The Truth Behind China's Currency Peg
Peter Schiff
Nov 21, 2009
"In short, the longer
they wait, the steeper our fall."
During President Obama's high
profile visit to China this week, the most frequently discussed,
yet least understood, topic was how currency valuations
are affecting the economic relationship between the United
States and China. The focal problem is the Chinese government's
policy of fixing the value of the renminbi against the U.S.
dollar. While many correctly perceive that this 'peg' has contributed
greatly to the current global imbalances, few fully
comprehend the ramifications should that peg be discarded.
The common understanding is
both incomplete and naive. Most analysts simply see the
peg as China's principal weapon in an economic struggle
for global ascendancy. The peg, they argue, offers China a competitive
advantage by making its products cheaper in U.S. markets,
thus allowing Chinese firms to gobble up market share and steal
jobs from U.S. manufacturers. The thought is that were China
to allow its currency to rise, American manufactures would regain
their lost edge, and both manufacturing firms and the jobs formerly
associated with them would return. In this narrative, the
struggle centers on the United States' diminishing leverage in
persuading the Chinese to lay down their unfair weaponry.
It's a sympathetic picture, but it tells the wrong story.
While the peg certainly is
responsible for much of the world's problems, its abandonment
would cause severe hardship in the United States. In
fact, for the U.S., de-pegging would cause the economic
equivalent of cardiac arrest. Our economy is currently
on life support provided by an endless flow of debt financing
from China. These purchases are the means by which China maintains
the relative value of its currency against the dollar. As the
dollar comes under even more downward pressure, China's purchases
must increase to keep the renminbi from rising. By maintaining
the peg, China enables our politicians and citizens
to continue spending more than they have and avoiding the hard
choices necessary to restore our long-term economic
health.
Contrary to the conventional
wisdom, when China drops the peg, the immediate benefits
will flow to the Chinese, not to Americans. Yes, prices
for Chinese goods will rise in the United States - but so will
prices for domestic goods. As a corollary, the Chinese will see
falling prices across the board. As anyone who has ever been
shopping can explain, low prices are a good thing.
In addition, credit will expand
in China while it contracts here. When China abandons the
peg, it will no longer need to swell its currency reserves
by buying Treasuries or other dollar-denominated debt instruments. Other
nations will no longer feel the pressure to keep their currencies
from rising, so they too could throttle down on their onerous
dollar purchases.
As demand falls for both dollars
and Treasuries, prices and interest rates in the United States will
rise. Rising rates will restrict the flow of credit that
is currently financing government and consumer spending. This
change will finally force a long overdue decline in borrowing. So,
not only will Americans lose access to the consumer credit that
funds their current spending, but the things they buy will also
get more expensive.
Our short-term loss will be
in sharp contrast to the gain felt by foreigners, who will be
rewarded with falling consumer prices and a more abundant supply
of investment capital. In other words, the American standard
of living will fall while that of our trading partners will rise.
However, this does not mean
that I want the Chinese to maintain the status quo. In the long
run, the U.S. economy will benefit from the abandonment
of a system that guarantees our dependency and inevitable downfall. De-pegging
will force the hand of U.S. politicians toward pursuing
realistic policies. The Chinese will come to their senses
eventually because it is in their interest to do so. Meanwhile,
the longer the peg is maintained, the more indebted we become,
the more out of balance our economy grows, and the more our industrial
base shrivels. In short, the longer they wait, the steeper
our fall.
A weaker dollar will price
many imported products beyond the reach of most Americans,
giving our hollowed out manufacturing sector the opportunity
to rebound. However, if our industry has any chance of getting
off the mat, we must reduce taxes, repeal regulations, reform
our cumbersome legal system, and, most importantly, replenish
our savings to finance the necessary capital investment.
If we position ourselves to
deal with the consequences, tough love from China will provide
a path back to genuine economic growth. However, if our
politicians continue to misread the problem and push us deeper
in the red, the inevitable 'rebalancing' could be truly ruinous.
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Nov 20, 2009
Peter Schiff
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
1 800-727-7922
email: pschiff@europac.net
website: www.europac.net
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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
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
County Register.
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
newsletters and advisory services.
321gold Ltd

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