‘The great enemy of truth is very often not the lie – deliberate, contrived and dishonest – but the myth – persistent, persuasive and unrealistic.’

J F Kennedy

Part I of the article, titled ‘Truths and Myths of the Currency War’  is here.

The battle of words coming from the U.S. administration on an undervalued currency in China has been there since last few years, as China accumulated higher and higher trade surpluses with the U.S. Henry Paulson, treasury secretary under the last administration, with his links from Goldman days, tried to persuade the Chinese administration, but failed.

A close scrutiny of China’s bilateral trade figures shows that China runs trade surplus with much of the developed nations and a trade deficit with many of the (resource rich) developing nations, thereby passing its huge trade surplus competitiveness to certain parts of the developing world, down the value chain. From the days of Paulson, although the U.S. has been concerned about rising deficit with China, and employment losses in manufacturing sector to China, they could achieve little in persuading China to appreciate its currency for the interests of the U.S.

Has the U.S. been appreciating its own currency now for the interests of the rest of the world? A strong dollar necessarily means a strong yuan and vice-versa. So if an undervalued yuan is a problem for the U.S. and for the rest of the world as well; a debasing dollar magnifies that problem for the rest of the world even more, albeit protecting the U.S. partly against the nuances of an undervalued yuan.

1st time in the history of the world, a nation has been singled out for being competitive (or manipulative) in having a sustainable competitive edge in manufacturing practices, due to an unending supply of cheap labor. One may cite the example of Japan and the Plaza Accord of 1985. However China isn’t Japan. China is ten-times bigger than Japan when it comes to population. Japan’s cheap labor advantage didn’t sustain long, albeit its process and technical innovations advantage has sustained.

Economics as a subject has been hijacked by the GDP-cult of Washington-consensus era, delinking it from the people for whose benefit the knowledge of the subject should be used. The problem with our present measurement system is that we have started looking at (dubious) GDP figures to be more important than the economic welfare per person (with populations of the nations).

Economists get more worried about economic problems at the world’s largest economies, and not necessarily at economic problems at world’s most populous economies.

Simply put, in a win-lose scenario of an economic war (one may sugarcoat the present situation, but it’s nothing less than the beginning of an economic, trade and currency war), the world needs to decide whether the interests of 1.3 billion poorer Chinese comes ahead of that of 300 millions of Americans. The biggest of the myth traditionally has been when the U.S. sneezes, rest of the world catches cold. The myth essentially implies that one needs to protect the largest economy for the bigger economic interest of the mankind of the world.

That era is now changing. Many may think that it won’t; the caveat here is it would take time. So coupling-reverse coupling-decoupling theorists better watch out and don’t hastily conclude anything. My sense is decoupling for the real economy has been initiated, however going forward we may see hiccups, due to the dollar-coupling effect. It’s only natural when one understands the significance of the event when the U.S. no longer drives the world economy, but merely acts as a large constituent of it.

Let’s examine the merits of the mutual accusations both sides make against one another. The U.S. opinion is China has artificially undervalued yuan to gain trade advantages (which Krugman also supports), whereas China has lately responded with charges that debasing dollar amounts to wealth stealing from the developing nations.  

So what’s the truth here? What is deliberate, contrived and dishonest lie and what in this battle of words is the persistent, persuasive and unrealistic myth, from the global perspective of the majority?

An undervalued currency, if true, helps China in having lower imports as domestic price of imported goods become costlier. However majority of China’s imports are commodity-centric and for industrial purposes than for direct retail consumptions. Do we assume that China’s economic policies should be guided for the small section of affluent Chinese who may be interested to buy imported Versace Bags against the interests of the exporting employment-generating firms in a nation whose per-capita income is hardly 1/10th of that of the U.S.? If yuan appreciates (against dollar), and dollar depreciates against rest of the asset-classes, what does the developing nations who presently run trade surpluses with China gain? They get more dollars, but when they try and import goods from China (or OPEC) again due to China’s competitive advantage in manufacturing (importing from the U.S. is a far-fetched idea, othe than defence related items), they get less goods. Alternatively they lose that export market of China altogether, but can have access to export market of the U.S. directly, beating China. Net-net, rest of the world does not gain much, rather it loses unless one is focused only on the deficit-and-debt ridden U.S. markets where rest of the world plays against China.

With undervalued yuan, U.S. industry has benefited as they got more yuan per dollar of FDIs they brought in China. Now if yuan appreciates (which it did, by nearly 25% since 2005), the same set of people would get more dollars per yuan, giving them capital appreciation due to currency appreciation, other than the growth dividend. So an undervalued yuan is not an unmitigated good thing for China as it increases capital inflows, whereas an appreciating yuan at this stage of China’s growth story offers the U.S. more benefits, and probably only benefits.

