Thoughts on China Currency Revaluation and Sustainability of the Current Dollar / RMB Model
The Economist has an interesting article about how China revaluing the Yuan and how this would be much more beneficial for China than for the States. This article was quite well written, and is better than my own two stabs at this subject here (Chinese Currency Undervalued) and here (China – Currency Manipulator). However, my thinking on the subject has changed a good bit since those first articles.
A year ago I would have completely agreed with the following comment from The Economist article, as well as its implications:
Trade with China helps, not harms the average American. Thanks to imports from China, prices are lower and real incomes higher. Commentators often refer to the â€œcheapâ€ yuan as being an unfair subsidy for Chinese exporters. But it is a moot question who exactly is subsidising whom. Not only do cheap imports subsidise American consumers, but China’s large purchases of Treasury bonds also hold down American interest rates, thereby subsidising home buyers. Suppose that overnight the yuan rose by 30%, what would happen? American interest rates would rise as China needed to buy fewer Treasury securities and prices at Wal-Mart would increase. If consumer spending and imports then collapsed, this would certainly reduce America’s trade deficit, but in a much more painful way than most Americans have in mind.
The article is absolutely right in saying that China is subsidizing America — if the Yuan was sharply revalued, prices would go up in tandem in shops like Walmart (Walmart recently had their largest year over year drop in sales in many years, partially thanks to a declining dollar vis a vis the RMB), and interest rates would go way up. How could they not? Demand for treasuries by the Chinese government would drop dramatically.
So a significant revaluation of the Chinese currency would hurt. And likely by quite a lot — with most of the damage hitting already hurting consumers. But it’s going to happen sometime, the only question is when.
In the meantime, American consumers continue to dig themselves further into debt, and America continues to sell more obligations to the Chinese government.
Sustainable no Longer
A year ago this was all very clear, it’s just that back then I still somewhat believed in the sustainability of the dollar / RMB currency arrangement. Now, the floodgates have opened and I realize that troubling times are right ahead for the States (and the world). Whether or not we pressure China to revalue the Yuan, Chinese demand for dollar backed securities (especially mortgage backed securities) is going to plummet sooner rather than later.
And unlike a year ago, I think this is a good thing (but only in the long run). It will cause a lot of pain, but as a nation we need to cut back on consumption and unwise capital allocation (read: housing) now, rather than later. The longer we wait, the worse. A sharp revaluation of the Yuan will force this reduction in consumption, but will unfortunately place a lot of strain upon the finances of the average American wanting to buy anything made in China.
That’s inevitable. What’s not is a shift in American values from entitlement and rampant consumerism to thrift and living within one’s means. Long ago the latter were the path to achieving the American dream (along with hard work, of course). Now it is assumed nearly everyone is entitled to the American dream. Although the buying power of the average American has already fallen and will continue to drop dramatically, the notion that we can afford what we want as opposed to what we need is still strongly ingrained in the American psyche, and will remain so without a shift in values.
What does this have to do with China? Everything. Privately and collectively as a nation we should be diverting money away from consumption and into reinvestment for the future, whether that means investing in alternative energy, other technologies, education, or even infrastructure. That can only happen if the average American, willingly or not, cuts back on consumption of the massive amount of goods flowing from China, and America as a nation stops gradually mortgaging our future away.