China's Currency Manipulations

Today's NY Times has an article, "Geithner Hints at Harder Line on China Trade" describing how Tim Geithner, the forthcoming Treasury Secretary of the U.S., quoted that Obama stated that China is engaging in currency manupulatation by devaluing it's currency compared to the US dollar. Why is this such a big deal? Here's why.

1) The article mentions that the US is increasingly dependent on China to finance it's deficit. In fact, China is the number one nation owning US debt. According to the Treasurey Department's monthly data on major foreign holders of treasury securities, in November 2008, China owned $681.9 billion in US treasuries out of the $3.085 billion owned by foreign countries. Contact me for a graph showing how China has rapidly increased it's ownership of US securities over the last 6 months. (Note that the UK and Carribean banking centers have also increased their ownership sharply in recent months.) In the last 12 months, China, the UK and Carribean banking centers increased their ownership by 49%, 107% and 104% respectively. Overall, foreign ownership is US treasuries is up 32% from Nov.07-Nov. 08. Why? The Obama administration needs nearly a trillion more in deficit spending to build US infrastructure and get the US ecnomy growing again. Borrowing from other nations is one way to increase US economic growth without saddling US citizens with all of the debt.

This week's Economist has an article, "When a Flow Becomes a Flood" that focuses on this same issue. The article says that, "Ben Bernanke, now the Fed’s chairman, then a governor, argued in 2005 that America’s low saving was a passive response to a global “saving glut” washing onto its shores. It was not that America had lapped up foreign capital; rather capital had been thrust upon it. The money flooding in from willing foreign savers had bid up government-bond prices, lowering interest rates and lifting house prices. That encouraged Americans to run down savings and to keep spending." This is exactly what occured in the US as American's conspicuous consumption kept growing by the day.The article concludes saying, "America, Britain and other deficit countries have drowned themselves in cheap credit from abroad. Because the structural forces behind the global saving glut are unlikely to abate quickly, there is a real risk that the dangerous imbalances will persist—with America’s public sector as the new consumer of last resort. " Moral hazard won't end with the bankers but the government's public debt may be the latest victim of moral hazard.

2) When a country (such as China) devalues it's currency, it becomes more expensive for this country (China) to buy foreign made goods (from the U.S.) relative to their own country's goods. In 3rd Qtr. 2008, the US exported over $54.9 billion to China, while importing $250.4 billion, for a trade deficit of $195.4 billion. The trade deficit with China is growing rapidly. In 2002, the US trade deficit with China was only $103 billion for the entire year. So the saying, "here goes the US, here goes China and the rest of the world" is likely to play out. The US can't keep spending unlimited capital forever, not can foreign nations continue forever to own foreign debt unless they believe that it's a safer risk-reweard based investment than they could earn elsewhere. The US needs to continue to fight for free currency exchanges with China to keep trade negotiations on a fair playing level. Globalization expands global economic output to the maximum when all nations engage in free trade in markets where exchange rates float rather than are fixed (or manipulated). China should not have an unfair comparative advantage in trade. Our economy's future in intricately tied to theirs.