Why China’s Devaluation, While Small, Is Bad News For The Global Economy

CHINA’S DEVALUATION of the yuan underscores the ongoing, dangerous, growth-retarding mess of U.S. monetary policy and, indeed, the fundamental deficiency of modern economic thinking. This intellectual bankruptcy threatens the ability of economies to grow and will consequently breed more political turmoil here and around the world.

Long term, it means the dollar’s days as king of all currencies will be over unless the next President knows enough to reverse the greenback’s decades-old slide in value.

Some key points:

• China’s move isn’t your traditional devaluation. Rather, it’s a response to the dollar’s recent (but temporary) surge in value. Dollar instability wreaks havoc whether it’s strengthening or weakening. A watch that can’t keep accurate time is useless, whether it’s too fast or too slow. On a trade-weighted basis the yuan had surged 22%, since mid-2012, before Beijing took action.

  • The dollar’s strength will likely continue. Unless the Federal Reserve changes policy on interest rates and bank regulation, bank lending won’t be strong for consumers or small and new businesses. The Fed has effectively frozen bank reserves, which means that the very thing it and every other central bank ostensibly fears–deflation–will continue. The yuan, despite Beijing’s reassurances, will likely experience small, continuing devaluations–the opposite of the crawling revaluation that began in the middle of the last decade. Commodities, such as oil, gold and copper, will experience more downward pressure.
  • Despite trying to compensate for the strong dollar, China’s move won’t be without consequences. A number of Chinese companies and local governments in recent years have taken on dollar-denominated debt, having forgotten what happened to similar borrowers during Asia’s 1997-98 economic crisis. The current upheaval will spur even more capital outflows from worried, well-to-do Chinese. The uncertainty will hurt domestic investment by internal entrepreneurs and will cause foreign direct investment to slow. Political tensions with the U.S.–already heating up (both Democrats and Republicans are increasingly angry and upset with Beijing’s growing assertiveness in claiming disputed waters and ocean real estate)–will be exacerbated.None of this bodes well, short term, for a vigorous resumption of growth.

    • Beijing may use dollar instability to set up a yuan-centered trading and monetary bloc with some of its neighbors, especially Indonesia, to reduce U.S. influence. The roaring greenback is increasingly wreaking currency and economic havoc in such countries as India, Indonesia, Malaysia, Thailand, South Korea and the Philippines.

Combined with Obama’s slashing of U.S. military strength and his deliberate weakness vis-à-vis Iran, ISIS and Russia, the dollar turmoil gives Beijing the opening it needs to begin patching together an Asia co-prosperity sphere that would isolate Japan and freeze out the U.S. This is a recipe for deadly instability à la the 1930s.

• If monetary policy today were a company, it would be declared insolvent. Today’s economic nomenklatura think money is a tool to drive and control economic activity. That’s about as accurate as saying that manipulating the way in which scales measure weight can drive down obesity levels.

Money is not wealth. It measures the value of products and services, just as scales measure weight, rulers measure length and clocks measure time. Money is a claim on goods and services. It makes buying and selling infinitely easier. Without the ability to trade with one another, we’d still be living in caves. Fixed weights and measures are essential to a smoothly functioning marketplace. So is money that has a stable value.

Unstable money hurts investing. After all, why take a risk if you don’t know the value of the currency in which you’re going to get paid back? It shortens the investing time horizon. The longer the wait period, the more risk of chaos.

By suppressing the market price of borrowing and lending dollars, the Fed has reduced the volume of bank lending, in the same way that rent control dam ages the building of new apartments.

The decision of the U.S. Treasury Department and the Federal Reserve in the early part of the last decade to gradually weaken the dollar has cost the global economy billions of dollars in lost growth. The weak greenback set off a commodities boom that sucked up countless billions of dollars in investment. The thinking was that if prices were going up that could only mean we needed more of those things. But the price signals were wrong; they weren’t a reflection of scarcity but of dollar weakness. This was even more glaringly evident in the false housing boom–the aftershocks of which still afflict us.

Overseas, surging commodity prices led to impressive prosperity in such countries as Brazil, Russia and South Africa. Now, however, these same countries are suffering economic contraction, which has been made worse by the strengthening dollar.

Needless to say, the roller-coastering dollar has hurt just about every nation, which is hardly conducive to sound domestic politics or constructive global behavior. It provides fuel for 1930s-style currency wars and protectionism.


Text: Forbes by Steve Forbes 19-18-2015

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