Free Floating Yuan = Stronger Yuan ??

An interesting assumption in virtually all debates concerning the Yuan is that it would appreciate against the Dollar, once let float freely. A good example is the article below in which this premise is applied, set in stone and unquestioned from start to finish:

A growing number of global leaders are urging China to look to its long-term interests and allow its tightly controlled currency to rise. But they are encountering reluctance from a government still very much worried about the economy in the short term.

President Barack Obama and Dominique Strauss-Kahn, managing director of the International Monetary Fund, in Beijing on separate visits Tuesday, told Chinese officials that yielding to market pressures for a stronger yuan would help the global economy recover.

Nonetheless, Chinese President Hu Jintao didn’t announce any new commitment on currency policy to Mr. Obama. Other Chinese officials and economists continue to defend China’s policy of keeping the yuan steady against the dollar to aid Chinese exports, which are still vital in sustaining the nation’s economic recovery despite growing domestic consumption.
[Geithner] Reuters

Treasury Secretary Timothy Geithner took a softer tone on China’s currency at a Senate Foreign Relations Committee hearing on Tuesday.

At a congressional hearing Tuesday, Treasury Secretary Timothy Geithner sounded a much softer tone than in the past on China’s currency, saying it’s “very important” that the Chinese government pursue “broader reforms to their exchange system over time.”

“China has to take steps to move away from excessive reliance on exports” and find ways to stimulate domestic consumption, Mr. Geithner said at the hearing before the Senate Foreign Relations Committee, refraining from harsh rhetoric toward the Asian giant. He said that China is already making progress on rebalancing its economy and that “we’re seeing very promising, early signs” of a shift toward growth that relies on “domestic consumption and investment.”

The discussions highlight how China’s heavily managed currency is once again at the center of debates over global economic policy, after being pushed to the background by the financial crisis.

Though Mr. Hu, Mr. Obama and other world leaders have promised to cooperate in pulling the world economy out of its deepest slump in a generation, coordinating economic policies across very different countries remains difficult.

High unemployment makes trade with China a volatile political issue in the U.S., but similar pressures make it difficult for China to yield to U.S. pressure on the currency. A stronger yuan would make Chinese exports less competitive, which is unappealing for China in a year when exports are down about 20% and many manufacturers have closed.

Chinese leaders who have criticized the West’s economic management may also find it politically difficult to yield to demands on the currency.

On the other hand, China’s economy has recovered faster than most. Because the yuan has weakened sharply against other currencies, European and Asian competitors complain that China has an unfair advantage.

Meanwhile, some economists worry the extra juice to the economy from the cheap yuan, in addition to huge government stimulus, risks new bubbles in real estate and stocks.

Mr. Strauss-Kahn said keeping the currency down may help exports in the short term, but it imposes other costs. “You have to balance your needs in the short term with the long term,” he said. For instance, an undervalued currency encourages companies to invest in ways that may not be viable once the currency rises.

“If you have wrong prices, you make wrong decisions, especially concerning investment in the long run,” he said, adding that it is time for China to look more toward long-term stability now that it has accumulated advantages from an undervalued currency.

A stronger currency also would boost the purchasing power of Chinese households, which would support the Chinese government’s drive to make economic growth less dependent on exports, Mr. Strauss-Kahn said.

Chinese officials frequently counter that big swings in the exchange rate can harm companies and disrupt the economy, which is of particular concern at a time when confidence is fragile. They sometimes contrast the stability of the yuan’s exchange rate — which makes it easier for firms to plan ahead — with the wild swings in the dollar’s value.

“China keeping a basically stable exchange-rate policy is, in reality, good for the global economic recovery,” Yao Jian, spokesman for China’s Ministry of Commerce, told reporters Monday. “If the request is to strengthen other currencies, while allowing the dollar to keep weakening, that’s not very fair.”

Chinese officials aren’t totally closed to arguments for a stronger yuan. In a statement many interpreted as a gesture to the growing concerns about the currency, the People’s Bank of China last week said exchange-rate policy would take into account “changes in international capital flows and the trends of major currencies.”

Still, many private analysts don’t think a move on the yuan is imminent.

Authorities may feel freer to shift once exports are growing again and inflation has turned positive, which could happen early next year. In coming months, China will have to tell other members of the Group of 20 leading economies how it plans to boost consumer spending.

Although China’s government publicly has grown more confident about the strength of its recovery, growth still remains heavily dependent on government stimulus programs.

“China needs the U.S. economy to recover strongly and renew its import growth. Otherwise, China will have a tough time sustaining its recovery,” said Eswar Prasad, an economist at Cornell University.

