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China About To End Dollar-Peg
The general attitude I have encountered (which is obviously fuelled by how the mainstream media chooses to report this issue) is that China's government is likely to retain the dollar-peg either because a) that has been its policy throughout the last decade; or b) that China is somehow "trapped" into maintaining the "peg". I firmly believe the exact opposite: that China's government is very close to abandoning the dollar-peg, and (in fact) has made a multitude of preparations to do so. Obviously, the first and more simpler basis for believing the dollar-peg will continue is easiest to address, so I will begin with that. While it can always be seen as simplistic to conclude that some trend will continue, simply due to some form of "inertia" (or just habit), we live in a universe where inertia is one of the most dominant forces. Thus, the "inertia" argument must always be considered carefully. I would argue that the appropriate way to conduct such an analysis is to look at what caused a particular event/trend (in the first place), and whether those causative factors still exist. Once any particular trend (especially an economic trend) is no longer being driven by anything other than "past practice", than the probability that such a trend is about to end rises considerably. Looking back to when China first chose to link its currency to the U.S. dollar in this manner, in April of 1994, there are several obvious factors to list. First of all, China had a much less-mature economy. It was a smaller economy, in absolute terms. It was much earlier in the major transition from a primarily agricultural, peasant population to a much more urbanized, 21st century society. Because of this, it lacked the population centers and distribution networks which must be present before a stronger, more consumer-oriented domestic economy can take hold. In turn, lacking a large domestic economy, its rapid industrial expansion was inevitably dependent on continued strength with its exports. What China already did have was a population with rapidly rising incomes, large pools of savings, and a manufacturing base that has clearly established it as the new, global leader in many categories of production. In other words, China possesses many of the same characteristics today as were seen in the U.S. economy - just before it became a global, consumption-juggernaut. While dogmatic ideologues may choke on the notion that China is "following in America's footsteps", China has long since stopped being a "communist" nation in any remotely literal sense. Unfortunately, many of the people who insist on using labels, use the wrong ones, time and time again. "Communism" and the sort of breath-taking industrial expansion currently taking place in China are simply not compatible. While "communism" may not prevent the leading Communists from setting aside a larger piece of the pie for themselves, it has always prevented the amassing of large personal fortunes through open commerce - which is officially anathema in any true, communist society. Obviously, the China of the late-20th and 21st centuries has engaged in a complete ideological reversal, and officially endorsed the concept of individuals seeking to prosper through their own efforts - something which we "capitalists" have always considered a trait which separated us from all "communists". It is important to be clear about this point, since one must assume that the endless rants of the China-bashers are fueled (for the most part) by their failure to understand the changes which have taken place in both its economy - and its society. Clearly, many of the factors which existed at the beginning of China's dollar-peg have changed considerably. China is now the world's second-largest economy - having leapfrogged nations such as Japan, and the world's other exporting-powerhouse: Germany. With this economic growth being largely based upon manufacturing, this means that there has been a great deal of additional wealth created in China's economy, further boosting both incomes and savings (i.e. cash-flow, and investment capital). While many myopic observers of China continue to conclude that China lacks enough domestic demand to reduce its reliance upon exports, not only is it the second-largest economy, but its domestic economy has been exploding. An analysis of China's economy published by the Harvard Business School in October of 2008 is highly illuminating. In 2007, the last year in which China's economy was supposedly being driven by exports, China's 11% growth was achieved through contributions of 5% growth from domestic consumption, 4% growth from investment, and a puny 2% growth from exports. That's right, in the year before China began to seriously move away from "export dependence", those exports accounted for less than 20% of China's growth. Furthermore, even when Chinese exports were at their peak, the "dependence" on mature (and sagging) Western economies was never what is pretended by the China-bashers. Together, exports to the U.S. and Europe accounted for less than half of China's total exports. Yes, those levels are falling further - and that is great news for China's economy. Less and less of China's goods are being paid for with Western IOU's (of highly dubious worth), while a greater and greater percentage of Chinese exports are being paid for with cash: the trade surpluses of other developing economies. Only the warped minds of the China-bashers could construe this shift to paying customers as being "bad" for China's economy. I could go on and on about China's domestic economic strength, but there is much more material to cover. Those interested in more reading on this area could refer to a couple of previous commentaries ("China's Problem: Too Much Money", "Soaring retail sales in China demonstrate economic shift"). Just as China's government has rapidly (and admirably) prepared China's domestic economy to replace some of the demand for its exports through increased domestic consumption, so too has China been rapidly