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Why Blaming China on our Economic Woes is a Cover up that is Foolish and that will not Stand

By : Ziad K. Abdelnour| 7 October 2010
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There is clearly a tendency today for countries all over the world to “beggar thy neighbor” (just as happened during the 1930s) and gain a leg up for their exports by cheapening their currencies.

“Beggar thy neighbor” for those who are not familiar with the term or “beggar-my-neighbor”, is an expression in economics describing policy that seeks benefits for one country at the expense of others. Such policies attempt to remedy the economic problems in one country by means which tend to worsen the problems of other countries.

The term was originally devised to characterize policies of trying to cure domestic depression and unemployment by shifting effective demand away from imports onto domestically produced goods, either through tariffs and quotas on imports or by competitive devaluation. The policy can be associated with mercantilism and the resultant barriers to pan-national single markets..

“Beggar thy neighbor” policies were widely adopted by major economies during the Great Depression of the 1930s and proved ruinous for the global economy then.

Is the world setting off down the same slippery slope again? Let’s hope not.

If you recall, the House recently passed legislation saying China is a currency manipulator and has to raise the value of the Yuan.

The rationale being that the Chinese Yuan is undervalued by 25%, which makes Chinese exports artificially competitive. Hence, the U.S. Congress is trying to blame China’s undervalued currency for America’s bad economy and unemployment woes.

But the former U.S. trade representative, Susan Schwab, says that – while there’s a very real problem in terms of China artificially keeping the renminbi low – this isn’t the way to solve anything. Schwab calls it “a signal-sending exercise during an election season”. She says that the bill won’t really do anything, even if the Senate passes it and it is signed into law. Schwab says it “makes no sense”, won’t solve any problems, will escalate tensions, and will only divert attention from the real trade problems between the U.S. and China.

Schwab further warns that other countries might decide that the U.S. bill means that it’s open season for addressing currency manipulation, and that other countries believe that the U.S. is manipulating our currency. She says there could be a “boomerang effect” from the legislation.

Ironically, an anti-sourcing bill – the kind of legislation which might actually keep jobs in the country – was defeated in the same week that the toothless China bill passed.

To put things into perspective China is currently in the middle of revaluing its currency and I frankly believe it has nothing to do with America’s economic woes.

There is indeed a direct line between China, its currency, its exports of lower-cost goods to the United States, and the erosion of middle-class life and now soaring unemployment. But U.S. manufacturing has been bleeding jobs for decades ….

What’s more, the recent loss of millions of jobs since 2008 has everything to do with the collapse of the construction and housing industries along with the near-death of the Big Three American auto makers than with any competitive challenge from China. China has become a large car market for General Motors, but not for export to the United States: for sale in China. It would take a massive leap unsupported by any fact to lay the demise of the U.S. auto industry at the feet of China, or for that matter hold China responsible for the sub-prime and derivative debacles. Those are the cause of recent job loss.

Furthermore, China has been revaluing its currency, nearly 20% between 2005 and 2008 and now nearly 3% since June when the government resumed that policy having shelved it during the midst of the global financial crisis. It is in the domestic interest of the Chinese government to raise the value of their currency because they are focused on building up on internal, domestic consumption market. They have no wish to be dependent long-term of the vagaries and whims of American consumers, and higher purchasing power for Chinese consumers is the answer. They are not revaluing quickly enough to suit an America stuck in second gear and looking for someone to blame, but revaluing they are.

I believe the real problem is global weakness in demand, and China is understandably trying to avoid what happened to Japan’s ramped-up currency, which led to the Lost Decade.

Further, it is not hard to see China’s point of view: it is desperate to avoid what it views as the dire fate of Japan after the Plaza accord. With export competitiveness damaged by its soaring currency and pressured by the US to reduce its current account surplus, Japan chose not the needed structural reforms, but a huge monetary expansion, instead. The consequent bubble helped deliver the “lost decade” of the 1990s. Once a world-beater, Japan fell into the doldrums. For China, self-evidently, any such outcome would be a catastrophe.

To be perfectly candid, I believe that the trouble with today’s capitalism is that there is little honest capital left in it. It has been drained away by quackery, debt and fraud. Real capitalism requires solid capital – money you can trust. But real money disappeared nearly 40 years ago. That was when the last traces of gold were removed. Since then, all currencies have been “managed.” No longer fixed measures of real wealth, they have become tools…supposedly used by the authorities to promote full employment and growth…but in fact little more than monetary felonies.

