Mr. Obama fired the opening salvo last week, urging Chinese Premier Wen Jiabao “to speed up the revaluation of the yuan, telling him in a two-hour meeting at the United Nations that the slow pace of reforms was affecting both global and U.S. economies.”

I’m going to give you a lot of quotes in this article because they are simply too hilarious to pass up. According to CNNMoney, “Lawmakers say China’s currency is unfairly cheap and passed a measure Wednesday that opens the door to tariffs that aim to help U.S. companies compete. The legislation, which authorizes the Commerce Department to impose duties on imports from countries with undervalued currencies, passed the House of Representatives by a vote of 348 to 79. The Senate, however, is not expected to take up the issue until later this year.” The article continues with a jibe at Republicans: “The bill got support from both sides of the aisle, a rarity in recent sessions, with Democrats framing the legislation as a jobs issue,” and follows immediately with a magnificent bit of economic insight from Representative Xavier Becerra, Democrat, of California: “We can talk, or we can act. International trade is a high stakes, cut-throat business, and every time we simply talk, the other side acts, and every time they act, an American loses a job.” Perhaps he should simply stop talking?

Honestly, I had no idea how incredibly funny left wing fiscal policy can be. Consider this gem: “China said this year it would allow its currency, the yuan, to trade in a wider range against the dollar. But the currency has scarcely appreciated since then, inflaming critics who charge the undervalued yuan helps steal U.S. manufacturing jobs.” No explanation is given for how the Peterson Institute of International Economics came up with a figure of a 24% discrepancy in the relationship between the two currencies, but the gang on the Hill believes it. Funny me…I thought foreign exchange rates were set by a bidding process on the FOREX. If all we have to do is declare the value of our currencies, what’s the problem? A simple Congressional resolution would do it. “Resolved: henceforth the US$ shall trade against the yuan at a ratio of 3:1 instead of 4:1, Sincerely yours, Congress. P.S. We really mean it.”

Let’s make it even simpler: how many dollars does it take to buy a barrel of oil? How many yuan are required? That shows us the Arab world’s opinion on the relative values of the currencies, if no one wants to believe world currency exchange rates. Obama’s position is claiming “undervaluation” drives up the price of our goods in China and makes Chinese products cheaper in the USA than they would be if a “fair” exchange rate were used. Okay, back to my complex economic model, compare the price of any Chinese export to America and the same item sold in any two other countries chosen at random. Do the Chinese price items differently according to the market or the currency used? Could the same sum not buy an identical amount of the third parties’ currencies? If so, then, yeah, the Chinese are probably playing dirty pool and our choice is to stop buying from them. If not, then this is just another ploy to raise revenue and stand up nobly declaring Demmies are the “working man’s” friend. CNN proceeds to this gem: “The House vote caps years of frustration for lawmakers as the United States has continued to shed manufacturing jobs, and promises of reform from the Chinese have failed to result in policy changes.” Wait a moment…didn’t we just read that China promised this year to reevaluate? Has anyone other than the current crop of solons carped about this? Seems to us that Reagan, Bush, and Clinton were all in favor of increased trade with China. We’ve been working on this since the time of RMN. Other than one on one I simply do not see how China can change the perceptions of currency traders and foreign nations concerning the value of the yuan.

Here is a real prize from Tim Ryan, D-Ohio, demonstrating a terrific grasp of the politics of envy and pipe dreams: “If this risks upsetting the People’s Republic of China, so be it…Whether you’re a Democrat or a Republican, a liberal or a conservative — millions of good-paying jobs have been lost and hundreds of thousands of families across this country have suffered as a result of China’s unlawful trade policies.” No, Tim, we cannot risk upsetting China lightly, partially because we owe them three-quarters of a trillion dollars. Far more to the point, those millions of good-paying jobs were not stolen by China, they were driven out of America by increasing taxes, regulation, and legislation. The current economic mess stems from those and government interference in banking, devastating “green” demands, and Bernanke’s policies.

