QE2: In the Currency Game, How do You Play With a Cheater?

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A conspiracy theorist I am not, but sometimes, after a good night’s sleep, my mind goes a little wonky (my new favorite word). It all started when I read this article from Reuters entitled US Dollar Printing is Huge Risk China C Bank Advisor. Commenting as an academic advisor to China’s Central Bank Monetary Policy Committee, Xia Bin said, “We must keep a clear mind. We must not lead the world in financial regulation, nor simply follow the deeds of mature economies. We must think ‘what is good for us.’

The comment strikes me as ironic because it’s hard to see how China has acted in anything less than its own self-interest (by the way, no value judgment there — self-interest isn’t a bad thing; in fact, it’s quite supportive of capitalism). The Reuters article goes on to say, “China already has a regime of tight capital controls in place, limiting its vulnerability to the wave of liquidity that analysts say U.S. easing could push towards emerging markets¦By closely managing the yuan’s exchange rate, Beijing has also been able to blunt appreciation pressure in the face of a weakening dollar.

And though many in the banking industry believe this QE2 to be foolish, here is an example of the tone of what many are saying along with a couple of points we have seen peppered throughout the media:

  • Deflation is not a real concern, in fact, CPI is a poor measure of inflation; instead look to the PPI (ed note: certainly many metals fall into the rising PPI bucket) for clues on inflation sentiment.
  • The second argument is that the dollar is “declining against almost all currencies, and is at or close to its all-time lows, both in nominal and real terms. When the dollar loses its purchasing power against gold, most commodities, and most currencies, that is about as close as you can get to a guarantee that it will lose its value against just about everything, according to the Seeking Alpha post linked to above. However, not everyone agrees that the dollar is at or close to its all time lows (see this chart from data derived from the Fed).

Source: Federal Reserve (see link) and Nucor Steel

So, whether you think that QE2 is the latest attempt by “our government to pop that diet pill or hope (and pray) for a silver bullet in the form of a new asset bubble (after all, we’ve tried dot com, construction and now government in the form of health care as examples of failed asset bubbles thank you RR!), let me lay out my Ëœwonky theory.’ If you agree that China is a currency manipulator, we believe this to be true as we have previously examined the numbers here and here and here (note this data comes from the Fed, lending credence to our conspiracy theory to follow) as the Chinese will readily admit that “Beijing keeps its financial markets isolated from global capital flows and tightly controls the exchange rate of its currency, the yuan, which has risen more slowly against the U.S. dollar than some other Asian currencies such as the Thai baht, according to this AP article. The Fed has made a brilliant strategic move for the Obama Administration and Congress.

That move is to effectively shut down the “currency manipulation debate with China.

How? First, it’s a great policy of Guanxi because we can now avoid a direct confrontation with China, whether it occurs at the WTO, via the State Department or a Congressional legislative debate. You see, if you run the printing presses as we are, we get a devalued currency. In other words, if China refuses to raise their currency, we can just lower ours. In fact, we just did. Discussion over.

Do two wrongs make a right? Probably not, but you can’t play by the rules if your opponent is cheating.

–Lisa Reisman

Comments (6)

  1. tberezowsky says:

    Germany’s finance minister seems to agree with you, Lisa:

    “Mr Schäuble added: ‘It is not consistent when the Americans accuse the Chinese of exchange rate manipulation and then steer the dollar exchange rate artificially lower with the help of their [central bank’s] printing press.'”

    From at FT article — http://bit.ly/aSo9nT

  2. Oleg says:

    This seems to be a dangerous path, Lisa. Next time you call China a currency manipulator you will need to add “just like US, as discussed in a our post on Nov 8”, right?

    1. admin says:

      Sure, like I said, two wrongs don’t make a right but at some point we need to stop being a net importer….LAR

  3. Anonymous says:

    written with a perception of China is wrong.

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