Renminbi Yuan, Cheap?
Research for Online Investors

by John Dalt

3/18/10

There is growing pressure in the U.S. to push China to let their currency, the renminbi yuan or “yuan” float on the world currency market.  U.S. politicians look at the Chinese export driven economy and are jealous.  Developed countries are jealous of China's mild pullback during the world economic crisis and quick recovery.

China is raising capital requirements on their banks to slow lending, while the U.S. Federal Reserve continues pumping money into the banking system at 0.00% to 0.25% interest on Federal Funds.  The implicit warning from China in this brewing war is that they could sell their dollar denominated holdings, thus driving the value of the dollar down if Washington pursues accusing China of manipulating the value of their currency.

Paul Krugman, Nobel winning economist, famously called for the U.S. to call China’s bluff on this threat.  Krugman believes that the U.S. has China over a barrel on the currency valuation argument.  He argues that China cannot dump their $889 billion in U.S. treasuries without hurting themselves, and it would not hurt the U.S.  Krugman believes the U.S. could maintain low short term rates, because the Fed could start buying treasuries again.  If long-term interest rates increased then Krugman opines, “the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.”

You can read Paul Krugman’s article from the New York Times, Taking on China

We now have word from on high.  Krugman believes short term rates would not increase, because the Fed is holding them low and long-term rates don’t have to increase because the Fed can buy more Treasury Bonds.  The Nobel committee that gave him recognition in economics must have been the same one that awarded Obama a Nobel for being elected and Al Gore for wearing a bathrobe on a glacier.

According to Krugman, if other countries don’t believe our debt is a good investment, we just fire up the printing presses and buy it with free money.  His argument is attractive, but makes no sense if you have any understanding of history.  He believes the U.S. should ‘force’ China to let its currency float or impose tariffs on their products imported into this country.  What would a 25% tariff on Chinese imports do to our economy?  Think Walmart rising prices.

Many may think this is a good thing, Walmart does not compete fair.  I disagree.  Walmart only sells what customers want, at a very good price.  The smaller chain stores that find it hard to compete may try to sell the same goods, but do not have the information systems to track sales, and the efficient distribution system to squeeze costs out of delivery.

A widget is a widget, no matter where you buy it, and they all come from China.  A tariff on imported goods would jump the inflation rate in the U.S. immediately.  The financial fallout from Krugman’s remedy would increase interest rates immediately.  The trade war that could result, would raise unemployment almost immediately. We know these things from history.  We know these things from thinking.  We know these truths because they are self evident.

The ‘Great Depression’ over seventy-five years ago was worse and lasted longer because of protectionist measures required by the Smoot-Hawley Act.  The Tariff Act of 1930 raised tariffs on over 20,000 imported items coming into the United States.  What did other countries do?  They raised tariffs on U.S. exports, throwing people out of work.  Nice trick, raise prices on the things people have to buy and make them unemployed.  Then Uncle Sugar will come up with a NEW employment five year plan.  Doesn’t this sound just a little to convenient?

Krugman along with much of the political establishment that believe in Keynesian economics, told us we would all be ok if the government rescued the banks and the Fed would pump trillions into the economy to replace private investment. In a play as classic as ‘three card monty’, they now want to divert our attention from their failures and label China a ‘monetary manipulator.’ Why answer hard questions, maybe they can make our economy worse and blame it on the Chinese. As a Wall Street Journal opinion asked, “Haven’t the done enough harm already?”

What should America do?  Press cases on individual imported items by filing complaints with the WTO if there is evidence of dumping or other unfair competition.  Ask the International Monetary Fund (IMF) to analyze current world currency exchange rates.  It is their job, and it would take the appearance of one country against another out of the equation.

We believe the U.S. should play hardball with China, but not in front of the cameras.  How many fights have occurred because when pushed too hard every one has to ‘save face.’  Millions of jobs, in the U.S. and China depend on intelligent actions, not knee jerk politics.

Our quote today was sent in by subscriber G.C.
"Wisdom consists of the anticipation of consequences."--Norman Cousins.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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