The Senate will not consider the issue until later in the year, which isn’t going to keep China from reacting quickly. That great economist, Charles Schumer, D-NY, pontificated, “We must take decisive action against China’s currency manipulation and other economically injurious behavior. (Ed. Note: unspecified) China is merely pretending to take significant steps on its currency,” Schumer said. “This sucker’s game is never going to stop unless we finally call their bluff.” In my experience, that is the sort of rhetoric heard on school grounds and probably between Crips and Bloods with vocabulary adjusted suitably to include “diss” and references to the opponents mothers. It is not the language of diplomacy or economics, but it is pre-election posturing. The proponents are hoping to make some money (the government keeps tariffs), but this is politics, not so pure, but simple. You have been told that you cannot judge a book by its cover, but in very large part you can make a quick decision on the advisability of any given bit of legislation by seeing who supports it. Don’t agree if the answer is “…trade groups and unions cheered the bill’s passage. AFL-CIO President Richard Trumka issued a statement of support and Scott Paul, the director of the Alliance for American Manufacturing echoed the message. “This is one of the most pleasantly lopsided trade votes in recent history,” Paul. “Voters are mad and Congress is finally responding.” I particularly like Mr. Paul’s statement. The Statists have finally figured out what the TEA Party is all about. Voters aren’t mad about runaway spending, higher taxes, higher costs of living, socialized medicine, and increasing regulation, by golly, we’re feeling menaced by the Yellow Peril, and it’s about time Congress did something about it. I feel that way every time I walk into my friendly “Everything $1.09″ store. Dirty bunch of commies, taking advantage of me that way.

I’ll close this preliminary discussion with another quote from the entrepreneur in the White House: “The reason I’m pushing China about their currency is because their currency is undervalued,” Mr Obama orated. “…people generally think they are managing their currency in a way that makes our goods more expensive to sell there and their goods cheaper to sell here.” He added, further, that “the resulting imbalance is a major factor contributing to the U.S. trade deficit.” I stopped at this point to take dear Charles to task, chastising him fiercely for having become a bore who drones on endlessly about how the Chinese are manipulating the currency exchange, threatening working class Americans, and destroying our way of life by offering four dollar bathrobes. Charles just grinned, of course, knowing full well that neither one of us had discussed China other than to speculate on the possibilities of collapsing bubbles and whiffs of rebellion in the air.

I’ve started with the light side because all of this is funny as indicative of what passes for thinking amongst Statists. Want more money? Pass another tax. Election prospects looking grim? Whip up the populace over an outside threat. Next time we’ll get into psychology and the real effects declaiming to the fans will have on the world you and I live in. They aren’t pretty, and it is a lot easier to start a war than it is to stop one. Mr. Obama is in dire need of a swift, victorious war, but this isn’t it.

It doesn’t help that China is overreacting, too, starting with accusing us already of “dumping product” on the Chinese market, in particular auto parts and chicken parts. I was under the impression that our primary poultry export to that portion of the world is the feet of chicken, which are considered a delicacy there and good for nothing other than grinding up for pet food after simmering to get a little coloring for chicken broth in the USA.

When the Chinese fling chicken feet on the table, I think they’re serious.

Regards,
Linda Brady Traynham
Whiskey & Gunpowder

October 6, 2010

P.S.: If you really can’t wait until next time and/or do not know why we do not wish to engage in trade wars, it seems to me that my discussion of the tire fiasco is archived under “Smoot Hawley Must Ride Again.” The reasons haven’t changed.

Asiatic Adventurism, Part I was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Pause That Refreshes

We saw a short reversal in the recovery trade that has benefited the risk currencies, especially Australia, New Zealand and the Eurozone. As of last Tuesday morning when I began this column, the risk push is back on: The euro and Kiwi are pushing new yearly highs with the Aussie hot on their heels. Poor Canada got dumped on due to its poor retail sales but will likely fall back in line.

Let’s look first at the euro. This really looks like a gasping market. It resembles all those that make higher highs on a relentless basis. And when you talk about relentless, the mighty euro sure fits the bill. Until Monday, the euro had not seen two down days in a row for the entire month. That’s remarkable.

But the real question is, does that movement arise from its own strength, or is it something else? I have long been a proponent of an impending euro disaster — and I’ve positioned my paid Master FX Options Trader readers accordingly.

The one thing that would forestall my forecast of disaster would be an intermediate recovery. Please notice two words in that previous sentence — “forestall” and “intermediate.” The euro disaster is not over — it has only been delayed. Like all excesses, it must eventually come to light and be dealt with. A foundation can only be undermined for so long before the structure it supports has to topple.

That’s what has been going on in the United States. And without a doubt, the euro problems are much, much bigger. Moreover, the European Central Bank’s remedies thus far have not been nearly as effective as they have been in the United States. But the second item of note — “intermediate” — is the type of recovery that will allow the Eurozone to gloss over their immediate problems.