That is one of the key reasons China is reluctant to lift its currency now. World Bank chief economist Justin Yifu Lin, a former Chinese government adviser, has argued that if a stronger yuan snuffs out a recovery in China’s export sector, it could weaken China’s entire economy and have negative consequences for global growth.

As I noted before on this matter (and so far I see no reason to change my mind on that):

Some points fundamentally support the thesis that the dollar should gain in value against the major currencies:

– Global deleveraging is driving investors from other currencies back to the Dollar
– Deflation hitting the US first, and other countries only later
– Imports into the US are falling rapidly
– Significant domestic spending sprees by the Chinese government

All this may indicate that if the Chinese government were to let the Yuan float freely at some point, it may actually drop significantly against the US Dollar. Such an event could possibly be the ignition for a significant Dollar rally in the years to come.

We will see how things develop over time. I am not saying that my scenario HAS to occur. But I think it certainly is a possibility over the next 2 years or so. What I reject is a completely one-sided approach to this question. As Ayn Rand always used to say: Whenever you encounter contradiction in your thinking, check your premise. I will surely check mine if I turn out to be wrong.

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Tariffs on Chinese Tire Imports – Continuing Mistakes from The Great Depression

So far, the US government has been diligently repeating each and every mistake committed during The Great Depression. The only thing they had left undone so far was to match the Smoot-Hawley Tarriff Act from 1930, widely recognized as the worst decision during that period:

In mid 1930 the Smoot-Hawley Tariff is signed into law, raising import tariffs to record highs, and spreading protectionism all over the world – consumers and exporters suffer from the ensuing decline of international trade

Now, president Obama is rushing in to fill that void:

In a break with the trade policies of his predecessor, President Obama announced on Friday night that he would impose a 35 percent tariff on automobile and light-truck tires imported from China.

The decision is a major victory for the United Steelworkers, the union that represents American tire workers. And Mr. Obama cannot afford to jeopardize his relationship with major unions as he pushes Congress to overhaul the nation’s health care system.

But China is certain to be antagonized by the decision, made less than two weeks before Mr. Obama will come face to face with Chinese leaders at a summit meeting in Pittsburgh for the Group of 20 industrialized and fast-growing emerging nations.

The decision signals the first time that the United States has invoked a special safeguard provision that was part of its agreement to support China’s entry into the World Trade Organization in 2001.

Under that safeguard provision, American companies or workers harmed by imports from China can ask the government for protection simply by demonstrating that American producers have suffered a “market disruption” or a “surge” in imports from China.

Unlike more traditional anti-dumping cases, the government does not need to determine that a country is competing unfairly or selling its products at less than their true cost.

The International Trade Commission had already determined that Chinese tire imports were disrupting the $1.7 billion market and recommended that the president impose the new tariffs. Members of the commission, an independent government agency, voted 4-2 on June 29 to recommend that President Obama impose tariffs on Chinese tires for three years. Mr. Obama had until this coming Thursday to make a decision.

American imports of Chinese tires tripled between 2004 and 2008, and China’s share of the American market grew to 16.7 percent, from 4.7 percent, according to the United States Trade Representative. Four American tire factories closed in 2006 and 2007, and several more are set to close this year.

The Tire Industry Association has opposed the tariffs, arguing that they will not preserve American jobs but will instead cause manufacturers to relocate plants to other countries where they can produce tires cheaply.

President George W. Bush received four similar recommendations from the trade commission, the most recent one involving steel pipe in December 2005, but he rejected all of those recommendations. Under the law, the president is allowed to accept or reject the commission’s recommendations.

“The president decided to remedy the clear disruption to the U.S. tire industry based on the facts and the law in this case,” the president’s spokesman, Robert Gibbs, said in a statement Friday night.

Mr. Gibbs said the United States, which already imposes a 4 percent tariff on Chinese tires, would impose an additional tariff of 35 percent for one year. The tariff will be reduced to 30 percent in the second year and 25 percent in the third year. The tariff is to take effect on Sept. 26.

The trade commission proposed higher tariffs than the president actually imposed, recommending an initial levy of 55 percent.

The president of United Steelworkers International, Leo W. Gerard, applauded Mr. Obama’s decision, saying, “The president sent the message that we expect others to live by the rules, just as we do.”

Senator Sherrod Brown, an Ohio Democrat who had pressed for the tariffs, also praised the decision.

He said in a statement, “If American workers and manufacturers are going to compete in the global market, they need to have a government that uses trade enforcement tools.”

