OK, say you are a good little mercantilist and you want to keep your currency artificially low (so you can undercut the other guy’s industrial base, capture all the manufacturing business, drive them out of business, then jack up the prices once you are a monopoly… oh, and employ all your people while sucking in all the other guy’s money too…). How do you do that?
One way is a “currency peg”. You simply set your currency artificially low and announce it. (This is what China had done for several years, until the USA made it difficult enough that they very slightly loosened the peg.) A currency peg “has issues” in that as folks buy a boat load (literally) of your stuff, they typically don’t have your currency, they have their own currency. So folks in the USA buy Chinese plastic crap and hand over dollars. These then get sent back to China. Where the local company deposits them into the Chinese bank in exchange for Yuan accounts.
Sidebar: Back in “The Old Days” accumulating the other guy’s currency was not a problem as the recipient could just melt down the gold coins and re-mint them as their own gold coins. (Though usually it was just bars swapped between central banks anyway, so you could skip the whole melting / minting process unless you needed some more coins in circulation). You only had a ‘problem’ when you ran out of gold, and that was a pretty clear moment in time. Along the way, folks realized they were running out of gold and tended to not play the game out all the way to the end. Now we use paper currencies so the opportunites for entertainment are much greater.
Now that Chinese bank has the problem. Can’t pay the locals in US Dollars, so you have to convert those dollars to Yuan. OK… but now there is demand for Yuan and supply of US Dollars. That would normally push the Yuan up and dollar down (assuming other pressures balance out, and this IS a ‘trade imbalance’ in favor of China). At this point, to “hold the peg” the central bank has to do one of two things. Supply more Yuan, or soak up the dollars.
This ends up with the central bank up to their eyeballs in US Dollars or printing Yuan (that causes local inflation). The “fix” for this is to not print the Yuan, but buy it via issuing bonds instead (soaking in Yuan from those folks wanting to invest in Yuan Bonds, and handing them back out again as bank deposits in Yuan; so no net gain). Alternatively, you could simply take those dollars and use them to buy US Bonds (thus putting the dollars back into the USA where they become the US Treasury’s problem…).
But after you have bought a $Trillion of US Treasuries and with Congress looking like it’s on a decade long Crack Bender and smells some snow around the next corner… you start to wonder if you really will be paid back.
What to do… what to do… If you stop buying US Bonds, you must issue more of your own (and that depends on folks willing to buy them. But if you have been making your currency low, folks don’t like that. If the USA is trashing THEIR currency, and you are pegged to it, you are ‘trashy’ too.) So you can either keep the peg, and have a trashy currency that folks won’t buy in bonds, while you give your Stoner Client more goods and services and accept more “IOU Sukka” bonds from them… or let go of the peg. Which is what China did just a little bit many months back.
Big ships take a long time to turn, though, and this has been no different. Also, China did not abandon the peg, so the imbalance pressures are still there, only reduced a little. So where are we now?
This story is from the end of the year 2010. China tried to sell more bonds, and failed twice:
China Fails to Complete Bill Sale for Second Time in One Month
December 30, 2010, 9:06 PM EST
Dec. 24 (Bloomberg) — China’s government failed to draw enough demand at a bill sale for the second time in a month as seasonal demand for funds and higher reserve-requirement ratios left banks with less cash.
The finance ministry sold 16.76 billion yuan ($2.53 billion) of 91-day securities, falling short of the planned 20 billion yuan target, according to a statement on the website of Chinabond, the nation’s biggest debt-clearing house. The average winning yield was 3.68 percent, higher than the 3.22 percent rate for similar-maturity debt in the secondary market yesterday.
OK, so they wanted to sell Yuan bonds to get the cash to give to the banks (instead of printing it) and failed. This, then, means they either leave the system starved of cash (which strengthens their currency that they are trying to keep pegged to the plunging real value of the US Dollar as we print them $Trillions at a time … notice they are waaaayyy down in single digit $Billions here…) or they trade their ‘reserves’ (ie US Treasuries) for Yuan on the world market (and strengthen their currency) or print a boat load of Yuan (that worsens their inflation – that is already worse than ours in the USA as they have a booming economy with rising house prices and we are being slowly killed having our economic blood sucked out of us; so not a lot of extra cash to drive up prices. Besides, all that cheap Chinese Crap is holding down our cost of living…)
Further down in that article, we see folks worried about the internal impacts of the Yuan printing:
China needs to return to a “prudent monetary policy” to curb prices and control money supply, the People’s Bank of China said in a statement posted on its website today. While inflation pressures are rising, regulators will allow reasonable growth in lending, the statement said.
“Banks are badly short of cash,” said Qu Qing, a bond analyst at Shenyin Wanguo Securities Co. in Shanghai. “Given the cash squeeze, the central bank probably won’t announce any tightening measure by the end of this year.”