From the end of the Napoleonic wars until the beginning of World Wars of the 20th century, the world’s money system was backed by gold. You couldn’t “manage” it. You couldn’t devalue it. You couldn’t talk it up or talk it down. You couldn’t “beggar thy neighbor” by cheapening it or enrich him by making it more dear. It was what it was. The new experimental money system began in the Year of Richard Nixon, 1971. Thereafter, the supply of money could increase much faster than the supply of goods and services. US money supply (M2) rose 1,314% between 1970 and 2008, from $624 billion to $8.2 trillion. What did all this new money do? First it flattered…then it corrupted…and finally, it robbed.

America’s working stiffs were the first to get whacked. Inflation made them feel like they were earning more; but they haven’t had a real, hourly raise since the system was put in place 4 decades ago. And now, America is struggling to make sure they get none in the future either. Lowering the dollar against the renminbi increases the cost of probably 90% of the goods in Wal-Mart and Costco – where the working classes shop.

But this has been going on ever since the managers began taking liberties with the dollar. In the 1960s, the working man – 90% of the population – got 60% of the income gains of the period. By the end of the bubble years – 2001- 2007 – he got just 11%. This has resulted in a “record income gap”. Half the nation’s income goes to the top 20% of the population, nearly twice as much, compared to the bottom 20%, as in 1967; it’s the biggest gap since they began keeping track.

Consumer prices rose 5 times over the last 40 years. The stock market went up 15 times – from 800 in January 1970 to over 12,000 in 2008 – roughly in line with the increase in the money supply. But the phony money betrayed the rich too. Investors were misled. Capitalists erred. Trillions of dollars went down rat-holes. Consumers were spent out, but the capitalists kept building shopping malls. Now, stock market prices have gone nowhere for more than a decade. And household net worth – most of it in the hands of the wealthy – has declined $12.3 trillion from the peak. When the mistakes are finally flushed out, they could be down another $12 trillion.

The horns have sounded and bells have been rung. It is 1939 in the currency war – just the beginning. When it is over, every managed currency in the world will be dead or wounded. But we will be wiser, too. When the new managed dollar was introduced in the “Nixon Shock” of August, 1971, nobody knew what it was worth. When the end comes, everyone will know.

Using a weak dollar to create American jobs is foolish, for two reasons.

First, no other country wants to lose jobs because its currency becomes too high relative to the dollar. So a weak dollar policy invites currency wars. Everyone loses.

Second, even if we succeed, a weak dollar makes us poorer. Imports are around 18 percent of the US economy, so a dropping dollar is exactly like an extra tax on 18 percent of what we buy.

It’s no big accomplishment to create jobs by getting poorer. You want to know how to cut unemployment by half tomorrow? Get rid of the minimum wage and unemployment insurance, and make everyone who needs a job work for a dollar a day.

The goal isn’t just more jobs. It’s more jobs that pay enough to improve our living standards. Hence, using a weakening dollar to create more jobs doesn’t get us where we want to be.

With the dollar as the world’s reserve currency – every county, including China, must devalue their currencies just to stabilize their economies:

It is traditional for our politicians to blame foreigners for problems that their own policies have caused. And in today’s zero-sum economies, it seems that if America is losing leadership position, other nations must be the beneficiaries. Inasmuch as China has avoided the financial overhead that has painted other economies into a corner, nationalistic U.S. politicians and journalists are blaming it for America’s declining economic power.

In fact, accusations that Japan, South Korea and Taiwan are “making their currencies cheaper” by recycling their dollar inflows into U.S. Treasury securities simply means that they are trying to maintain their currencies at a stable level.

It is how most central banks throughout the world are responding to the global dollar glut. They are increasing their international reserves by the amount of surplus free credit” dollars that the U.S. payments deficit is pumping out. To pretend that China is “manipulating its currency” by doing what central banks have done for over a century is utterly false. Back in the early 1970s, U.S. officials told OPEC governments that if they did not do this, it would be deemed an act of war. And Congress has refused to let China buy U.S. companies – so China can only recycle its dollar inflows by buying Treasury securities, thereby financing the U.S. federal budget deficit.

