CURRENCY WARS

Many Americans think that China is stealing their jobs. So the U.S. Senate has voted through a bill, which would penalise Chinese imports, if the Chinese authorities do not increase the value of the yuan against the dollar. Although the House of Representatives is unlikely to pass it, and President Obama would probably veto it if they did, this is a terrible piece of legislation. For three reasons.

First, trying to manipulate currencies (whether by China or anybody else) has a long history of failure. Generally it doesn't work.

Secondly, the reason why China has a massive trade surplus with the U.S. is that U.S. consumers love all those things that China is producing. Or to put it another way, they don't like all those things that America is producing.

Raising the value of the yuan against the dollar might work, at least for a while, and might wean U.S. consumers off Chinese goods. However, that uncertainty has to weighed against the absolute certainty of point number three. The flipside of the Chinese trade surplus is that the Chinese have invested most of those dollars in dollar assets, notably U.S. Treasury Bills. To put it simply, China has financed the huge budget deficits that the U.S. Government has been running for the past few years. If the value of the yuan rose against the dollar, then all of those billions of Treasury Bills would immediately fall in yuan terms, and the Chinese would suffer a loss. Why would the Chinese go along with that? Apart from the immediate hit, it would also make it much less likely that the Chinese would buy Treasury Bills in the future. Which in turn would give the U.S. Government a financing problem.

U.S. politicians have been hopeless at economic policy during this financial crisis. The Senate vote is but another example of that.

Walter Blotscher