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This is it boys, this is war.
Sep. 1st, 2011 10:16 amSomething unusual happened the other day in the world of international finance: the US Federal Reserve announced there would be no new round of Quantitative Easing – QE3 – and the markets went up. This was strange because the markets had been jittery in the light of sluggish US growth and doubts about their debt levels and had been expecting another round of financial stimulus to help them along. No QE3 should, on the face of it, have been bad news.
International finance is a subject most people steer well clear of and I can’t blame them but I’m interested because I find the flow of power fascinating, so many people don’t really get what QE actually is. Essentially, it’s printing money. The first round – QE1 – was occasioned by the credit crunch of 2008 when approximately 20% of all the money in the world vanished in the space of a month meaning that lines of credit dried up and the global economy was in real danger of grinding to a halt. Banks teetering on the brink we recapitalised (i.e. some of the vanished money was replaced) by state intervention and you, the taxpayer, agreed to stand surety for that. Very kind of you, I thought. The second round – QE2 – happened a year or so later when it became clear that QE1 hadn’t really done the job. This time the US govt printed money with which it bought back its own debt. Inflation went up, but cash was funnelled to debtholding institutions – once again, mostly banks – to provide them with yet more much needed liquid cash to go about their business.
The reason the market was expecting QE3 was because US growth is still low and the credit lines are still jittery. But it didn’t happen, yet the markets rallied sharply. Why? Because almost immediately after the Fed said there would be no QE3, they quietly muttered that the revenues from the bought bonds acquired during QE2 would be used to buy more bonds back from the market. In essence, this is an indefinitely rolling QE3, but it wasn’t called that so the US republican party get to save face to their constituents and Barack Obama looks decisive. But that’s not the only reason the US is buying its own debt with phoney money, thereby weakening its own currency. Another reason they’re doing this is the ongoing trade war with China, and that’s a big reason why there’s no end point to this process given.
Not many people noticed back in 1995 when China quietly declared war on the United States. I certainly didn’t, and nor did Bill Clinton when he granted them Most Favoured Nation trade status, but that’s what they did when they pegged their currency to the dollar at an artificially low level. You see, by doing that they ensured that Chinese exports to most of the rest of the world were nice and cheap*. This has – you might have noticed – led to impressive economic growth in China as industry has shifted there in a wholesale way. Where a hundred and fifty years ago Britain was the workshop of the world, now China is.
You might be asking how pegging a currency works. Well, it’s like this – you decide what exchange rate you want between your currency and another and then use your currency to buy theirs. By doing this you create demand for their currency (there’s a buyer in the market) and reduce demand for yours ( there’s a seller in the market). You keep doing this until your currency reaches the exchange rate you want. Initially this was done by the Chinese buying dollars on the international markets and over time, as dollars flowed to China to pay for cheap good manufactured there, they bought them from Chinese citizens who, thanks to strict controls on currency amongst the population, hadn’t got much use for them. They also bought US government bonds to keep their value up whilst releasing Yuan into the market, further depressing its value. In short this artificially lowered value of the Chinese currency resulted in severe damage to the US manufacturing base. It’s so much cheaper to make things in China and ship them overseas that making many things in the US became uncompetitive against cheap imports. An assault of this scale on a national manufacturing base carried out with bombs would be taken quite seriously; carried out with cheap labour everyone was delighted (everyone who counted that is, such as creditors, bondholders and shareholders. You? You don’t count so much).
However...
Holding the value of your own currency down artificially has consequences. It’s only really to your advantage for as long as your peg currency remains strong. Under those circumstances your own currency stays relatively strong as well, meaning that the disparity doesn’t matter so much to your own people who have to buy stuff with it. When the peg currency declines in value – as the US dollar has been doing lately – it starts getting troublesome. The value of your currency declines as well by the same amount, an that’s what is happening now and what’s more the evidence suggests that the rolling QE3 bond purchase is deliberate policy on the part of the US administration to do precisely this.
