House Vote Against Chinese Yuan – Double Dumb (but expected)

Folks,

This is basic economics (and I think physics) – every action has a reaction. Case in point – the US House of Representatives voted to authorize the Commerce Department to impose duties on products from countries who currencies are “undervalued” (read: China). Some of you, who don’t spend your whole day reading economics and studying finance might think this is a good idea. Reasons given and accepted by many Americans include:

  • offshoring of US manufacturing to China
  • Chinese manipulation of their currency to keep their currency, the Yuan, from rising against the dollar (making Chinese goods more expensive to foreigners)
  • The resulting US/China trade deficit

While it’s understandable that people might get EMOTIONALLY roused up by some of this data and by a good (yet uninformed) speech by some politician, the truth is far different. Understand that this is a populist measure, which if you read history, are usually not well-thought-out moves and often are reacting to some emotional argument with little logical base (for research, check out the rise of Mercantilism and its failures). First off, let’s cover 4 reasons why we have a trade deficit and why manufacturing has moved to China – and this is a overview – not an indepth analysis.

  1. American lifestyle increases as we move to more educated careers – oftentimes the design, engineering, research & development side – which requires more education and the people who do this work require higher pay, and this is where our economy does quite well. This is also one area of our economy where we actually EXPORT – our technology. The resulting productivity increase from technology advances means we earn higher wages but also means  that low paying jobs aren’t possible in the US as the cost of living, due to the demand for goods by people with higher incomes, doesn’t allow us to hire people for $3/hour (can’t live in US on $3/hr) and why Americans want to buy more cheap goods – i.e. they have more money to buy lots of stuff! (how many unused things have you bought from discount stores?)
  2. The Federal Reserve debasement of the US dollar over the years has actually made this closer than it should be. Americans have to have higher paying jobs  – price increases in wages to compensate for increasingly expensive costs of living – the falling value of the dollar makes goods and services more expensive (especially commodity-based goods) and we need cheap labor to make stuff or we can’t afford things!
  3. Cheap credit is an issue as we buy MORE than we can afford – mortgage write off’s on refi’s, 2nd mortgages, and home equity lines of credit (HELOC), used to add $50k kitchens, 2nd homes and cars (and to pay off credit card balances) are good examples of Americans either buying too much and/or experiencing a cost of living that is rising faster than their wages (see Fed Reserve debasement point above!)
  4. You like YOUR CHEAP STUFF FROM CHINA –  The iPhone 4 costs roughly $550 without a contract. Apparently, the cost to manufacture this is under $300. That’s WITH cheap Chinese labor. Therefore, if you don’t want to pay $2,000 for an iPhone then either ask the Fed to raise interest rates and strengthen the US Dollar (and thus our purchasing power) or ask the geeks at Apple to take salary cuts – whichever you choose, go for it.

But the bottom line, don’t fall for this foolish Congressional attack on Chinese currency “manipulators.” If you do, you would be showing an enormous lack of understanding of the issue. Now, is China some innocent bystander in all this? No not at all – they are just playing their role of the rising manufacturing power growing quickly in many directions, like America was to Britain in the 19th century. Nonetheless, if the US goes down this track of assigning duties (tariffs) on Chinese goods, here’s how China can (and is) responding.

  • China recently issued duties on US chicken imports (one of the few products where we have a trade surplus with China). China can also, with their huge reserves, drive the dollar higher if they choose.
  • They could also threaten to sell their enormous position in US government debt which would be disastrous as interest rates would likely rise as demand for low interest US Bonds would plummet. Then we’d get the real kick in the you know where as it’s been shown that if interest rates returned to 5%, then over 50% of US personal income tax revenue would go simply to PAYING INTEREST ON THE DEBT.That ‘zero hour’ is coming anyway, but China could accelerate it. Then we Americans who live such a coddled, comfortable life, would be in real doo doo (including me – I’m still working on diversifying this risk!) and our endlessly reelected politicians would have no recourse other than defaulting on the debt.
  • China could respond with more trade measures igniting a trade war (who knows what all of these highly-educated government planners in China could come up with – look what a few did to our economic system). We would respond, and the result is the cost of everything you buy rising 50%+. Congress can talk tough but most Americans who – are increasingly shopping at Walmart, Family Dollar, Dollar Tree, Dollar General, 99 Cent Only Stores (Dollarama in Canada), getting their checks cashed by pawn shops and selling their family gold there too, and renting furniture that they can’t afford from Aaron’s or Rent A Center – the Americans will be CRUSHED by Congressional stupidity (well, they’ve been getting crushed all along but perhaps this will be the coup de grace). There’s a reason that dollar store stocks are shooting up.

This could all end badly. For more color on this, read this short opinion piece in the Walls Street Journal titled How to Start a trade War.