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Is it Just the Chinese Manipulating Currency?

Written by Geoffrey Pike
Posted August 14, 2015

This past week, China has received a lot of attention — and with it, a lot of blame — for devaluing the Chinese yuan.

The Chinese central bank sent markets into a tailspin on Tuesday when it announced a 1.9% devaluation of the currency.

It is interesting that many people think the Chinese currency is going to take over the U.S. dollar as the world’s reserve currency. Right now, Chinese officials are supposedly just trying to get included in the IMF’s basket of currencies.

But how can a currency be included — let alone take over as the world’s reserve currency — when it can’t even be freely traded on open markets? And now the Chinese government is just making its already-manipulated currency look even worse by proclaiming a formal devaluation.

The yuan continued falling after the official announcement. The central bank says it will fix the yuan using a different method, instead of a basket of currencies that is dominated by the U.S. dollar. But the central bank shouldn’t be fixing it to anything. It should be the market determining the value of the currency.

This whole thing has sparked expectations of a currency war. I don’t really get this, because how much worse can it get? The Bank of Japan and the European Central Bank are already engaging in unprecedented monetary inflation. Meanwhile, the Fed just finished three big rounds of monetary inflation last year that took place over a period of about six years.

Because of the move of the People’s Bank of China, is the central bank of Japan really going to create even more money out of thin air? Is the European Central Bank going to buy even more government debt from bankrupt European countries?

One of the cited reasons for the yuan devaluation is that exports fell by more than 8% in July. But this is just a sign of the major economic downturn that is becoming evident in China. Ironically, much of it is a result of a prior loose monetary policy that fueled asset bubbles in stocks and real estate.

Now that those bubbles are popping, the Chinese central planners are desperate to delay the pain. They are trying the usual tricks of big government. They are trying to cover it up with more easy money.

Exporting Mercantilism

Regardless of what you think of Donald Trump, he has been great entertainment for the presidential race. Even though the Fox News “moderators” went after him in the debate, Fox News should be sending a “thank you” card to Donald Trump for the high ratings.

While Trump has been a successful businessman, it is curious that he doesn’t really understand some aspects of economics. He said the Chinese are beating out the Americans, and I don’t think he is talking about table tennis.

This is rather ridiculous when you consider that the average American’s standard of living is far higher than that of the average Chinese. The Chinese economy has come a long way over the last 30 years, but the overall standard of living is still nowhere close to what Americans have. Meanwhile, the Chinese economy is headed for disaster right now.

A lot of people want to blame the Chinese for problems that are happening in the United States. But I believe most of this blame is misplaced.

The Chinese central planners are a bunch of mercantilists. Perhaps they learned it from the “best and brightest” coming out of some of the top universities in the United States. You could say it is just another form of Keynesianism.

The Chinese central planners believe they have to devalue their currency in order to help their export sector. As we know, China does export a lot of manufactured goods. It is a large part of the economy. The problem is, by devaluing the currency, it also hurts Chinese consumers, or around 1.3 billion people.

Americans should want a free China that is openly trading with the United States. This should not be managed trade. It should be free trade, done voluntarily by parties that see it as mutually beneficial.

Still, if the Chinese government is going to manipulate the yuan, it doesn’t really hurt Americans much at all. In fact, it probably helps Americans in the short run.

It could hurt some exporting industries, but even there it can’t be of too much significance. How much are the Chinese buying in terms of manufactured goods coming out of the United States? Obviously, it is mostly the other way around.

Whether Americans want to admit it or not, they like buying Chinese goods. They vote with their pocketbooks. They buy Chinese goods because they are generally less expensive. If the quality is acceptable, then this is a rational choice, and there is nothing wrong with it.

Americans are capable of manufacturing the same goods that come out of China, but it is a matter of comparative advantage. It makes more sense for Americans to specialize in other areas.

The bottom line is that as China devalues its currency, it will actually benefit American consumers. It will be done at the expense of Chinese consumers. We can blame the Chinese government for bad policy, but we shouldn’t blame it for most of the problems in the United States.

Devaluation vs. Depreciation

The term "devaluation" is widely used. But just for a little history, the term actually means a formal devaluation within a fixed exchange rate system. It is essentially what the Chinese central bank is doing now.

But when talking about the U.S. dollar, we technically no longer have formal devaluations. This hasn’t happened since 1971 when Nixon broke the final link between the dollar and gold.

Since the dollar is no longer tied to gold or anything else and it is a freely floating currency, we no longer have technical devaluations. We have a depreciating dollar because the supply of them increases, but not a formal devaluation.

Many people will use the term “devaluation,” however, to describe the process of the dollar losing purchasing power. It is hard to criticize its use in this way, though. When the Fed creates new money, it means your money is losing value relative to what it would have been worth if the Fed hadn’t created new money. It is losing value. It is being “devalued.”

Regardless of the terms you use, it is ironic that there are so many critics of Chinese officials for manipulating the yuan. This is just being done in a more formal matter. But what do you call it when the Fed or the European Central Bank or the Bank of Japan buys up massive amounts of government debt using money created digitally on a computer? If this isn’t currency manipulation, I’m not sure what is.

In other words, every other major country/region is doing basically the same thing as the Chinese. It may be done in a different matter or to a different degree, but it is still being done.

If anything, we should be looking at what is going on in China and simply learning from the huge experiment that has gone wrong there. The central planners are failing, and it is affecting over 1.3 billion people.

U.S. Market Fallout

The Chinese devaluation has led to massive volatility around the world, including in the U.S. But if there is an economic downturn in the U.S., it isn’t China’s fault. This means the U.S. economy was not structurally sound to begin with.

If the economy were structurally sound, then investors would probably not care too much about a devalued yuan. There have been times in the past where the U.S. almost seemed immune to recessions happening in other parts of the world.

It has also been interesting to watch gold since the Chinese announcement. The gold price spiked up. Perhaps part of this was a fear of currency wars or that the Fed may be less likely to keep a tight monetary policy.

Whatever the reason, it provides a good lesson. Even though gold has struggled recently, it is still an important piece of a good portfolio. You don’t really know when there will be chaos in the financial markets. Gold serves as something of an insurance policy in such scenarios.

Gold stocks also spiked up in a big way. I am not at all ready to declare a new bull market in gold and gold stocks, but this past week has given us a nice glimpse of what is possible. When gold stocks do return into favor, there are going to be opportunities for absolutely huge profits.

If you are an American investor, you should be concerned. But it isn’t really China’s fault. There are 1.3 billion people who will have enough anger at Chinese officials, and rightly so.

As an American, you should watch what your own central bank is doing. In the meantime, enjoy your subsidy from China in the form of more inexpensive goods.

Until next time,

Geoffrey Pike for Wealth Daily

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