Tuesday, November 17, 2009

Economic illiteracy 101

Usually, I don’t act disrespectful (unless your name starts with K and ends with rugman) against people who clearly have much more education in economics than I do. Well, maybe I do, but usually I add a disclaimer that my conclusions aren’t based on an official economic education, rather something I usually refer to as “logic”, which is in effect in what people generally call “reality”. With that being said, I have to jump on this article. It is clearly written by someone who wishes to make a point, and tailors his argument to fit that point (and to make things worse – tries to make Ludvig von Mises complicit in this fraud) :

“President Obama’s arrival in China has predictably generated all manner of commentary about the economic relationship between it and the United States. Not surprisingly, the majority of the commentary has been economically untrue, misguided, or both. First up is the notion that China artificially keeps the value of the yuan lower than it would naturally be. What this commentary misses is that currencies aren’t commodities, rather they are concepts. Nothing else.”

The nonsense begins. If the central bank of china didn’t stock-pile dollars, what would it be worth? If this doesn’t affect the value of the US dollar, why don’t we do an experiment and dump $2 trillion on the forex markets. According to the author of this article, it wouldn’t change the value of the US dollar? The reason that the actions of the chinese central bank matters is that :

1 ) China’s exporters accept payment in dollars, not in yuan, thus the central bank of china affect the value of the yuan towards the USD when it trades in these dollars for yuan.

2 ) The result is pretty obvious – an enormous trade deficits. If the central bank of china didn’t accept an infinite amount of dollars from chinese exporters, these would end up on the forex market. This would mean an amount equal to the US-China trade deficit per month. Try dumping that amount on the forex market EACH MONTH and see if you find any buyers under a fixed-rate-exchange policy. There would be a desperate shortage of yuan, and an overflow of dollars.

“In that sense, China is one of many countries that pegs its currency to the dollar in order achieve for it a measure of credibility due to the dollar being the world’s currency. Much as trade among the fifty states in the U.S. is made more frequent thanks to there being a common currency, the yuan’s stable relationship with the dollar is what has fostered a great deal of trade between individuals in the U.S. and China. Trade is the reason we produce, and currency stability facilitates trade.”

A rather erronous comparison, because China does not use dollars as their own currency. Nor is the US dollar exchangable for any real asset (gold, for instance) that can be used to gauge what the yuan should really be worth. Currency stability is a good thing, but printing immense amounts of paper currency and relying on a foreign central bank to sop it up to create “currency stability” is not the way to go. The reason that the US dollar is falling against ALL CURRENCIES EXCEPT THE YUAN is that other central banks do not wish to become paper dollar storage facilities. People who receive dollars in trade want their own currencies back, so they trade dollars for domestic currency. Regardless of if this goes through a central bank or other clearing institute, unless the dollars are stockpiled they end up on the forex market.

Many commentators seek an absence of policy whereby the yuan and dollar would float against each other as “fundamentals” warrent, but as Von Mises so clearly saw, floating currencies “complicate the technique of exchange” given the basic truth that uncertain currency values make it more difficult for producers to confidently use money in order to transact. Money is merely a medium of exchange, and the less uncertainty we have, the better off all parties to trade are.

Mises was correct – it is preferable if currencies keep their value. But if the yuan was truly fixed to the dollar, without any stockpiling by the Chinese central bank, then there would be a shortage of yuan and a surplus of dollars. Chinese exporters would not be able to exchange their dollars for yuan – and would thus stop accepting dollars, and demand payment in yuan. US importers would not be able to retrieve any yuan for the same reason. During a fixed-exchange-rate regime, two outcomes are possible :

  • If currencies are pegged to gold, there is an outflow of gold from the country with the trade deficit to the country with the trade surplus if the central bank accomodates this.
  • If currencies are not pegged to gold, or the central bank of the trade surplus nation refuses to accomodate the trade surplus by printing paper currency and stockpiling the trading partners currency (like China is currently doing) there will be a shortage of the currency of the trade surplus nation, and a surplus of the currency of the trade deficit country. This can only be resolved by revaluating the currencies against eachother, thus it becomes a floating-exchange-rate regime

Looking at the yuan, it’s “settled logic” among the commentariat that currencies must reflect an economy’s fundamentals, but not only is this untrue, it perverts the reason for currencies altogether. Indeed, when individuals trade, they’re not trading money, instead they’re using money in order to measure the value of goods so that goods can be exchanged. That is why currencies are meant to be stable value concepts, rather than floating paper values lacking any definition.

