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China’s Currency War, the Enemy #1 for Global Economy

Currencies / Fiat Currency Oct 09, 2010 - 11:16 AM GMT

By: Bryan_Rich

Currencies

Best Financial Markets Analysis ArticleWhen Brazil’s finance minister said the world was in a currency war, it came as big news to many people — a surprising “new” economic threat. But there’s nothing new about a currency war. China has been waging a war — an economic war — with its currency for a long time.

Over the last 14 years, China’s economy has grown four times as fast as the U.S. economy, and it has quickly soared to become the world’s second-largest. The key to China’s success has been a weak yuan — it’s method of manipulating a sustained advantage over its competitors in global trade.


This strategy of manufacturing an artificially weak currency to corner the world’s export market has led to a massive imbalance in global trade. It was a key contributor to the current economic crisis, and it’s proving to be a key barrier to a sustainable global economic recovery.

Put simply, these global trade imbalances have proven a recipe for more frequent boom and bust cycles.

That’s why the G-20, the IMF, the OECD — all of the major institutions and central banks of the world have been harping on the importance of repairing global imbalances. And all along they’ve been speaking directly to China.

Yet after all of the negotiations, threats from U.S. Congress and concessions China is said to have made, it has managed to gain an even bigger trade advantage through the three years of global economic crisis!

Consequently, we’re seeing the rise in currency market interventions from some of China’s key trade competitors as a way to combat their damaging currency disadvantage.

This is a clear sign the team effort pledged by G-20 members to combat the economic crisis is falling apart …

Last March, when the G20 assembled during the depths of the worst economic crisis, they broke camp with a vow to fight the battle together — to act in coordination.

Central bankers slashed interest rates. Governments rolled out fiscal stimulus packages, and the world economy started producing what many thought was an impressive recovery.

But it turned out to be nothing more than a stimulus-induced flop.

Now leaders around the world are seeing the writing on the wall — a long period of deleveraging, littered with more economic pain and shocks. And the vow of coordination is giving way to every man for himself.

Growing Divisions

On September 15, the BOJ took a desperate move.
On September 15, the BOJ took a desperate move.

Japan stepped in last month to weaken the yen with its biggest daily intervention on record, buying more than $23 billion in the open market. Historically intervention in a major currency is a coordinated event, supported by other major central banks. But this time Japan went in alone.

South Korea, Thailand and Singapore have been consistently intervening to stem the tide of strength in their currencies in recent months.

And Brazil has been doing the same, plus tacking on additional taxes on foreign capital to deter the influx of hot money flooding through its borders — i.e. currency controls.

Take a look at the chart below and you’ll understand why …

chart1 Chinas Currency War: Enemy #1 for Global Economy

You can see the strong rise in Asian currencies over the past year — with one exception, the Chinese yuan. China’s manipulation of the yuan has consistently allowed it to corner the lion’s share of global exports.

But now its trade competitors are fighting back through currency manipulation of their own. Consider these growing responses to the weak yuan the early warning signs of a spreading …

Threat of Protectionism

I’ve said in past Money and Markets columns that ultimately, the rest of the world will have to choose action over diplomacy in dealing with China. And now we’re starting to see it.

The next steps will likely be imposing sanctions on China and trade restrictions on Chinese goods — an effort that is already progressing through Congress.

But the problem with protectionist activity is that it tends to bring about retaliation, and it becomes contagious. That’s exactly what happened in the Great Depression. And it’s what brought global trade to a standstill.

Today, with unemployment sustaining high levels, the political support to act is there. Many would think that “standing up to China, is standing up for us.”

With about 15 million Americans out of work, the demand for protectionism is soaring.
With about 15 million Americans out of work, the demand for protectionism is soaring.

Of course, when jobs are tight the perception by most workers towards globalization becomes more negative. And studies show that during these times, the number of people who favor the idea of higher tariffs on imported goods rises considerably.

As it becomes increasingly evident that China will not play ball on allowing its currency to appreciate to a fair value, geopolitical tensions are bound to elevate, and protectionism will likely follow.

And given the sovereign debt crisis that’s already underway, protectionism is yet another risk to the global economy that increases the probability of another bout with recession.

In fact, protectionism has historically put fragile economies in a deeper and more prolonged crisis …

Take a look at this chart of the S&P 500 from the Great Depression years. It gives you a clear understanding of why protectionism is so dangerous.

chart2 Chinas Currency War: Enemy #1 for Global Economy

You can see that the stock market topped in 1929 and fell 45 percent in just three months. Then, it had a sharp correction, recovering 47 percent from the November ‘29 low.

In June 1930, two U.S. Congressmen, Smoot and Hawley, championed a bill to slap a tariff on virtually every foreign good. And that was the catalyst for the second leg down … a massive plunge in the stock market and arguably the catalyst for the Great Depression.

As an investor, it’s always important that you anticipate plausible scenarios. If a China conflict scenario plays out, you can expect the outcome to be bad for global growth and bad for global financial markets.