The stupidity behind those tirades is so rampant and obvious that most people will of course be able see through it easily. If American workers want to be competitive in the global market they need to be productive and their services priced competitively when compared with workers from other countries.

The very reason why higher tariffs are introduced is the fact that they are NOT competitive, and they will stay uncompetitive without the necessity to outstrip competition. We have already seen this with the big auto manufacturers. Now they are moving down the supply chain to wreck yet another industry. This will of course ultimately discourage investment and destroy jobs.

“The president sent the message that we expect others to live by the rules, just as we do.”

What is he talking about? Which rules? The rule that a Chinese entrepreneur should not benefit US importers by offering affordable goods which in turn benefits those consumers who buy end products from them?

Reactions to follow

To every action there will be consequences. China will probably retaliate in kind and impose similar tariffs. On top of that, other labor associations may feel encouraged now and start pushing for more similar tariffs. Up to now, it seemed to be a gentlemen’s agreement among governments not to resort to protectionism because they all claimed to understand the disastrous long term consequences on global trade. Now it seems as though all that is forgotten and all bets are off.

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Rally in Chinese Stocks – Time to Kiss it Goodbye and Cash Out

The Chinese stock market has staged a remarkable 100% rally from October 2008 through the end of July 2009. August 09, however, hasn’t been good for Chinese stocks. Since August 4th, Chinese stocks have now fallen by more than 20%.

The Shanghai Composite Index:
Click on image to enlarge.

EWI writes China’s Stocks Crash: Is The United States Next?:

In the past three weeks alone, China’s formerly sizzling stock market has gone from bull market leader to bear market letdown. On August 30, the Shanghai Composite Index plummeted 6.7%, its largest one-day drop of 2009 so far. And, of the 89 global markets tracked by Bloomberg, the Shanghai index came in last place.

As for what caused the freefall, mainstream experts point their collective finger at one main factor: Growing fears that China’s monetary officials will turn off their easy-money spigot. Here, this August 31 BusinessWeek stands in:
“Investors began selling on concerns that banks will cut back on lavish lending that had helped push shares up by more than 80% since that start of the year.”
Here’s the thing: the drunken lending habits of China’s banks have been on the global Concern-O-Meter for quite some time now. And last I checked, its needle reading jumped from “Don’t worry be happy” — to — “Be Afraid, Be Very Afraid” many months ago. To wit:
  • May 2009: China’s deputy central bank governor seriously questions the “sustainability of the rapid growth in credit and its possible adverse impact,” and a Wall Street Journal piece warns that China’s stimulus spree is “pillaging bank balance sheets” as the quantity of loans vastly outweighs their quality.
  • June 2009: “China’s Banks Are Warned About Loans” (WSJ). China Bank Regulatory Commission issues an internal directive to commercial banks to “tighten supervision of loans” and ensure those loans serve the needs of the “real economy” and not “financial speculation.”
  • July 2009:“China Aims To Rein In Lending.” (Associated Press) China’s two largest lenders reveal they will “sharply slow credit growth.”
Yet during that time, the mounting anti-lending rhetoric failed to take the wind out of the Shanghai Composite Index’s sails. Prices rallied without resistance to new yearly highs until early August.
So if the “fundamental” shoe doesn’t fit, what’s the real story here? Well, I’ll make it really simple: the Shanghai Composite Index has plunged more than 20% from its 2009 high on August 4. And, in the days leading up to the market’s reversal, China landed on the radar of several of EWI’s subscription-based publications. For our analysts, the time had come to stage a full frontal attack and warn of a major turn in China’s fortunes.
Here, the following catalogue of previous publications fills in the blanks:
August 2009 Elliott Wave Financial Forecast observes the unsustainable nature of China’s latest stock market rise and writes: “China’s debt bubble will succumb.”

August 14 Asian Short Term Update: “All eyes continue to be on China as we ascertain whther or not an intermediate-term-top is in place.

August 14 Short Term Update: Presented the following close-up of China’s main stock market and wrote: “A break of the trendline will be the next important tip” that a larger decline is underway.

August 14 European Short Term Update: “Though not under our normal purview for ESTU, China has been the central source of liquidity…China’s sharp decline may be a case of the pin meeting the balloon.”

And how about the fundamentals of the oh so vibrant, dynamic, unbreakable, sound, and decoupling economy? Some facts Mish posted today about China’s unsustainable stimulus and property bubble:

A 4-Minute Tour of the China Property Bubble

What is China doing with all that printing? Please take a A 4-Minute Tour of the China Property Bubble to find out.

