Sunday, October 10, 2010

Chinese Monetary Manipulation

Or "the pot calls the kettle black".

Unless you've just not been following the news at all lately, you might have noticed that there is some controversy between the governments of the United States and China over Chinese policy with regard to the value of their Renminbi against the US Dollar. It is said that, by devaluing their currency, the Chinese government is impairing the ability of US manufacturers to compete with Chinese manufacturers, making their own export goods cheaper than US manufactured goods. To those who attempt to directly compete with Chinese manufacturers, this is a bad thing.

Rarely mentioned, due to certain parties' never-ending quest to confuse the intended results with actual policy, is the question of HOW the Chinese government goes about devaluing their currency against the US Dollar. The answer is simple: they buy US Dollars with newly issued Renminbi. This added demand for US Dollars raises the price of the Dollar in terms of the Renminbi. It also increases the price of the Dollar in terms of other things, as well.

This increase in the price of the Dollar influences Federal Reserve policy with regard to inflation. The tendency for prices to increase due to Fed policy is counterbalanced (to a degree) by the tendency for prices to fall due to Chinese central bank policy. In other words, the Fed happily supplies more dollars to meet Chinese central bank demand. Chinese monetary expansion is piggybacked on, and therefore dependent on, US monetary expansion.

This would not be a problem if China had nothing more to do with these dollars than to spend it on goods from the United States. Once they'd gained cash holdings of a certain size, it would no longer make sense for the Chinese bank to keep acquiring more. They'd have to start spending it on something, and this would begin the process of sending US Dollars back to the US, a new demand on US exports.

However, they do not do this. Instead, they buy Treasury bonds. This would result in the private holders of treasury bonds having additional cash to buy US goods, were it not for the fact that Congress gladly meets Chinese demand for treasury bonds by issuing more than they could otherwise get away with. In other words, Chinese monetary policy is also dependent upon Congressional fiscal policy.

In other words, in the absence of an irresponsible US monetary and fiscal policy, the Chinese could not continue their policy of devaluing the Renminbi relative to the Dollar indefinitely. It is US policy, not Chinese policy, that is to blame for the situation.