continued secular weakness of the United States dollar (see my post “The Dollar and the Fed,” http://seekingalpha.com/article/226286-the-dollar-and-the-fed).

The decline in the value of the United States dollar will not automatically correct America’s trade balance problems. The problems go much deeper.

And, this gets me to Leonhardt’s second point: we should not “view the exchange rate as a cure-all” because “economies, like battleships tend to turn slowly.”

China will continue to maintain a long-term view of where it is going. The United States will continue to focus on the short-term. As a consequence, the specifics of United States policy will vary this way and then it will vary that way, attempting to maintain high levels of economic growth and high levels of employment. The thing we have learned over the past fifty years is that such a short-run focus eventually fails to achieve either higher levels of economic growth or high levels of employment. Such policies have led to one out of every four individuals of employment age being under-employed, the capacity utilization of American industry hovering under 80%, and continued growth in income inequality.

Business is in a “funk” right now concerning the future. Uncertainty about future economic policy is high. Few people place much confidence in where the Obama administration is going policy-wise and even more people have much confidence that the Federal Reserve knows what it is doing.

The Chinese have taken the road to economic power that Germany, Japan, and the United States have taken in the past. This path relies upon becoming an exporter and reaping the advancements that come from successfully becoming an important part of world trade. Now comes the hard part, building up “a thriving domestic economy. Leonhardt argues that China is now moving slowly to achieve this.

My belief is that the Chinese will continue to travel along this path. Some of the bumps along the road, however, are going to come from sources like the United States that have created their own problems and now want others, like the Chinese, to bail them out from the weaknesses they have created for themselves. This situation will not change until the United States stops pointing fingers at others and takes a very hard look at itself.

China is Changing the World

Earlier, on March 25, I raised the question “Why Should China Change?” in my post, “Why Should China Change?” (http://seekingalpha.com/article/193689-why-should-china-change)
The thrust of the post was captured in the following:

“The world has changed and we in the United States have not accepted the fact.

Why should China change direction at this time?

China is growing stronger and stronger. The United States, and most of the rest of the west, is in a weakened state. The United States, and most of the rest of the west, has gone through a very severe financial crisis and the worst recession since the 1930s.”

The United States is still the number one power in the world, both economically and politically, but its relative position has changed. And we continue to see that in our relationship with China (and India and Brazil and Russia).

The current ‘high-level’ meeting in Beijing of representatives from China and the United States highlights the changing relations between the governments of China and the United States. As reported in the New York Times, “the opening session laid bare a recurring theme…the United States came with a long wish list for China…while China mostly wants to be left along…” (http://www.nytimes.com/2010/05/25/world/asia/25diplo.html?ref=business)

China is “turning into an economic superpower” according to the Times article and wants to continue along on its merry way. The United States, other than initiating an all out trade war, seems incapable of slowing down the Chinese economic machine or even getting the attention of the Chinese leaders.

Chinese President Hu Jintao did pledge to continue reform of China’s currency, but then repeated the standard operating response: “China will continue to steadily push forward reform of the renminbi exchange-rate formation mechanism in a self-initiated, controllable and gradual manner.” That is, we will change things when we want to change things and no sooner.

Secretary of the Treasury Geithner graciously replied: “We welcome the fact that China’s leaders have recognized that reform of the exchange rate is an important part of their broader reform agenda.” What else could he say?

The United States, and most of the rest of the west, is in a weakened state. But, this weakened state goes beyond the short-run. The United States is facing longer run, structural problems it must deal with. Economic growth and financial strength are important factors in world economic power. However, when a nation extends itself and stretches itself too far due to over-commitment and over-leverage, thinking it can do too much, it exposes itself to other nations that are not in a similar position.

It is the United States, the number one world power that is asking China to change. China is in a position where it does not feel the need to cave into the American requests. China is strong and disciplined. The United States is strong, but undisciplined. Therein lies the difference.

And, the (supposed) allies of the United States are little or no help. Europe is attempting to resolve the problems it created for itself. As a consequence it is slowly fading into the background. The G-7 group of nations, the United States, Canada, France, Germany, Italy, Japan, and England, is losing relevance in the world. The G-20 includes the seven, but more importantly includes several emerging nations that are more strategic to the future than is the “old boyz club” from Europe.

De-emphasize the G-7 and raise up the G-20!

The ultimate problem of the United States is its lack of discipline. For the past fifty years or so, the United States has lived for “the short-run” because, we have been told, that “in the long-run we are all dead.” The economic policy of the United States has been designed to combat short-run increases in unemployment with a constant pressure to achieve high rates of economic growth. But, this creates an inflationary bias in economic policy. Because of this the United States has seen the purchasing power of its dollar drop 85% from January 1961 until the present time, underemployment has grown to about 20% of the working age population and the capacity utilization of its industrial base has declined to less than 75% at present (but rose to only slightly more than 80% in its most recent cyclical peak).

These are not signs of economic strength. Furthermore, the value of the dollar over the past forty years has dropped by approximately 35%. Huge amounts of United States debt, both public and private, have been financed “off shore”. These developments do not put America in a very strong bargaining position.

China thinks in decades. The United States thinks in terms of the next election. Discipline does matter.

There are still many economists in the United States who argue that the government must spend more and create more debt to get the country going once again. Their fundamentalist view of how the world works blinds them to the fact that it was the loss of fiscal discipline, the exorbitant creation of huge amounts of government debt and the subsequent credit inflation that this encouraged, that put the United States into the position it now finds itself.