Regards,

Bryan

P.S. I’ve been showing my World Currency Alert subscribers how to use exchange traded funds to profit from rising and falling currencies, like the Japanese yen, the Chinese yuan and the U.S. dollar. Click here to discover more.

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


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Comments

Rick
09 Oct 10, 18:41
No Currency War Needed, Just Smoot-Hawley

Come on Bryan! You can do better than that. Trying to lay blame on the fall of the S&P 500 during the 1930's with the Smoot-Hawley Tariff Act is pure fantasy. The level of trade between the United States and its partners was simply too low at that time to have had any measurable effect on the economy. Moreover, the corporations and the unions at that time were ecstatic that President Hoover signed that Act, and borrowing a quote from former President Reagan: "You can't argue with success".

Now we are faced with an entirely different situation as one can witness by the overwhelmingly lopsided trade between the United States and third world despots. Fortunately however, we have the Smoot-Hawley Tariff Act at our disposal to combat this monstrous imbalance, and the sooner the better. We will have to do whatever it takes to restore our manufacturing base in this country, and create a real and vibrant economy in the process. The alternative is "more of the same" and perpetual servitude to a third world economy of Wal Marts and pop stands.


Shelby Moore
10 Oct 10, 00:17
big mess solved by individual action

Rick we already had this debate and you did not reply to the final conclusion:

http://www.marketoracle.co.uk/Article23142.html#comment95223

The new information I want to offer is that the big socialism mess ("Great Harlot system") is going to die irregardless of how you try to save it:

http://www.chrismartenson.com/blog/prediction-things-will-unravel-faster-than-you-think/45297?page=6#comment-90991

The only options forward are individual decisions to come ou of the big mess. The political non-solutions you are suggesting, won't work to save the big mess of socialism.

Rick you do realize you are being a socialist, when you want collective action?


Rick
10 Oct 10, 17:59
Socialism Or Smoot-Hawley (The Choice Is Your's)

Shelby: I think that the country would be willing to entertain some form of socialism rather than serve under the exploitative capitalist masters any day. Now is socialism necessarily bad? Well, I suppose it depends on one's point of view, so let's take France for example. Here we have a country that's run by a predominantly unionized work force in a heavily subsidized society.

Now no multi-national with operations in France is exploiting their labors as opposed to what has unfortunately been the norm in this country. Moreover, we're all fully aware by now of what the consequences would be if some French government official or corporate chieftain should dare threaten the state of affairs. The French labor unions would respond in tandem, and one could expect (with a high degree of certainty) a virtual shut down of the entire country.

I'm not sure what "individual decisions (to come out of the big mess)" that you had in mind, but what's there to decide? I suppose that an 'individual' can 'decide' if he is prepared for "more of the same" and "exploitative capitalist rule" If not, then it seems to me that every 'individual' should 'decide' to contact his or her congressman and demand that a protective tariff be imposed on all imported goods and services.


Nadeem_Walayat
11 Oct 10, 02:49
Socialism

Rick

Ask yourself this, who creates the jobs ?

Socialist politicians ?

France is a basket case in terminal decline with a brain drain to London and elsewhere.

The only way you can create real jobs is by allowing the wealthy to invest capital in factories.

Instead the US is becoming ever more socialist by taking capital away from the rich for one off consumption.

The bottom line - The less capital availabel the less jobs.

Deficit and stimulus EAT capital.


Shelby Moore
11 Oct 10, 03:03
re: France & Economics 101

Rick, you are conflating the issues.

Some of France's main reasons for economic success are the individual actions:

1) their women make enough babies, unlike rest of EU, so they do not have horrific funding crisis due to declining population and youth.

2) Their INDIVIDUAL small farmers right for their individual interests and resist being used as pawns for nationalistic collective action (as is your proposed tariff):

http://www.independent.co.uk/news/world/frances-farmers-cause-a-stink-over-fast-food-1115226.html

The above free market individual actions are enough apparently to offset some of the negative socialistic pursuits of the unions in France:

http://www.just-food.com/news/farmers-intensify-pressure-over-milk-prices_id112077.aspx

Rick you simply don't understand Economics 101. If you manipulate (distort) the pricing of the market, you distort the market supply and demand, but nature always finds a way around your manipulation and thus your manipulation is a misallocation of resources and will come crashing down with great loss to those who participated.

You ask what individual actions we can do to escape the socialism and fascism we have now? Well certainly not adding more socialism (amazing you try to fix your problem by making it worse and adding to power of those who are manipulating you and you can't even see that!).

Well for one, buy gold and silver and save more. Second, move out the USA, or move to a rural area to lower expenses to near 0, and take up farming and a vocation on the internet. I am paying big money for programmers, graphic design, etc.

End of debate. You don't get it.


Shelby Moore
12 Oct 10, 11:00
College grads getting $95k+

Rick,

You keep lamenting that people have to work for lower salaries, well because they didn't pursue an engineering degree that is high demand:

http://techcrunch.com/2008/01/30/stanford-computer-science-grads-getting-95k-offers-from-google/

That is the free market. People who make poor choices learn from hard knocks.


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