I remember a while ago reading an article about Barack Obama which said he’d been a terrifying poker player on the Chicago circuit, and when he took over I was initially impressed by his grasp of Machiavellian politics: making Gordon Brown look a complete bozo on his trip to Washington was a move straight out of The Prince. Since then, I’ve been confused as he hasn’t really lived up to those early indications. Or has he? You see, by forcing down the value of the Renmimbi the US is taking the trade war to China on China’s own terms and, as the US is bigger and more powerful, the dollar can fall further than the Renmimbi can. In poker terms, the US is forcing China off the table by buying the pot.
Now, the Chinese aren’t stupid. They twigged what was going on almost immediately QE was first announced in late 2008 – it’s no coincidence they started to call for a new, global reserve currency in early 2009 when the long-term effects on US QE on their own currency become clear. But really, they’re caught in a bind, as they have two options. First is to maintain their peg. This will keep their exports low cost and economic growth higher, but will fan inflation at home as commodities and goods rise in price. This is happening – Chinese inflation hit 6.5% last month and is on an upward trend. Given that growth has slowed to 9.5%, the likelihood is that inflation will outstrip growth within the next two years on current trends. The alternative is to unshackle the Renmimbi from its dollar peg and let it float. This will cause the international value of the currency to rise sharply, reducing the price advantage of Chinese manufactured goods. Given the slowing of growth and the lack of an internal market to take up the slack I don’t know what they’ll do – probably try to arrange a soft landing by systematically raising the value of the currency peg over time. I suspect that’s probably the least worst option, because either way (a slowing of growth or rising inflation (or both)) that’s not good for internal social harmony, as we’ve recently rediscovered in this country. Once again, it's no co-incidence that this morning the CCP has legalised ‘disappearing’ social malcontents. That’s not to say they didn’t do it before (Ai Weiwei, for example), but now they can do it with no comeback.
It’s interesting that the US appears to have won the trade war without a shot being fired by leveraging their position, but that’s what I’m seeing today. Could be wrong, but I wouldn’t bet against them at this stage of the game.
So, American readers. Once you've got this one won, do us a favour and remember who your friends are, eh? I, for one, welcome our new - and old - American masters.
*In 2005 they shifted this peg to a basket of currencies including the Euro, the Pound and the Baht. However, given that 49% of all the money in the world is denominated in US dollars that was just a sop to the gallery and made no real change. It’s like me bringing home a hundred mars bars and one apple and claiming I’d got a mixed basket of groceries.
International finance is a subject most people steer well clear of and I can’t blame them but I’m interested because I find the flow of power fascinating, so many people don’t really get what QE actually is. Essentially, it’s printing money. The first round – QE1 – was occasioned by the credit crunch of 2008 when approximately 20% of all the money in the world vanished in the space of a month meaning that lines of credit dried up and the global economy was in real danger of grinding to a halt. Banks teetering on the brink we recapitalised (i.e. some of the vanished money was replaced) by state intervention and you, the taxpayer, agreed to stand surety for that. Very kind of you, I thought. The second round – QE2 – happened a year or so later when it became clear that QE1 hadn’t really done the job. This time the US govt printed money with which it bought back its own debt. Inflation went up, but cash was funnelled to debtholding institutions – once again, mostly banks – to provide them with yet more much needed liquid cash to go about their business.
The reason the market was expecting QE3 was because US growth is still low and the credit lines are still jittery. But it didn’t happen, yet the markets rallied sharply. Why? Because almost immediately after the Fed said there would be no QE3, they quietly muttered that the revenues from the bought bonds acquired during QE2 would be used to buy more bonds back from the market. In essence, this is an indefinitely rolling QE3, but it wasn’t called that so the US republican party get to save face to their constituents and Barack Obama looks decisive. But that’s not the only reason the US is buying its own debt with phoney money, thereby weakening its own currency. Another reason they’re doing this is the ongoing trade war with China, and that’s a big reason why there’s no end point to this process given.
Not many people noticed back in 1995 when China quietly declared war on the United States. I certainly didn’t, and nor did Bill Clinton when he granted them Most Favoured Nation trade status, but that’s what they did when they pegged their currency to the dollar at an artificially low level. You see, by doing that they ensured that Chinese exports to most of the rest of the world were nice and cheap*. This has – you might have noticed – led to impressive economic growth in China as industry has shifted there in a wholesale way. Where a hundred and fifty years ago Britain was the workshop of the world, now China is.