The rest of that article has details like actual interbank rates inside China and other things that economists care about. Then there are these bits:
The cash shortage has also sapped demand for bills sold by the central bank. The monetary authority has sold 1 billion yuan of one-year bills at each of its last four weekly auctions, the lowest sales amounts since October 2007.
“The market is desperate for cash,” said Chen Liang, a bond analyst at Guohai Securities Co. in Shenzhen. “It’s too costly to park money with debt at such a price given the seven- day repo rate has risen above 5 percent.”
So as inflation has picked up (due to the USA printing like crazy and China trying to hold a peg) putting money in Yuan Bonds has lost attraction. Right when they want to sell bonds the most, demand softens. That’s economics for you… The Invisible Hand is very hard to beat in the long run.
Now, notice in the next bit that they say the bonds are yielding 3.x and inflation is at 5.x (it’s not hard to make that calculation… I can lose 1.x of my money if I buy Yuan bonds?
The yield on the 3.67 percent note due October 2020 was little changed at 3.81 percent, and the price of the security was at 98.89, according to the China Interbank Bond Market.
The finance ministry sold 11.55 billion yuan of 91-day bills on Nov. 26, less than the planned 20 billion yuan. The average yield was 2.74 percent. China’s inflation accelerated to a 28-month high of 5.1 percent in November, the statistics bureau said on Dec. 11.
This is what you would call a “currency war” or a “race to the bottom”. And the USA wants to “win” this race…
The yuan has risen 0.3 percent since Dec. 6, when 30 senators sent a letter to Chinese Vice Premier Wang Qishan calling for the yuan to “appreciate meaningfully” before President Hu Jintao’s visit to Washington next month.
The currency strengthened 0.24 percent to 6.6270 per dollar as of the 4:30 p.m. close, the biggest advance since Nov. 9, according to the China Foreign Exchange Trade System. It’s risen 0.43 percent in the week, the biggest weekly gain since October.
Also of interest is that some of the local banks may be side-stepping the China Central Bank (and working against the Central Bank policies). This is a bit of an act of desperation:
“Some banks may be buying the local currency in the foreign-exchange market because it’s hard to borrow money in the fixed income,” said Li Tao, a foreign exchange trader at Shenzhen Development Bank Co. in Shenzhen. “There is also concern the appreciation may get quicker before President Hu’s visit.”
–Judy Chen. Editors: James Regan, Ven Ram
To contact Bloomberg News staff for this story: Judy Chen in Shanghai at email@example.com.
To contact the editor responsible for this story: Sandy Hendry at firstname.lastname@example.org.
Oh, btw, the Congress needs to think through what happens when it DOES win this race. Yes, you have a printing press and clearly you know how to use it. But perhaps knowing how to NOT use it would be better. Because WHEN you succeed, you will have made Chinese goods more expensive. And that is going to suddenly hurt the US population who have come to depend on China for substantially everything other than cars (but give them a bit of time…) and food. There will be a sudden and very painful spike in US Inflation rates. That will then spike bond yields which will result in a great increase in US Bond debt service payments. I.E. the deficit will be even more obscene and out of hand.
Back in ‘the old days’ mercantilists were dealt with by putting on a tariff until they got a clue. This would sometimes lead to a bit of a trade war, with reductions in trade and countervailing tariffs until someone gave up. But at least we didn’t have to destroy the life savings of everyone in the country in the process. The Dollar was “good as gold” because it WAS gold. That reduced the opportunity for these kinds of shenanigans.
But those days are long gone. We now (thanks to Mr. “Tricky” Dick Nixon) have a rubber currency being inflated like a cheap balloon. Just watch out for that “pop” at the end… The “good news” is that so far we’ve had most of that inflation show up overseas in other countries and in commodities priced in dollars. The “bad news” is that this has brought with it food riots, the downfall of a couple of countries (and counting…) and when the “pop” comes, it will come flooding home to us. (But don’t worry… Ben Bernanke is sure he can think of something in time…)
OK, so what is China trying now? Afterall, the Yuan bond sales were a dud. What next? It can’t print Yuan with that 5+% inflation and rising and hope to avoid a massive inflation hit and even worse bond sales.
China sells $34.2bn of US treasury bonds
Analysts fear Beijing’s move may suggest a loss of faith in American government’s economic policy
Tania Branigan in Beijing and Heather Stewart
guardian.co.uk, Wednesday 17 February 2010 17.11 GMT
We saw before where China traded $200 B of US Treasuries for oil rights in South America and more for some other mining rights and future coal deliveries. Now they are resorting to open sales of US Treasuries. And in non-trivial amounts.
China sold $34bn (£21.5bn) worth of US government bonds in December, raising fears that Beijing is using its financial muscle to signal that it has lost confidence in American economic policy.
I’d say they lost confidence a year or two ago (and about 1/4 $Trillion of US Bond dumping ago…) and are only now running out of folks willing to trade 30 years of resources for US Paper…
US treasury figures for the period ending in December 2009 show that, following the sale, China is no longer the largest overseas holder of US treasury bonds. Beijing ended the year sitting on $755.4bn worth of US government debt, compared to Japan’s $768.8bn.