Thus it looks like “business as usual” for European banks and businesses. During the boom-boom years, the systemic problems of the Eurozone were easily glossed over. If we can return to that sense of “normalcy” — and believe me, that’s what every central bank is working toward — then the euro and the U.S. dollar will continue to part ways. Mainly because the U.S. problems are all exposed and out there for everyone to see. The Eurozone has managed to weather the storm, keeping its central bank rates higher than the U.S. rates, so it has all the appearances of not needing the drastic measures that America has taken. Ipso facto, it must not be in as bad shape as its North American counterpart.

But the way things seem is not always the way they are. Everybody has to pay the piper, and what you sow is what you reap. There are NO exceptions. So when we sow thievery and oppression, crushing economies to benefit the friends of central bankers, there will be hell to pay. And I’m not just using a figure of speech.

So then, the euro has posted a new high. It doesn’t have the internal strength on its own to continue higher. But as “good” recovery-style news comes out, they keep the Ponzi going.

So what will be the real drive going forward? Let’s take a look.

The Dollar Carries On

First of all, the U.S. dollar is in danger of becoming the currency of choice for the new “carry trade.” We’ve discussed this before, but it’s worth mentioning again — especially for new readers.

Plainly put, the carry trade is when a trader borrows money in a currency with a low interest rate, then uses the proceeds to buy a currency with a higher interest rate. So even though he has to pay interest on the currency he borrowed, he’s making even more in interest with the currency he bought.

Since the interest rate difference is so small, the carry trade is only worthwhile if it involves a tremendous amount of cash. That’s why it’s generally done by the really big, big players. Here’s an example of how it works.

Say an institutional investor borrows a bunch of dollars at a .25% interest rate. Then he uses those dollars to buy, say, Australian dollars, which are paying a 2.75% interest rate. So, he’s losing .25% on the dollars he borrowed, but making 2.75% on the Australian dollars he bought. And he earns that in perpetuity. He doesn’t have to do anything. It just keeps earning money day after day.

For years this has been done with the yen, as it always had the lowest rate of interest. It helped to keep the yen very cheap, which is exactly what the Bank of Japan wanted. It hoped the cheap currency would expand their perpetually receding economy.

Now this same scheme is being done to the dollar. So far, it’s only been in “bite-sized” chunks — but only because no one is very sure if the world economy is out of the woods. Still, unless more bad news comes, this is a profitable trade.

Also, higher interest rates tend to attract more money going forward (as all the scared money comes back into the market) — so the higher-yielding currencies also appreciate against the lower-yielding ones. Therefore, the investor makes a double boon: the interest and the appreciation.

So the big institutions have an interest in depressing the dollar. Any gain in strength or interest rates threatens the easy money of the carry trade.

But, as noted, the institutional players aren’t the only ones who want to keep the dollar down.

Bad Politics = Bad Currency

As I mentioned, the Bank of Japan was all too happy to let the yen carry trade go on, since a weaker currency was seen as a way out of its economic mess. The U.S. government is essentially taking the same route. Without a doubt, it is complicit in driving the dollar lower.

Like in Japan, a cheaper currency helps service ever-increasing debt (I’m certain they have long since abandoned any prayer of paying it off). And the indebtedness is increasing at a faster rate than at any time in history. As long as the major economic power wants to see its currency cheaper, it will do whatever it takes to get that done.

By the time you read this missive, the Fed will be ending their two days of meetings to determine what to do about U.S. interest rates. If you haven’t already heard the answer, what do you think it will be? It is important to formulate an answer to that with all the evidence before you, because it will give you an added insight into how the central bank works. Here’s my answer. They will not be raising rates.

Now that, of course, is no new revelation. But what will they do looking ahead? When will they start earnestly looking at raising rates? The answer to that question lies in our own recovery.

While data appear to show that the economy might be coming out of recession, unemployment is still at multiyear highs and is not decreasing. Housing numbers are improving, but they will NOT be coming back to what they were. All the weight put on housing starts, new purchases, purchases of existing homes, new permits issued, etc., are all a smokescreen. And if not intentionally an “illusion,” it certainly will not make a difference to the economy. Here’s why…

Under the “old economy” (two years ago), a house was a store of value. We all implicitly knew that our savings were not “safe” in a bank, and if they were, they certainly were not growing to keep pace with inflation. So we invested in real estate. I don’t mean that everyone went out and bought rental properties or tried to flip houses. What I really mean is this:

If you ever refinanced your house and took “cash out,” you invested in real estate. If you ever used a home equity loan or a home equity line of credit — you invested in real estate. The unwritten assumption was that your house would continue to increase in value, even as you were using the equity. We became a nation of equity spenders. Treating our homes like ATM machines, we attempted to increase our wealth by means of a bubble market. Even if you didn’t think you understood the nature of a bubble market, implicitly, or even instinctively, you did.