To pretend that exchange rates are determined mainly by international trade is “Junk Economics”. International currency speculation and investment is much larger than the volume of commodity trade. The typical currency bet lasts less than a minute, often being computer-driven by arbitrage swap models. This financial fibrillation has dislodged exchange rates from purchasing-power parity or prices for export and imports.

The largest payments imbalances have little to do with “market forces” for imports and exports. They are what economists call price-inelastic – money spent without regard for price. This is true above all for military spending and maintenance of America’s vast network of foreign bases and political maneuverings to control foreign countries. During the 1960s and ‘70s U.S. military spending accounted for the entire balance-of-payments deficit, as private sector trade and investment remained in balance. Escalation of America’s oil war in the Near East and the hundreds of billions of dollars spent to prop up America-friendly regimes, end up in central banks – whose main option is to send them back to the United States in the form of purchases of U.S. Treasury bills – to finance further federal deficit spending!

None of this can be blamed on China.

U.S. strategists would not mind seeing China’s economy similarly untracked by letting global speculators bid up the renminbi’s exchange rate – by enough to let Wall Street speculators make hundreds of billions of dollars betting on the run-up. “Free capital markets” and “open financial markets” are euphemisms for setting the renminbi’s exchange rate by U.S. and European currency arbitrage and capital flight. The U.S. balance-of-payments outflow would increase rather than shrink, thanks to the ability of American banks to create nearly “free” credit on their keyboards to convert into Chinese or other currencies, gold or other speculative vehicles that look to rise against the dollar.

“An undervalued currency always promotes trade surpluses,” Prof. Krugman explains. But this is only true if trade is “price-elastic,” with other countries able to produce similar goods of their own at only marginally different prices. This is less and less the case as the United States and Europe de-industrialize and as their capital investment shrinks as a result of their expanding financial overhead ends in a wave of negative equity.

Congress is increasing the drumbeat of accusations that China is violating international trade rules by protecting itself from financialization. “Democrats in Congress are threatening to slap huge tariffs on Chinese goods to undermine the advantages Beijing has enjoyed from a currency, the renminbi, that experts say is artificially weakened by 20 to 25 percent.” The aim is to make China “lift the strict controls on its currency, which keep Chinese exports competitive and more factory workers employed.” But such legislation is illegal under world trade rules.

This kind of propaganda does not see the United States as guilty of “managing the dollar” by its quantitative easing that depresses the exchange rate below what would be normal for any other economy suffering so gigantic and chronic s payments deficit. What makes this situation inherently unfair is that while the Washington Consensus directs other countries to impose austerity plans, raise their taxes on consumers and cut vital spending, the Bush-Obama administration blames China, not the U.S. financial system or post-Cold War military expansionism.

The cover story is that foreign exchange controls and purchase of U.S. securities keep the renminbi’s exchange rate low, artificially spurring its exports. The reality is that these controls protect China from U.S. banks creating free “keyboard credit” to buy out its companies or load down its economy with loans to be paid off in renminbi whose value will rise against the deficit-prone dollar.

It’s the arbitrage opportunity of the century that lobbyists are pressing for, not the welfare of workers.

Paul Krugman and Robin Wells blame China for Wall Street’s junk mortgage binge. Instead of pointing to criminal behavior by the banks, brokerage companies, bond rating agencies and deceptive underwriters, they take the financial sector off the hook: “Just as global imbalances – the savings glut created by surpluses in China and other countries – played an important part in creating the great real estate bubble, they have an important role in blocking recovery now that the bubble has burst.”

This sounds more like what one would hear from a Wall Street lobbyist than from a liberal Democrat. It is as if the real estate bubble didn’t stem from financial fraud, junk mortgages, NINJA loans or the Federal Reserve flooding the U.S. economy with credit to inflate the real estate bubbles and sending electronic dollars abroad to glut the global economy. It’s China’s fault for running large trade surpluses “at the rest of the world’s expense.”

Wall Street’s idea of “equilibrium” is for foreign countries to financialize themselves along the lines that the United States is doing, then global equilibrium could be restored.

Such suggestions are a cover story for America’s own financial mismanagement. The U.S. idea for global equilibrium is to demand that that the rest of the world follow suit in adopting the short-term time frame typical of banks and hedge funds whose business plan is to make money purely from financial maneuvering, not long-term capital investment. Debt creation and the shift of economic planning to Wall Street and similar global financial centers is confused with “wealth creation,” as if it were what Adam Smith was talking about.

