China's Simple Solution
May 16, 2008
As China grapples with the
consequences of its devastating earthquake, it has also begun
to finally confront the destabilizing forces bubbling up beneath
its economic landscape. This week, several key Chinese
officials, typically not known for their candor, conspicuously
noted the need to both stimulate domestic consumer spending and
bring down roaring inflation. While at first blush these
two goals might appear mutually exclusive, China's leaders do
have a magic bullet that can hit both targets at once.
A stronger currency, commensurate with China's increased economic
strength, will both tamp down inflation and allow Chinese consumers
to buy more goods and services. However, for reasons not
entirely clear to me, or few others for that matter, China's
leaders are resisting this simple and beneficial solution.
The Chinese leadership's stated goal in prodding their citizens
to spend more is to decrease their economy's dependence on exports.
If the Chinese, who currently save 50% of their incomes, saved
less, more of their production would be consumed locally.
As a result, China would be less vulnerable to economic downturns
abroad. Without a vibrant domestic market, over-leveraged
Americans will apparently remain China's most important customers.
A strengthened Yuan would lower the real costs of goods for domestic
consumers and allow the Chinese themselves to compete more evenly
with consumers in other nations to whom they currently send the
fruits of their labor. As goods become more affordable
in China, the Chinese will naturally consume more. A rising
Yuan would therefore kill two birds with one stone: it would
reverse recent consumer price increases and it would induce Chinese
consumers to buy their own products.
If the Chinese were to follow such a sensible path, the consequences
here in America would be immediate and severe. By allowing
their currency to appreciate, Chinese monetary authorities would
no longer need to buy and remove as many dollars from the open
market, producing an immediate reduction in the demand for U.S.
Treasuries, mortgage backed securities and other U.S. dollar
denominated debt. The result in America would be a simultaneous
increase in both consumer prices and interest rates. Such
developments would only compound the problems already rippling
through our economy.
To spur domestic spending absent such currency rebalancing, Beijing
must instead rely on the nominative, simulative effects of inflation.
By further expanding their money supply and allowing those increases
to be passed on to workers in the form of higher wages, Chinese
consumers will have more Yuan to spend and hence will buy more.
However, such a policy will only solve one problem by aggravating
Further, by penalizing savers through the erosive effects of
inflation, China would discourage savings and jeopardize one
of the true sources of its rising living standards. Contrary
to the economic hocus pocus propagated on Wall Street, Washington
and at American universities; economies grow not as a result
of consumer spending, but as a result of savings. Under
consumption is the true source of prosperity as it engenders
capital formation, which lies at the root of sustainable economic
Here too the implications for Americans are dire. In effect,
by only spending half of their incomes and lending much of the
rest to us, Americans have merely been enjoying the current consumption
that more frugal Chinese consumers have decided to defer.
As the Chinese consume more, Americans will simply be forced
to consume less.
Low prices and rich consumers are a potent concoction that is
sure to soothe China's roaring economy while raising the living
standards of its hard working citizens. It's a simple solution
that only an economist can miss.
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C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
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Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
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