Spending a house’s future earnings meant that we believed our money would be worth less in the future than it is now. We believed its value was decreasing. (Incidentally, we were right.) But we were on the “safe side of the bet.” Because we would spend valuable dollars now, but repay our bill with less valuable dollars later. This is why a 30-year mortgage in a centrally managed and inflationary economy is such a good deal. You lock in today’s price, but pay it off with increasingly inflated money. It is that very inflation that makes your house go up in “value.” Any reasonable consideration would conclude that a house is not as “valuable” after 30 years of living in it. It must depreciate, because it “wears out.” Anybody who has ever owned a home knows this to be true. Defer just a few years of maintenance, and it will soon overwhelm you. Before long, you begin to wonder if you own the house, or if the house owns you.

But in the end, when houses were all in debt up to their value, and many far more than their value, we stopped investing in real estate. Mainly because we couldn’t afford it any more. Either our payments were already too high, or our equity was too low. At any rate, when people stopped “investing,” the residential market began crashing. It will not return to what it was, and vainly hoping for more increases in housing numbers to do that will only bring to pass the old proverb, “He that sows to the wind will reap the whirlwind.” In other words, vain hope isn’t gonna save the farm.

Getting back to the moral of our story, the government, which will not control or reduce its spending, can only raise taxes, cut services or inflate the currency in order to get us out of this mess.

Of course, raising taxes or cutting services are the easiest ways for a politician to lose his or her job. So the third option is always exercised. If done properly (according to prevailing monetary theory), it will be painless, and the effects of inflation will be partially offset by the ever-popular cost of living increase. That way everyone shares in the illusion that they are “keeping up with” inflation. But that’s all it is… an illusion.

So we’re up to two entities with a vested interest in keeping the dollar down — the institutional investors who want the carry trade to continue, and the U.S. government, which needs a weak dollar to plaster over its massive debt.

And the dollar has yet another enemy…

Neither a Borrower Nor a Lender Be

It’s easy to overlook, but when you buy bonds, you’re buying debt. You are loaning the issuer your money and getting their interest rate as your profit. Corporate bonds represent the debt of individual companies. When you buy Treasury bills and the like, you’re buying the debt of the U.S. government.

No nation in the world sells more debt every single month than the United States. Because of our existing budget (that’s using the term very loosely), we are forced to borrow money every 30 days. To pay Social Security, welfare, medical payments, elected officials and bureaucrats, the military, foreign aid, student loans — anything and everything that gets money with a federal stamp on the check.

And we have to borrow it. Somebody has to give us their money with the expectation that they are going to get it back, plus interest (uninflated).

Now, imagine your neighbor asked you to loan him some money, promising to pay it back with interest. A week later, all that money has been spent… so your neighbor asks for another loan. And another. Then another. How much longer would you keep lending him money? Even if he continues to pay the interest he owes you, you still have to wonder how long before he needs to borrow money just to pay the interest he owes you for borrowing the money.

That’s why everyone I know is casting a wary eye on America’s “neighbors” — the countries holding much of the U.S. debt. With our massive spending plans and dim economic outlook, other nations must be worried about our ability to repay our debt. What will we do when the Chinese stop buying? What will happen when the European Central Bank stops buying? What will we do when Japan stops buying? Will the government stop spending even then?

One way or another, the you-know-what is going to hit the fan. Oddly enough, however, foreign investment is higher this year (43.1%) versus last year (only 27.1%). That’s a year-over-year increase of 60%!

So instead of being worried, the U.S. government feels invincible. Foreign countries will always be happy to buy our debt, it thinks, so there’s no reason to adjust our destructive spending plans. It’s like giving more liquor to an alcoholic to sooth his tremors — a short-term fix that doesn’t do anything to solve the problem. Make him feel good enough, and soon he won’t feel anything ever again.

If I were you, I’d position my short-term and long-term currency savings accordingly.

Regards,
Bill Jenkins

September 30, 2009

The Euro, the Dollar and the Future of the Forex was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.