More nonsense. In a fixed-rat-currencty environment, there would not be enough US goods for the Chinese to purchase, as compared to the Chinese goods for the US to purchase. This would lead to the Chinese not wanting dollars. For currencies to be stable-value concepts, there has to be equal production of goods and services in both nations, as well as equal amounts of currency printing.

As to the absurd suggestion that currencies are supposed to reflect economic fundamentals, this might surprise those who watched Japan’s yen triple in value versus gold during its near two decade recession. This might also surprise Americans who witnessed a much more vibrant U.S. economy vis-à-vis England’s in the aftermath of World War II; all this occurring despite the pound being stronger than the dollar. It would be more realistic to say that excessive currency strength or weakness is an economic retardant, as opposed to the result of economic strength or weakness.

The yuan tripling in value against gold is not hard to explain. Japan is a massive trade surplus country, so it is natural that their currency appreciate against other currencies. The gold price was sinking due to either lack of demand or manipulation until 2001, which further pushes the yen/gold ratio down. The reason that the US was better off after WWII than the UK has little to do with the relative value of the currencies – it has to do with a better business climate. Artificial currency rates are an economic retardant. Why is it that the US has a crippled manufacturing sector and no reserves, while China has an enormous manufacturing sector and enormous (worthless) dollar reserves? Why is it that americans consume vastly more in relation to their production than Chinese do? Artificial currency rates, as maintained by the Chinese central bank.

“Currencies once again aren’t supposed to move in value, because when they do the changes in value distort the money prices of all investments and transactions. The whole point of the Bretton Woods gold standard wasn’t for currencies to float, but for them to be tied to the dollar so that peaceful trade could reliably occur among individuals around the world. Stable currencies not only enhance wealth-enhancing trade, but they free up those engaged in mere economic facilitation (think currency traders, hedge funds) to actually produce economic goods thanks to floating money values no longer being an economic variable.”

As preferable as it would be to have currencies maintain their relative value, this requires either a gold standard, or strict, co-ordinated, disciplined central banks all over the world. Needless to say, no central bank has ever been able to withstand the pressure to print for the sake of the short-term gain. In addition to this, it would necessitate equally valued production by all nations, which is a laughable idea in the world of today. But it is indeed correct that the resources used in economic facilitation could be vastly cut down if central banks tied down the value of their currencies. It cannot, however, be done in the way China does it, something the US will soon experience.

“Lastly, implicit in the jawboning of China for its yuan policy is the assumption that somehow its citizens don’t suffer from the same currency weakness that now weighs down the U.S. economy. More realistically, inflation is death by a thousand cuts anywhere it exists, which means the unseen is how much China’s economy would be growing if U.S. monetary policy weren’t transferring an to inflation it. China is not aided by our inflationary policies as evidenced by its need to import all sorts of goods to create finished products, so it’s naïve for anyone to assume that China is enjoying the decline of its currency thanks to our irresponsible Treasury.”

The only correct point in the entire article. China is NOT enjoying their currency falling together with the US dollar. They are being empoverished by it. The reason they put themselves through this is the governments wish for political stability, which is hard to maintain during large economic shifts. Changing from an export economy to a stable economy that consumes equal to its production is such a change, because millions of exporters need to go out of business and become producers for the domestic market. This is undesirable from a Chinese government point of view, so instead they stockpile worthless dollars and eat american inflation.

Next up is the myth offered up by the Daily Telegraph’s Ambrose Evans-Pritchard (among others) which suggests that with its artificially cheap currency, China is exporting deflation. Comments like this merely prove that many who write on economics don’t have a clue what deflation is.