China is trying to help by voluntarily cutting back its rare earth exports. It has almost a monopoly, accounting for 97% of global trade in these 17 metallic elements. These exports are “price inelastic.” There is little known replacement cost once existing deposits are depleted. Yet China charges only for the cost of digging these rare metals out of the ground and refining them. They are used in military and other high-technology applications, from guided missile steering systems and computer hard drives to hybrid electric automobile batteries. This has prompted China to recently cut back its exports to save its land from environmental pollution and, incidentally, to build up its own stockpile for future use.

So I have a modest suggestion. If and when China starts re-exporting these metals, raise their price from a few dollars a pound to a few hundred dollars. According to theory put forth by Mr. Krugman and the U.S. Congress, this price increase should slow demand for Chinese exports. It also would help promote world peace and demilitarization, because these rare metals are key elements in missile guidance systems. China should build up its national security stockpile of these key minerals for the future – say, the next prospective five years of production. Let this be a test of the junk paradigms at work.

After all, there is a trade imbalance with China which needs to be addressed over some reasonable time-frame. But it cannot be done overnight.

By now nearly everyone recognizes that raising the value of the renminbi is a necessary part of the process of raising the real value of household income and improving the balance between producers and consumers, but if the currency rises too quickly and so leads to rising unemployment, it will actually cause household income (and with it household consumption) to decline as unemployment rises. The imbalance will still improve, but it will improve in the “wrong” way, in the form of production declining faster than consumption.

In the meantime, America has not addressed its own fundamental problems (such as rampant speculation and fraud) which led to our financial crisis. And as former trade representative Susan Schwab notes, the Congressional bill is nothing but political theater which might boomerang on all of us.

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

Comments

  1. steve davissteve davis

    For many years I have felt like John The Baptist..crying my warnings in a deaf desert.. as the propaganda media continues to spin the truth and ignore economic realities. I am glad to know I am not alone and people like you get what is happening. If we just prosecuted those that perpetrated the financial fraud..Demanded full restitution, and gave them jail time America would regain some credibility. Bravo on you article.

  2. Joshuaa CarpenterJoshuaa Carpenter

    Hi – I am new to this blog and website. Liked both, because it has substance. Much of the actions being taken are counter common-sense approach. Some laws are universal and the same holds true for the finance/economics field as well. We experienced a ‘thud’ in 2008 and yet like a drug-addict want to pursue the same path. I couldn’t agree more about the year 1971 when Nixon commenced this fiat-money experiment and like most of his decisions will end with disastrous consequences. Hope to be a more frequent participant. Thanks for your time.

  3. Michael HickMichael Hick

    My first visit to the United States was in 1959. I was amazed! My fist view of Manhattan – awesome! My interaction with American “can-do” was electric! The country was a powerhouse of innovation and work-ethic – nothing could stop America getting to the top! My first visit to the new China was last month. I was amazed. My first view of Shanghai-awesome! My first interactions with Chinese confidence and “can-do” were electric! The country is a powerhouse of innovation and work-ethic – nothing it seems can stop China from getting to the top! Almost everything is driven by attitude – including countries. If attitude is driven by envy, jealousy, protectionism then failure is assured. If it’s driven by optimism, creativity, transparency and hard work then success is assured. One of the most distressing sights of the 80’s was of a group of Congressmen publicly busting a Japanese electronic import – they didn’t like Japanese competition. Why? It made life difficult for their constituent companies. Oh, for heavens’ sake – that’s what business is all about. The sooner we realize that we live and work in a global arena the better, so…… 1. We had better start getting competitive on a global basis. America can still make the best T shirts, tables and chairs, ships and airplanes at the best prices compared to quality, customer service and production cost. 2. Tell Congress to either understand the principals of global trade and commerce or get out of the way and let American business get on with free international trade. 3. Tell the unions and special interests that we’ve only got a year or two left at the present rate of deficit spending – stop moaning and start cutting their cloth according to what’s available. 4. Let’s stop complaining about the guys who are winning all the games and put our own team in order. We need to start winning again. America needs to get back to its can-do attitude again; the attitude that encouraged me to emigrate and live and work in this great country.