Remember how much news there was over China surpassing Japan? Well, they are headed the other way now and going as fast as they can while not completely screwing their trade mercantilist policies. Japan, desiring to bugger the Yen so as to get more trade, is now soaking up the US Bonds. Welcome to The Race To The Bottom, boys… “Anyone need a nother fifths of Buorbonn? WEsh makss a lots of it in thhe UShA…” “Drink up me hearties Yo HO!”
But the news intensified concerns about China’s appetite for bankrolling ever-widening American deficits. Premier Wen Jiabao told reporters last year: “We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried.”
“You see I’ve forgotten, if they’re green, or they’re blue…”
Don’t worry Wen, your assets are safe. We can print more dollars for you any time you want some more… and can you send us some more steel, shoes, socks, jackets (bit snowy out) and some room heaters and toaster ovens and maybe even some laptops and a few more tires (snow tires would be good) and…
But it’s not like they are a fickle trading partner that might do something irrational (or perhaps very rational as it would be an easy excuse to ‘take the money and run’…)
China Threatens to Dump U.S. Treasury Bonds Over Taiwan Arms Sales
By Megan Carpentier | 02.10.10 | 4:13 pm
Majors General Zhu Chenghu and Luo Yuan and Colonel Ke Chungqio of the Chinese People’s Liberation Army were quoted in an official Chinese publication calling for the Chinese government to retaliate against the United States economically for the recent decision to sell $6.4 billion of arms to Taiwan. China has already announced unspecified sanctions against U.S. companies that participate in the sale.
Luo, also a researcher at the Chinese Academy of Military Sciences, doesn’t think those sanctions go far enough. He told China’s Outlook Weekly:
“We should go in for a strategic mix of retaliation across politics, military matters, diplomacy and economics… For example, we could sanction them using economic means, such as by dumping some US government bonds.”
The article goes on to make the same points as here, that dumping US bonds would be economically difficult for China in the face of the mercantilist desires.
But, you never know….
I would also note that in addition to selling food, military equipment is one of our few major global exports. So, like it or not, we are an arms merchant to the world and would benefit from a ‘bit of war’ here and there. Just because we are increasingly despirate for some real money and need to export SOMETHING, doesn’t mean we’d sell arms to just anyone. They have to be at least as sane and trustworth and “good folks” as the Shaw of Iran, Saddam Hussein, Mubarak, and Pakistan… I’m sure China has nothing at all to worry about… I mean, it’s not like we’re selling billions of dollars of arms to India with whom they have had wars on and off over the years… Oh, wait, we have:
But hey, shoes, tanks, what’s the difference? Commerce is commerce…
I would expect that the USA will continue to print and spend into the $Trillions of excess and China will try to edge for the exit, $20B to $100B at a time, and that eventually the USA will “win” this Race To The Bottom. Along the way some other folks, like Japan, will pick up some of the credit card but in the end, the USA will have a massive increase in costs for basically everything the typical American family buys. (What we don’t buy from China tends to be Japanese… think Honda, Toyota, Nissan, Nikon, Cannon, Sony…)
The other big issue here is that the US Budget as proposed by Obama has a $1T scale gap in it. With China cutting back on US Bonds, and Japan not quite able to pick up just the amount China has dumped: Who will be buying that $Trillion PER YEAR for the next several years?. Face, meet floor.
China will end up with needing to “accept” that it will have a monopoly position on things like socks and toasters and we will just need to pay a higher price for them. I’m sure they will be all broken up over it…
And we, in the USA, can take solace in having WON the Battle! While we realize that our $100 US Savings Bond might, just maybe, buy a tank of gas… but not a weeks worth of groceries, nor even a dinner out at a high end restaurant….
IMHO, we are watching folks jockey for position for The End Game in this event. Since the outcome depends on decisions of individuals who are sworn not to give clues, it can not be seen in advance. But what I would expect to see are continued crop failures in China (as we’ve turned back to the 30 year volatile and cold weather half cycle) and increased appetite among the Chinese for better food. This will result in China buying even more grains on the open market and dumping dollars to do it. That will result in more “bread riots” elsewhere in the world (Africa, poor parts of Latin America, some of South East Asia and South Asia) and more governments will fall.
Eventually the USA will “win” and we’ll get a bit more “competitive” in world trade; but at the expense of having impoverished every holder of US Dollar denominated financial assets. Quite a price to sacrifice on the altar of Global Free Trade… And we will buy less Chinese product. Not because we want less, but because we will be paying more for it, but have fewer dollars of lower value.
The good news is it will be easier to get a job. The bad news is that you will need two of them to make ends meet and the country will be impoverished. Oh, and it might result in a heavily armed world on the verge of W.W.III, but that’s not much different from where we are already…