This is wrong beyond the line of ridiculous. If one country actively stockpiles another country’s currency, then this reduces the supply of this currency. Deflation is a reduction in the money supply of a currency. Even in the case where China uses the dollars to purchase US government bonds, this still causes an excess demand for US dollars, and removes a certain amount of dollars from circulation because there are always a number of dollars in the process of being cleared by the Chinese central bank and being exchanged for US Treasuries. It isn’t Chinese exporters that accept US Treasuries in payment, it is the Chinese central banks that buys treasuries after its exchanged USD for yuan. Thus, there is always a certain amount of USD existing somewhere between when the chinese exporter receives payment and the chinese central bank transferring these dollars to someone else in exchange for Treasuries.

It’s worth noting, however, that while stockpiling US dollars is deflationary for all other holders of USD, Treasuries actually counteract this effect somewhat by enabling the US government to spend more money – and we all know that excess government spending is highly inflationary.

“Secondly, the import of cheap Chinese goods is in no way deflationary. That is so because if cheap Chinese shoes allow individuals to spend $50 on loafers when they used to spend $100, that merely gives them $50 of new demand for a wider range of goods, thus driving up the costs of other goods previously demanded less. The broad price level by definition cannot be changed by imports; instead it can only move up or down based on changes in the value of money. In that case, all signs point to inflation worldwide, the U.S. Treasury the main miscreant in this regard.”

This is so utterly moronic that it makes you want to cry. If something is cheaper, it doesn’t drive down the general price of goods, because the money saved from purchasing a cheap good (over an expensive good) will be used purchasing something else, thus driving the price of that good up. Yes, but not by an equal offsetting amount. Unless you didn’t think of it, you now get two goods at the price of one. This is only possible if the price of these two goods taken together falls. And when Friedman said that “inflation/deflation is always and everywhere a monetary phenomenon”, he didn’t mean that a collapse in production cannot cause higher prices. And there will be inflation worldwide, until foreign central banks stop printing to accomodate their own short-term economic goals. The US will have even worse inflation, because the US government will crowd out the US consumer.

“The third impoverishing myth possessing many adherents is the one that says China is pursuing an “export strategy.” If we ignore the certain truth that countries don’t trade, to suggest a country is pursuing an export strategy is as idiotic as the suggestion that a country could pursue an “import strategy.”  Good luck importing unless you’re exporting. “

Re-read what I wrote about stockpiling dollars to maintain an oversized export sector. If you are willing to eat someone elses price inflation then you can export more than you import. If someone else is willing to eat yours, you can print enough money to import more than you export. Like the US is doing.

“What’s forgotten is that exports and imports are but two sides of the same coin, and unless the supposed “experts” in our midst believe that Chinese producers are exporting in order to remain impoverished, there’s no such thing as an export strategy. In truth, the dollars taken in by Chinese producers are either used to buy U.S. products, equities, land and debt, or they’re traded to others with designs on what we have in the United States. Individuals export so that they can import, which means that to the extent U.S. citizens are complimented by a great deal of imports, that means they’re also exporting something of value in order to have the means to buy imports.

Von Mises once observed that “Economic history is the story of the gradual extension of the economic community beyond its original limits of the single household to embrace the nation and then the world.” That’s exactly what’s happening right now, and stable currency relationships are bringing the producers of the world closer and closer on a daily basis.

So rather than nonsensical commentary that perverts the purpose of currencies, we should embrace any measures taken that enable more, not less in the way of cross-border trade. In that sense, we should hope that more countries follow China’s responsible lead in pegging the yuan to the dollar, all the while hoping that monetary authorities in the U.S. wake up to the economy retarding inflation they’re foisting on the world, which threatens the wonderful process whereby individuals the world over are becoming more, rather than less economically interconnected.”

The US citizen is unfortunately under-exporting : Has the author never heard the term trade deficit. What is being exported is paper dollars and US debt, which are used for stockpiling. As long as this is OK with everyone involved, then there isn’t a problem. Unfortunately, it has lead to an economic imbalance that isn’t sustainable, because debt has to be serviced, and once again the US dollar will collapse if these exported and subsequently stockpiled dollars are put to use.

Please, dear economic commentators, do not write things that can be debunked by an amateurish blogger like me. It really is frustrating to have to tell professional economists and writers that they are utterly wrong all the time…..

Original article here (RealClearMarkets)

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