  4. Reiner D MeierReiner D Meier

    Thanks for your analysis. On Oct.05 2010 THE SPIEGEL of Germany posted an Online article “World Faces New Wave of Currency Wars”. Worth reading it as to underline soem of your points. You also explained generally why nobody trusts the USA: The US governtment doesn’t shy away from illigal actions and breaching international agreements and to misinform the US population.

  5. James VenaJames Vena

    China has certainly become a scapegoat for many politicians now looking to defer blame for the US economy. Protectionist views and government inntervention to manipulate currency valuations is not advisable and runs counter to how the #1 economy of the world should react. If we as a country are truly the financial power of the world, we should act the part and stay on higer ground than cast blame on other nations. The situation in China is a very dangerous one as forcing the Chinese government to try and “thread the needle” to slow it’s ecomomy down, just may result in a revolt from within, that will surely spiral out of control. This is no longer the same China that we saw in 1989 during the last episode in Tianamen Square. Here is a piece I recently wrote and thought to share it here as it is apropos to the thread. Can China really slow down it’s economy, in order to avoid the inflationary pressures that may one day spiral out of control? My first visits to Asia & China (on business) were in the early-mid 1980′s. Things were obviously much different back then, at least on the surface. It was a much more supressed society, with the government management of all companies, which were of course nationalized. The workers were, for lack of a better word, drones. In those days, trade and investment into the People’s Republic of China, was in it’s embryonic stage, especially from the USA. Many Corporations, seduced by the size and potential of the new market, entered China with reckless abandon. Most made bad deals, that ultimately resulted often in financial losses. The control over the economy and it’s people led many to believe, that things most likely would never change, thus ultimately, everything will work out. I saw something a bit differently. Though I was young at the time, (20 something). I saw, that behind the Mao suits, were an industrious and very driven younger generation. Most, had a thirst for knowledge, and an entrepreneurial spirit, that while supressed, was evident. Even in the mid to late 80′s, prior to the Tianamen Square incident, the younger generation, aspired to become rich, educated and desired a glorious, western style life. I recall on one of my earier trips in 1987, in Lanzhou (Gansu province) on a JV project with the local Oil Refinery (Sinopec), and seeing signs that were derogatory to western culture and so called “bourgois captilism”. It was propoganda of course, but I noticed the embarrassment of the younger people of the delegation when they learned I was told the meaning of the signs. It made me think that this generation didn’t agree with the propoganda, and the re-education process wan’;t really getting through the masses. The silence wasn’t a sign of agreement. While many things have changed aesthetically, the reality is that most still believe that the government of China can continue to surpress the animus from the masses, no matter what the situation. However, now that it’s citizens have come to see material success, in my view it will no longer be possible, to control the ambitions of it’s citizens, or silence them the next time around. There will be no “Great Leap Forward” this time. The next Cultural Revolution, if there is one, will be based on the end of the silence, and an outright call for freedoms, democracy and capitialism. After all, China is not a democracy. While things may seem fine for now, that indeed may change. China’s economy continues to blossom and the vast majority continue to enjoy better lives than their past generation. But, they still cannot vote, and have no say in policy. Not a great percipitous to a long term, properly functioning stable government. Up until now, China’s economy has grown rapidly enough, to keep the “carrot” of a glorious lifestyle on the stick in front of its citizens. The Chinese government will only succeed in maintaining its political hold as long as the economy continues to expand, and offering the dream of wealth, to both those who have tasted it, and more so, those trying to get to the “well”. However, can the government ever again, actually slow economic growth to a crawl, if it needed? It is one thing to curtail and harness growth to a reasonable number, but it will be a bit more difficult to slow economic expansion outside the major coastal cities. If a billion citizens no longer find their lives improving, will they continue to sit back and allow the government to control their destiny? Or will they suddenly vocalize doubt in the competancy of the leadership, and lose confidence in the government. Will this younger generation, be silenced this time around? Will the tail “wag the dog” this time? It has always been glorious to get rich in China, as Orville Schell wrote long ago. The question is not if the people have changed, but if they are ready to speak out loud the next time. James Vena

  6. Herbert Biloboski GreenspanHerbert Biloboski Greenspan

    Blaming China absolutley does no good. Blamming politicans makes more sense. George Washington warned us about politicians in his farewell address. This POV makes the case for an independent president. I would case my vote for Mike Bloomberg. He might have insight as to how to recover the $39 trillion of capital missalocated by bankers

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