World’s Largest Shopping Mall Sits Vacant

The world’s largest shopping mall, South China Mall in Guangzhou, China, is almost entirely empty. Click on the link to see a fascinating video.

If you thought Minnesota’s Mall of America was the world’s biggest shopping center, think again. South China Mall is a Vegas-like spectacle built in 2005 that now sits almost entirely empty. In the current economic climate, could this be a symbol of things to come?

The entire mall sits empty save 10-12 small shops.

Malinvestments and Commodity Prices

Think about all the concrete, steel, copper, and energy it took to build that mall. This is not an isolated case either as the previous 4-minute video shows.

Let’s not confuse a renewed crack-up boom in China with a sustainable recovery. And let’s not pretend much of this building is anything other than malinvestment.

The truth is: There is no decoupling. The Chinese economic miracle is a mirage, a very popular one to be sure. If it is China the world is banking on to lead a recovery, then the world is royally screwed.

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US on the Hook for Chinese Investments

When a government has to publicly start assuring foreign creditors about the soundness of their debt holdings, it is high time to worry:

Some excerpts from Obama Administration Tries to Reassure China on Treasury Debt:

“There’s no safer investment in the world than in the United States,” White House Press Secretary Robert Gibbs said yesterday at a briefing in Washington.

This statement shows the sheer arrogance of policymakers. Even if there was no safer investment in the world than in the US, it is most definitely not with the US government. Why should it be? Why should an organization that does nothing but borrow and spend money, while facing a massive tax shortfall and not creating any factors of production be a “safe” investment? Just because they are currently considered a safe haven and might continue to play this role for quite a little while longer, who seriously believes that this will never come to an end?

White House National Economic Council Director Lawrence Summers, asked yesterday about Wen’s remarks, said overseas “confidence” in Treasuries would be hurt without the administration’s steps to end the economy’s decline.

Yes, and confidence in Treasuries deserves to be hurt. Too much confidence in debtors is what created the credit crisis in the first place, in case anyone still remembers.

“The U.S. Treasury market remains the deepest and most liquid market in the world,” Treasury spokeswoman Heather Wong said in an e-mailed statement. “President Obama is committed to taking the steps necessary to restore growth and put this country on the path of fiscal sustainability, including cutting the long-term deficit in half over the next four years.”

Actually President Obama is doing absolutely nothing to restore growth. Which one of his policies exactly restores growth? Which intelligent and/or competent person would seriously believe and say with a straight face that this government will cut the deficit in half within the next four years, while at the same time passing a budget that dwarfs all previous ones and while facing a massive tax shortfall.

The administration is “tackling many long-ignored problems, ensuring that the U.S. will be in a stronger position than ever,” Wong said. “We are facing whatever challenges come up and will continue to do so.”

The truth is: The government is not tackling any long-ignored problem. It maintains business as usual and it has proven this in the fields of fiscal as well as foreign policy. Wong is simply firing platitudes at the problem, hoping they will stick.

“Of course we are concerned about the safety of our assets,” Wen said after an annual meeting of the legislature. “To be honest, I am a little bit worried.”

You should be.

China should seek to “fend off risks” as it diversifies its $1.95 trillion in foreign-exchange reserves, Wen said. Yu Yongding, a former adviser to the central bank, said in an interview on Feb. 10 that the nation should seek guarantees that its Treasury holdings won’t be eroded by “reckless policies.”

China has no other choice than to stop buying US treasuries and begin ensuring that past obligations will be paid. The US will need to export more and import less while China has to reduce exports to the US and import more. This is the only way the US will ever be able to pay off their debt to China. More on this in The US Current Account Deficit.

U.S. Secretary of State Hillary Clinton urged China, while visiting officials in Beijing on Feb. 22, to continue buying U.S. debt, which she called a “safe investment.”

She actually urged China to keep buying treasuries which are a “safe investment”? If they were such a safe investment then why should Hillary Clinton need to assure them about their safety. Why at the same time would she need to “urge” them to buy more?

The outcome of all this is pre-ordained: The massive current account deficit will be reduced because people in the US consume less. Americans have begun to save more. There is no way this trend will stop anytime soon. China will need to export less and begin investing more domestically, while at the same time importing and buying more goods from or in the US. This will happen, whether the US government likes it or not. The End of Consumerism is in full swing. But the government’s reckless borrowing, spending and bailouts assure that this correction will take a very long time. I don’t think it is unreasonable to assume that it will take until 2020 or so until an approximate trade balance between the US and China is restored.

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