"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Monday, January 17, 2011

Chinese President Hu Jintao: "The current international currency system is the product of the past"


Hu Jintao's comment is no surprise really.  All global currency systems are borne of power struggles and reflect the status quo.  From Rome, to the Spanish and British Empires, to the current US Superpower, a global currency has always been adopted after much bloodshed.  Having a global currency is the reward one "earns" by winning wars and globally projecting power.  At least that's what history tells us.

And so President Hu Jinato's comment is describing a new world order.  China is saying that the post World War II and post USA-Soviet eras are OVER.  A new multilateral world is slowly emerging.  But, he also tempered his statement by saying that the Chinese Yuan would take a long time to become an accepted global currency.  Why?  Because he still wants the Chinese Yuan to be artificially low and pegged to the US Dollar for trade purposes, and he also wants the US Dollar to maintain its value to ensure the value of China's US Denominated holdings.   Those are two conflicting goals.  Good luck with that.

The US has no choice but to devalue the dollar.  That's what is keeping the economy afloat - negative real interest rates.  So long as interest rates are below inflation, and that's how Bernanke wants it, the US Dollar will continue to devalue over the long haul. which means that China's vast holdings will be devalued as well.

So what is really going on here?  It's geopolitical maneuvering.  Both the US and China have engaged in a trade relationship based on recycled dollars.  China sells things to the US, and in return, re-invests its surplus in US debt to keep selling things to the US.  It is a vicious, unsustainable cycle.  A surplus grows in China, and an usustainable debt load grows in the US.   This system only has two futures:

A slow unwind; a managed rebalancing, if you will, or,

a breakdown.

Everything else Hu Jintao and Obama discuss this week is just noise.

7 comments:

Jim Slip said...

We focus a lot on whether China's reserves are gonna lose in value or not. We shouldn't ignore what China has gained during this imbalanced period.

China has gained jobs, infrastructure, technological know-how. These things are worth more than their "savings".

I think the three choices are: a) maintain the current status (perma-surplus economies accept perma-deficits economies and the resulting fiscal policies), b) mutual rebalancing, c) non-mutual rebalancing (aka trade wars and capital controls).

Btw, Misthos, are you gonna do more posts on the mechanics of MMT? I believe you haven't touched one of the integral parts of MMT, namely that of the interest rate the central bank wants to set (to control the price of money), and the tools it has to achieve that goal by manipulating bank reserves.

Misthos said...

I agree that China has gained a lot, but the question still remains, is the status quo sustainable? China has its share of empty factories and empty office towers. Perma-deficits require perma-currency devaluations - a vicious cycle. And that to me, is very unstable. I don't see the process continuing forever, and two things could really shake things up:

1) China Property bubble crash:

China is facing demons of her own. There is a massive property bubble heating up that China has yet to successfully cool off, hence last Friday's "tightening." To me, this represents a potential crisis in 2011.

2) Oil crisis/Much higher oil, similar to 2008's peak, with a subsequent crash in Western aggregate demand, this too would affect China's property bubble.

You are correct that there are technically three choices. But the status quo can't be sustained - so I don't count on it. I am highly doubtful of mutual rebalancing, though I don't rule it out either. Your last scenario, is the most likely outcome, in my view - and I think this is the outcome that is playing out right now. Neither country trusts the other. This week's Washington visit by Hu Jintao will be very interesting.

It's already started off on the wrong foot with Jintao's comment on the US Dollar.

Re: MMT - I do plan on continuing the series. I feel that many blogs out there that are critical of the current monetary system leave out MMT. And so their analysis suffers, in my opinion.

Jim Slip said...

Misthos, why do perma-deficits require perma-currency devaluations?

If we assume that China wants to maintain a trade surplus with the USA, and that the peg to the dollar is a means towards achieving that goal, then China is gonna keep buying dollars to prevent the remnibi/ dollar adjustment from happening, and the US is gonna keep having government deficits to spend dollars into existence.

I understand that you can only defy gravity for so long, though, so it will happen eventually. However, when the adjustment happens, I think the US economy is gonna handle it nicely. If the US economy won't, then who will? The European South certainly won't.

The US can produce stuff again if it wants to. It did before and it can do again. However, countries like Greece, even in the days when they had their own currency, never produced much apart from the basics, and in general can't be internationally competitive due to cultural reasons. Germany should realize this and let go.

Misthos said...

Jim,

You gave me an idea for a new post. I will write it hopefully tomorrow. But I'll say this: Much of the US Economy is a house of cards ready to topple. Bernanke has not been successful in keeping house values high. QE has only succeeded in the stock market.

To a large degree, the US Economy is driven by asset valuations and debt based consumption. Both are crumbling, which will also affect the China-US trade arrangement. As I wrote, China has headaches of its own.

The US can not sustain permanent deficits. Interest rates will at one point rise. Inflation has already started to creep up - despite how it is officially "measured."

As for Greece - I agree, it too will need to produce, but at least Greece, if inflationary problems arise, can feed itself. Just look at the food riots occurring in countries that can't. The food crisis, however, is only partly driven by currency devaluations resulting in high energy costs. It is also driven by recent bad weather, and a possible peaking in conventional oil production.

Unless another cheap energy source for transportation is produced, globalization, as we know it, will change.

Misthos said...

Jim,

One more thing to think about. In the 1920s, the US was the world's largest exporter, the world's largest oil producer, and the world's largest creditor (not debtor) nation.

When the credit bubble of the 1920s collapsed, what happened to the US? It had 25% unemployment, a severe contraction in GDP, and soup lines - and yes, the stock market still rallied during the 1930s.

Some will argue that we no longer have a restrictive gold standard, and so MMT will save the day. My belief? Today's fiat money only delays the inevitable.

Credit bubbles produce malinvestment and create imbalances that one way or another will ultimately correct. Nations will pursue self interested policies that will exacerbate the problems.

Keep in mind: the current global credit bubble is the largest in world history.

Dave Narby said...

Great post Misthos.

One other thing, China is beginning to experience food price increases, due to our exporting inflation (not sure how that works, I suspect it may have more to do with cost-push inflation). They also have an arable-land/water supply problem AFAIKT.

Jim, one thing about Greece is that they have a lot of state and privately held gold. They will do just fine when the 'reset' button is pushed.

Misthos said...

Dave - good points. That's why China has been pursuing a mercantilist policy in Africa - buying up arable land to feed its own people.

As for Greece and gold - Greece has much more official gold reserves per capita than even China, India or the UK. UK readers can thank the idiot Gordon Brown for that.