China Isn't For Dummies

While I have too much suspicion of actual motivation to accept much financial page analysis, the recent admonition "Watch Your Flanks" from the Christian Science Monitor has struck me as worth attention.

China finances the US deficits as part of a broader mercantilist strategy to keep its currency undervalued. The way it does so is to set a "fixed peg" between the US dollar and the Chinese yuan. To maintain that peg in the face of a record trade imbalance between the US and China, China simply recycles its surplus US dollars back into the US bond market.

Today, as a result of its currency manipulation, China has become the largest monthly net buyer of US securities. More than two-thirds of its massive and highly undiversified $1 trillion in foreign currency reserves are estimated to be invested in US bonds. China will very shortly eclipse Japan as America's largest creditor. And its foreign currency reserves are projected to double within a few short years.

Here's the clear and present danger: What may have started out as a simple mercantilist currency gambit for China to sell its exports cheap and keep imports dear has morphed into a powerful weapon to hold off any effective US response to China's unfair trade practices. And make no mistake: Such practices run the gamut from a complex web of illegal export subsidies and currency manipulation to rampant piracy and woefully lax environmental, health, and safety standards.
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China can now credibly threaten to stop financing US deficits and start dumping greenbacks.

This is a very credible threat. If executed, inflation, the costs of imports, and interest and mortgage rates would skyrocket. With higher housing costs leading the way, consumers would soon be overburdened. The result: a nasty stagflation shock.

Some say that the Chinese would never take such an action because it would hurt them as much as Americans. But it's Beijing's view that the Chinese people are far tougher and better able to withstand any economic shock than Americans who've grown soft living the good life – and they are probably right. Chinese officials also take a far longer view of strategic action. So if a "dump the greenbacks" strategy needs to be implemented to break the back of a rising American protectionism, to secure Taiwan, or to achieve any other strategic goals, sobeit. [emphasis added]

The challenge to its own people is a weapon that the government of China can use without the peril of being ousted. That is one of the advantages an authoritarian regime can weild, and something that our own government evidently wishes it had. While committing such atrocities as the mistreatment of our wounded soldiers at VA hospitals and VA administrative bodies across the country, the maladministration touts its generosity for public consumption. Not so, China. It is possible for the central government in China to deny service to its people without pretending otherwise.

For U.S. investors, there is a clear and present danger as well, as the currency manipulation has sway over a lot of mutual fund investments.

Moody's said the rise in the size and number of MMFs in China was such that they command a meaningful role in the Chinese asset management industry. As of March 2006, the assets under management of 26 MMFs had reached 235.5 bln Chinese Yuan, or 54 pct of the total managed assets of China mutual funds.

Even after huge redemptions in June 2006, triggered by IPOs in China's equity market, and the decline in the assets under management of MMFs to 112 bln Chinese yuan as of September 2006, the funds still account for 28 pct of total managed assets

Incidentally, the huge size and limited communication system of China means that much that goes on in the provinces goes unnoticed by the central government. Recently the central government even sent troops to close down dams along the Mekong River that had been built without authorization or knowledge of the central government, that were affecting its flow into lower areas and bringing disaster to water-deprived areas downriver from the rogue dammers. This probably couldn't happen in more interconnected countries such as the U.S. We have a government with more control - and in our present situation, badly used control.

This present maladministration concentrates on control of this country by misuse of its powers, while letting other governments such as China make gains that harm U.S. interests.