If a company operates with less margin, is it a crime? If Chinese exporters operate on razor-thin margins, they should be praised for that. A look at Foxconn as a major manufacturing outsourcing entity in China and comparing it with IT outsourcing firms in India show the vast difference in profit or operating margins in which they operate. Foxconn makes losses from time to time, or at most operate on single low-digit margins, whereas Indian IT firms operate on 20-30% margin. IT has not penetrated Indian society in a significant way or amongst the bottom of the pyramid in the global society; Foxconn however helped  many poor people globally to own an ICT device like a mobile phone.

Beyond margins, there’s also the question of interest rates, overt/covert subsidies (power costs), employment costs, and government taxation policies for exporting units. It is true that exporting units also generate employment, directly and indirectly. As long as the benefit of (employment + taxes) in primary and secondary exporting units score more than the overt/covert subsidies, nations realize exporting makes sense. China probably follows it religiously, however Japan has also been found to be engaged in many such practices. In many parts of the world, profit motive alone determines what’s ethical business practice, compromising national or social interests of business.

In a nutshell, China’s trade practices might have worked against the interests of a few (domestic manufacturing employment elsewhere, profitability of firms elsewhere), but it has simultaneously resulted in benefiting much of the world as vast majority of the world could afford many of these Chinese-made products for the 1st time (which forced competition to cut costs also), erstwhile reserved for the rich, at costs within their reach.

Unlike above, one finds enough merit in China’s allegation that by debasing the global currency dollar; the U.S. has effectively been stealing wealth from the poorer developing nations. The only thing in which the U.S. has been gaining competitive edge over last few decades is in printing more and more dollar with the help of (1) foreign holding of treasuries and (2) flooding rest of the world with liquidity of dollar. People or organizations having access to cheap dollar (from the U.S. banking system) can always buy relatively cheaper assets in developing world where liquidity is less, as eventually these asset prices would rise. The U.S. runs a debt per capita of closed to $60K or more, and with $60K – one can buy a hell lot of assets in developing world. So the U.S. steals wealth in two ways – (1) giving less to the nations who have invested in U.S. treasuries or in dollar, and (2) by acquiring cheaper assets from developing, illiquid markets with borrowed or printed money, by encashing the status of dollar.

One may not be wrong to say that FIIs own nearly 50% of the free floating stocks of Indian markets. Indian assets are getting owned for relatively better returns with foreign money, and irrespective of growth rates – asset prices in developing worlds like China or India is likely to go up over next many years, beating growth rates of the U.S. Rather than making these assets available to local people as their income levels grow, external liquidity drives these asset prices leading to speculative asset bubbles in these developing large economies, depriving the local people of their real need. A depreciating dollar further helps these U.S. centric FII units to make more money in dollar, one from rising local asset values with more inflows in apprehension of a weak dollar, and 2nd from rising local currency appreciations.

All by simply printing dollar! Effectively, U.S. entities (or nations with global currencies), on top of having a choice in terms of where to invest and in which attractive global markets (because of free flow of capital), further gain when dollar gets weakened, getting the best returns from the best performing markets of the world with twin benefits. Developing nations, having almost no choice on whether to hold dollar reserves, find their investment values depreciating with further and further debasing of dollar, and lower growth in the U.S.

Free flow of capital has benefited the U.S. or the developed world who supply most of the capital by not earning it but by merely printing it; whereas free flow of trade and services would help the rest of the world. The former has happened with more intensity than the later.

One may argue that a depreciating dollar may make U.S. assets cheaper to rest of the world, however when the U.S. has been facing a heavy headwind due to fundamental reasons and when physical assets in the U.S.  anyway happen to be much costlier than that of developing nations, there’s no apparent benefit or future of cheaper U.S. assets to rest of the world. The priority of the developing world is to build roads or to generate electricity in their respective nations where many people don’t have access to these basic infrastructures, and not to own homes and stocks in the U.S.

For a long time, with dollar the U.S. has been having the cake and eating it too. China understands its unique complex position which may even become a trap of its own making. However, as of now it looks like China has been getting ready to expose what’s true, lie and myth behind the beginning of a prolonged dispute in currency and trade areas.

 

I invite you to visit my blog, Wondering Man (or take a look at my book, Wondering Man, Money & Go(l)d that rightly predicted the housing-led economic crisis of 2008, rise of gold prices to the currency war being played now). You are also invited to join me on Twitter.

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