More spending and more debt are not going to make the situation any better. I examined this issue in my May 13 post “Government Deficits and Economic Activity”: http://seekingalpha.com/article/204948-government-deficits-and-economic-activity. My basic conclusion was that in the present situation where the Federal Reserve has pumped so much liquidity into the banks that big banks and big companies can play games in world financial markets and cause major problems for areas like the euro-zone. The continued creation of deficits and more government debt is not going to solve this problem for Europe…or the United States.

Until it gets it act under control and in order, the United States will be the one asking China to change the way it does things. China, given the present circumstances, will continue to do things in their own interest and at their own speed. In addition, it is my guess that other, emerging nations will begin to exert themselves in similar ways. And, the United States will not be in a position to resist their efforts.

As I said earlier, “The world has changed and we in the United States have not accepted that fact.”

All we can really control is ourselves and if we fail to do that we give up the chance to influence others.

More on Crybabies: No One is Responsible!

I am moving more and more to the belief that we will see some substantial inflation in the Western world in the next few years.

Being an optimist, I keep hoping that the leaders at the Federal Reserve can bring off the Fed’s “Great Undoing” and succeed in reducing the excess reserves in the banking system before these reserves turn into loans and spending.

I keep hoping that the federal government will honestly address the issue of its budget deficits which I see increasing the federal debt outstanding by $15 trillion in the next ten years.

I keep hoping that businesses will reduce how much they are leveraged and concentrate more on the production of goods and services rather than on their trading activities.

I keep hoping that consumers will get their balance sheets back in order and begin to live within their means.

I keep hoping…

But, for these things to take place, someone must take responsibility for their actions.

I am not seeing this happening!

All I am seeing are the crybabies that place the blame for their problems on the backs of someone else.

Alan Greenspan and Ben Bernanke did not see (or, they did see, depending upon which speech you listen to) the looming financial crisis, for no one could (or, they could but could do nothing about it) have recognized the future.

Paul O’Neill, Jack Snow, and Hank Paulson had no idea that such huge deficits would be created during the 2000s and contribute to a decline in the value of the United States dollar of over 40% against other major currencies, for they were all in favor of a ‘strong’ U. S. dollar (whatever that is).

And, the leaders of European nations were not responsible for the current financial disorder in the market for sovereign debt. It is obvious in recent remarks (among others):

• “Irish Official Calls Markets ‘Irrational,’” (http://www.nytimes.com/2010/04/29/business/global/29punt.html?scp=1&sq=irish%20official%20calls%20markets%20'irrational'&st=cse);
  
• “Critics Assail Rating Firms for Fueling Woe in Europe,” (http://online.wsj.com/article/SB20001424052748703648304575212422057151414.html#mod=todays_us_page_one).
  

Sure, the rating agencies are not to be believed and they always move ‘after-the-fact’, but where there is smoke, there must be fire.

And, what about those people that sell securities short and those that deal in Credit Default Swaps. They are nothing but trouble makers taking advantage of the bad press put out by the sensationalist world media. Greedy bastards!

And, bank managements are not really responsible for any of the trials and tribulations of the past several years. That was obvious in testimony given in Congress this week. All of the emphasis on trading rather than financial intermediation, leverage ratios of 40-to-1, increased assumption of risky assets, and the mis-matching of maturities was just ‘business as usual.’

Families and homeowners were not responsible either.

And, this attitude has existed for the last fifty years.

Moral hazard reigns!

If no one is responsible for what took place over the last fifty years or so, then the way people behaved over the past fifty years or so will be repeated. Why? Because, if no one is responsible then we all have to ‘ante up’ so that those who are hurt by a financial collapse can get bailed out. And, since the music continues to play, the dancing must go on.

This ultimately means that the national government budget deficits will not be reduced. It means that the Fed’s “Great Undoing” will not take place. It means the foundation for price inflation will be in place. It means that consumers, businesses, and other governmental bodies will continue to borrow and leverage up. And, it means that financial innovation will continue to permeate the economy.

The Debt Deflation will be prevented. Another round of Credit Inflation, therefore, seems in store.

There is no indication that attitudes or behavior has changed. “Watch the hips, not the lips!”

Why concentrate on Western countries?

Because, over time, those countries that are disciplined will be the ones that benefit relative to those that do not discipline themselves. In this we see several of the emerging nations becoming relatively stronger as they focus more on the future political alignment of the world rather than on short-run outcomes.

These nations understand that power does not like a vacuum. When a powerful country gives up some of its position, others immediately move in to replace what is lost. And, some of these countries understand that slow and steady win the race and proceed in a disciplined way.

Yesterday, there was a very revealing opinion piece by Gerard Lyons of Standard Chartered Bank in the Financial Times titled “When ‘Made in China’ becomes ‘Paid in renminbi’” (http://www.ft.com/cms/s/0/24307398-525d-11df-8b09-00144feab49a.html). Perhaps the most important line in this piece is the statement that “Gradualism dictates the Chinese approach to most policy measures.” China thinks in decades and not in years I have been told. And, other emerging nations are learning this rule as well.

In the United States and other western countries, economic policy has been focused on the short run. And, by focusing on the short run, outcomes can seem to be the result of random or uncontrollable events. Hence, no one needs to claim responsibility.

However, we are responsible for our actions; for the short run does become the long run and in the longer run success depends upon the acceptance of responsibility and acting with discipline. This is one of the problems that Greece and Portugal and others are having at this time. They are being compared on these terms with other nations, like Germany, and are found wanting. And, they don’t like the implication that they have acted in an irresponsible and undisciplined fashion.

So, cry foul!