During President Obama's high profile visit to China this week,
the most frequently discussed, yet least understood, topic was how currency
valuations are affecting the economic relationship between the United States
and China. The focal problem is the Chinese government's policy of fixing the
value of the renminbi against the U.S. dollar. While many correctly perceive
that this 'peg' has contributed greatly to the current global imbalances, few
fully comprehend the ramifications should that peg be discarded.
The common understanding is both incomplete and naive. Most
analysts simply see the peg as China's principal weapon in an economic
struggle for global ascendancy. The peg, they argue, offers China a
competitive advantage by making its products cheaper in U.S. markets, thus
allowing Chinese firms to gobble up market share and steal jobs from U.S.
manufacturers. The thought is that were China to allow its currency to rise,
American manufactures would regain their lost edge, and both manufacturing
firms and the jobs formerly associated with them would return. In this
narrative, the struggle centers on the United States' diminishing leverage in
persuading the Chinese to lay down their unfair weaponry. It's a sympathetic
picture, but it tells the wrong story.
While the peg certainly is responsible for much of the world's
problems, its abandonment would cause severe hardship in the United States.
In fact, for the U.S., de-pegging would cause the economic equivalent of
cardiac arrest. Our economy is currently on life support provided by an
endless flow of debt financing from China. These purchases are the means by
which China maintains the relative value of its currency against the dollar.
As the dollar comes under even more downward pressure, China's purchases must
increase to keep the renminbi from rising. By maintaining the peg, China
enables our politicians and citizens to continue spending more than they have
and avoiding the hard choices necessary to restore our long-term economic
health.
Contrary to the conventional wisdom, when China drops the peg,
the immediate benefits will flow to the Chinese, not to Americans. Yes,
prices for Chinese goods will rise in the United States - but so will prices
for domestic goods. As a corollary, the Chinese will see falling prices
across the board. As anyone who has ever been shopping can explain, low
prices are a good thing.
In addition, credit will expand in China while it contracts
here. When China abandons the peg, it will no longer need to swell its
currency reserves by buying Treasuries or other dollar-denominated debt
instruments. Other nations will no longer feel the pressure to keep their
currencies from rising, so they too could throttle down on their onerous
dollar purchases.
As demand falls for both dollars and Treasuries, prices and
interest rates in the United States will rise. Rising rates will restrict the
flow of credit that is currently financing government and consumer spending.
This change will finally force a long overdue decline in borrowing. So, not
only will Americans lose access to the consumer credit that funds their
current spending, but the things they buy will also get more expensive.
Our short-term loss will be in sharp contrast to the gain felt
by foreigners, who will be rewarded with falling consumer prices and a more
abundant supply of investment capital. In other words, the American standard
of living will fall while that of our trading partners will rise.
However, this does not mean that I want the Chinese to maintain
the status quo. In the long run, the U.S. economy will benefit from the
abandonment of a system that guarantees our dependency and inevitable
downfall. De-pegging will force the hand of U.S. politicians toward pursuing
realistic policies. The Chinese will come to their senses eventually because
it is in their interest to do so. Meanwhile, the longer the peg is
maintained, the more indebted we become, the more out of balance our economy
grows, and the more our industrial base shrivels. In short, the longer they
wait, the steeper our fall.
A weaker dollar will price many imported products beyond the
reach of most Americas, giving our hollowed out manufacturing sector the
opportunity to rebound. However, if our industry has any chance of getting
off the mat, we must reduce taxes, repeal regulations, reform our cumbersome
legal system, and, most importantly, replenish our savings to finance the
necessary capital investment.
If we position ourselves to deal with the consequences, tough
love from China will provide a path back to genuine economic growth. However,
if our politicians continue to misread the problem and push us deeper in the
red, the inevitable 'rebalancing' could be truly ruinous.
For a more in-depth analysis of our financial problems and the
inherent dangers they pose for the U.S. economy and U.S. dollar, read Peter
Schiff's 2008 bestseller "The Little Book of Bull Moves in Bear
Markets" and his newest release "Crash Proof 2.0: How
to Profit from the Economic Collapse." Click here to learn
more.
More importantly, don't let the great deals pass you by. Get an
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Five Favorite Investment Choices for the Next Five Years." Click here to dowload the report for free. You can find more free services for global investors, and
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Peter D. Schiff
President/Chief Global Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax: 949-863-7100
www.europac.net
pschiff@europac.net
Also
by Peter Schiff
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and U.S. dollar denominated investments, read my new book : The Little Book of Bull Moves in Bear Markets" (Wiley,
2008).
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