You might be asking how pegging a currency works. Well, it’s like this – you decide what exchange rate you want between your currency and another and then use your currency to buy theirs. By doing this you create demand for their currency (there’s a buyer in the market) and reduce demand for yours ( there’s a seller in the market). You keep doing this until your currency reaches the exchange rate you want. Initially this was done by the Chinese buying dollars on the international markets and over time, as dollars flowed to China to pay for cheap good manufactured there, they bought them from Chinese citizens who, thanks to strict controls on currency amongst the population, hadn’t got much use for them. They also bought US government bonds to keep their value up whilst releasing Yuan into the market, further depressing its value. In short this artificially lowered value of the Chinese currency resulted in severe damage to the US manufacturing base. It’s so much cheaper to make things in China and ship them overseas that making many things in the US became uncompetitive against cheap imports. An assault of this scale on a national manufacturing base carried out with bombs would be taken quite seriously; carried out with cheap labour everyone was delighted (everyone who counted that is, such as creditors, bondholders and shareholders. You? You don’t count so much).
However...
Holding the value of your own currency down artificially has consequences. It’s only really to your advantage for as long as your peg currency remains strong. Under those circumstances your own currency stays relatively strong as well, meaning that the disparity doesn’t matter so much to your own people who have to buy stuff with it. When the peg currency declines in value – as the US dollar has been doing lately – it starts getting troublesome. The value of your currency declines as well by the same amount, an that’s what is happening now and what’s more the evidence suggests that the rolling QE3 bond purchase is deliberate policy on the part of the US administration to do precisely this.
I remember a while ago reading an article about Barack Obama which said he’d been a terrifying poker player on the Chicago circuit, and when he took over I was initially impressed by his grasp of Machiavellian politics: making Gordon Brown look a complete bozo on his trip to Washington was a move straight out of The Prince. Since then, I’ve been confused as he hasn’t really lived up to those early indications. Or has he? You see, by forcing down the value of the Renmimbi the US is taking the trade war to China on China’s own terms and, as the US is bigger and more powerful, the dollar can fall further than the Renmimbi can. In poker terms, the US is forcing China off the table by buying the pot.
Now, the Chinese aren’t stupid. They twigged what was going on almost immediately QE was first announced in late 2008 – it’s no coincidence they started to call for a new, global reserve currency in early 2009 when the long-term effects on US QE on their own currency become clear. But really, they’re caught in a bind, as they have two options. First is to maintain their peg. This will keep their exports low cost and economic growth higher, but will fan inflation at home as commodities and goods rise in price. This is happening – Chinese inflation hit 6.5% last month and is on an upward trend. Given that growth has slowed to 9.5%, the likelihood is that inflation will outstrip growth within the next two years on current trends. The alternative is to unshackle the Renmimbi from its dollar peg and let it float. This will cause the international value of the currency to rise sharply, reducing the price advantage of Chinese manufactured goods. Given the slowing of growth and the lack of an internal market to take up the slack I don’t know what they’ll do – probably try to arrange a soft landing by systematically raising the value of the currency peg over time. I suspect that’s probably the least worst option, because either way (a slowing of growth or rising inflation (or both)) that’s not good for internal social harmony, as we’ve recently rediscovered in this country. Once again, it's no co-incidence that this morning the CCP has legalised ‘disappearing’ social malcontents. That’s not to say they didn’t do it before (Ai Weiwei, for example), but now they can do it with no comeback.
It’s interesting that the US appears to have won the trade war without a shot being fired by leveraging their position, but that’s what I’m seeing today. Could be wrong, but I wouldn’t bet against them at this stage of the game.
So, American readers. Once you've got this one won, do us a favour and remember who your friends are, eh? I, for one, welcome our new - and old - American masters.
*In 2005 they shifted this peg to a basket of currencies including the Euro, the Pound and the Baht. However, given that 49% of all the money in the world is denominated in US dollars that was just a sop to the gallery and made no real change. It’s like me bringing home a hundred mars bars and one apple and claiming I’d got a mixed basket of groceries.