preparing the renminbi to take over as "reserve currency" from the U.S. dollar. This has taken the form of reducing the use of U.S. dollars in global trade, combined with shoring-up the "reserves" with which it backs its own currency. The move to reduce the use of U.S. dollars in trade has been a two-part process. While China has engaged in a long series of bilateral trade agreements to boost its share of global trade, it has simultaneously inked numerous "currency swaps", supplying its trade partners with renminbi to use in their future trading - and permanently excluding the U.S. dollar from those bilateral relationships. Indeed, inept Western analysts point to the large hoard of U.S. dollars still in China's possession, and conclude (erroneously) that the Chinese government is still increasing its holdings of U.S. IOU's through "buying" its debt. In fact, such accumulation has almost stopped. China is willing to take whatever "hit" that it must on the U.S. dollars which it is holding (through currency swaps), because it is effectively "sterilizing" global trade from the cancerous effect of the biggest flood of greenbacks in history (and the horrific inflation they would cause). Instead of these depreciating dollars being used again and again, in that back-and-forth flow of trade, those dollars have been removed from global markets - and replaced with renminbi. The second aspect of China's monetary campaign is to improve the "backing" of the renminbi through a "hard asset": gold - instead of the worthless paper of Western bankers. Indeed, this is clearly the favorite means of China's government to rid itself of dollars - by swapping them for gold. Now, every time the anti-gold cabal drives down the price of gold a few percent, the Chinese government steps in, buys the cheap gold, and rids itself of unwanted dollars. The only problem with this program (from the perspective of China's government) is that it is holding at least one hundred excess U.S. dollars for every dollar of bullion which the cabal still has left to dump onto the market. More generally, with other central banks taking the "cue" from China (and India) to accumulate gold reserves, China must now compete for limited gold stockpiles with several other central banks (and, soon, dozens of them). Having detailed China's thorough preparations to abandon the dollar-peg, it's time to illustrate why it will be forced to act on those plans - most likely this year. For those who have actually been paying attention to the financial picture of the U.S. (as opposed to simply listening to the propaganda), 2010 can be seen as the year where the U.S. government is forced into an open choice. With large numbers of jobs being lost, and large numbers of defaults/bankruptcies/foreclosures being piled atop the world's largest mountain of debt; with government revenues plummeting downward at the fastest rate in history and with 40 states already experiencing serious solvency problems; and with consumer credit (the fuel for this consumer economy) plummeting downward at the fastest rate in history, this is an economy which is still rapidly moving toward a Soviet Union-like debt-implosion. Meanwhile, with U.S. deficits already larger than those of the rest of the world combined (see "Treasury Department Stalls Budget Report"), and with the U.S. government having already exhausted its borrowing capacity, now the U.S. government must choose. Will it allow this house-of-cards of debt to implode, or will it nakedly print trillions of new dollars - to pretend to "pay its bills"? No one has a better feel for the "pulse" of the U.S. economy than John Williams, the eminent economist, and founder of Shadowstats.com. For several years, Williams has been predicting a "hyperinflationary depression" in the U.S., at some point in the future. Like many (including myself), Williams believes the "depression" has already begun. However, he has recently revised his forecast of U.S. hyperinflation: suggesting that it could now arrive as early as 2010. Clearly, with 20% of the world's population, and average incomes which are still modest, by Western standards, China cannot and will not tolerate "importing" U.S. inflation/hyperinflation through maintaining the "peg". Clueless critics continue to insist that this will be a traumatic event to China's economy, ignoring the fact that China has already taken all the measures necessary to immunize itself from the U.S. "cancer". Inflation inside the U.S., and inflation in commodity prices expressed in U.S. dollars means little when China has neither trade-dependence nor currency-dependence on the U.S. With the renminbi taking over as "reserve currency" and with it rising in value against other currencies, suddenly the renminbi becomes the vehicle for all economies to rid themselves of U.S.-imported inflation (through the use of the U.S. dollar). While many can/could validly argue that the world is not prepared for such an important transition, the win/win benefits of dumping the use of dollars and embracing the renminbi is so large that this will quickly turn into a powerful (and self-fuelling) dynamic. Remember that every dollar replaced with renminbi in trade is one more excess dollar permanently dumped upon this already-oversaturated market for dollars. Those nations/economies who delay abandoning the dollar will be punished by crippling inflation (and the political consequences of crippling inflation) - and through the value of those dollars they are holding rapidly moving toward zero due to non-existent demand. It is entirely moot (at this point) to debate whether China "should" dump the dollar-peg. The facts are obvious: China must dump the peg, and both China and the rest of the world will benefit enormously from it doing so. Jeff Nielson |
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Having received several comments and questions from readers about the future of China's monetary policy, which "pegs" the price of the renminbi to the U.S. dollar, that usually serves as a good indicator that this is a topic worthy of a more detailed discussion.