Tag Archives: currency peg

Currency Manipulation 101

It’s always about the money.

– attribution unknown


Of all of China’s weapons of economic destruction, the Yuan peg – China’s fixed exchange ratio of Yuan to dollars – is both the most blatant and yet subtle. As China’s undervalued currency vacuums jobs out of America, it also cruelly punishes China’s consumers and feeds the US government’s profligate spending.

However, probably 8 out of 10 Americans I question are essentially unaware of it and still picture China’s competitive advantage in trade to be based on cheap labor. Outside of a very few, low-end, labor-intensive products the notion that American labor is non-competitive is totally false. Consider an Apple iPhone 4 made at Foxconn City in Shenzhen, for instance. At $600 (actual price before you get a plan commitment discount to say $299) the thing has a truly insignificant labor cost of maybe $10 in China. Or think about high-end pair of Nike’s that might run $200 with labor again around $10. Labor simply isn’t a big a portion of the cost for these expensive goods and while America labor is more costly, it is typically far more automated and efficient than the Chinese competition. If the labor cost of either of these doubled either the consumer or Apple or Nike could easily absorb it. The same goes with many heavy manufactured goods like steel, where Thomas Danjczek recently told us that the cost of transporting the material across the Pacific alone is higher than the entire American labor input.

We will go into this in greater detail in a later blog, but suffice it to say the 40% advantage* created by China’s currency scam is a much bigger motivator for firms like Nike Apple to leave thousands of US assembly workers standing idle than their wages. There are, of course,  a plethora of other China cheats and many US regulations that contribute to this, but none is as clear nor as powerful as the peg.

In order to investigate this further (or to argue with your friends who are still drinking that Chinese Kool Aid) it is incumbent on us to actually understand the mechanism by which this is achieved, so let’s dive right into Currency Manipulation 101 and explain the mysterious process know as “sterilization”:

When you take your government tax rebate stimulus check to Best Buy to pick up the newest Vizio big screen TV, or whatever, you “stimulate” a low paying, dead-end retail job or two and then the majority of your dollars fly right off to Guangzhou, Shanghai, or Shenzhen. They DON’T contribute to the vitreous cycle of consumption, investment, and production that John Maynard Keynes imagined back in the 1930s, but that’s a whole ‘nother story for a coming blog.

The Chinese manufacturer now holding those dollars could use them to purchase US components, machinery or supplies. However, China’s domestic content requirements – another future blog topic – and the laundry list of policies and factors that make US parts noncompetitive render that choice pretty unlikely.

So, the Chinese firm must nearly always exchange these dollars for China’s currency – variously known as the Yuan, Renmenbi or RMB – in the form of little pink bills featuring the disarming likeness of China’s patron saint of totalitarianism, Mao Tse Tung.

In a real free market when a great deal of one item – in this case a currency –  is being sold it’s value naturally drops. Consider it this way: fiat currencies are like baseball cards. They have no inherent value. They are valuable only because people want to collect them. If nearly everybody wants to trade their Barry Bonds for Jackie Robinson the exchange rate of Bonds to Robinson is going to up. You’ll need more Bonds cards to pry loose each available Robinson.

In the same way, every time another Chinese firm needs to unload a bundle of greenbacks, those holding Yuan should be able to demand a better deal since they have a lot of buyers in line for this trade. The number of Yuan you get for each dollar should drop.

Consequently the cost of US products, valued in dollars, should drop for Chinese consumers who have Yuan. And reciprocally, the cost of Yuan valued products should rise for Americans with dollars. People holding the in-demand Yuan will be able to buy more stuff and those with unloved Dollar less. The trade imbalance should right itself as Chinese buy American goods and Americans cut back on purchases. Economist and philosopher David Hume explained this law more than 100 years ago and trust us the Chinese policy makers understand it.

Just as the Chinese government doesn’t want their manufacturers to utilize American built subcomponents, they don’t want their consumers purchasing any finished goods from Ohio. So what’s an unethical authoritarian regime to do?

Contrary to the popular assumption, neither the Boys from Beijing nor any other government, can merely issue an edict and say “thou will exchange my currency for $x”, even if it has Mao on it. Inside China they can set an official rate and force the state owned – who conduct virtually all finance – to comply, but once the currency is in circulation OUTSIDE of the people’s prison, they don’t own it and people will trade for the actual value they perceive on the FOREX markets. Within China, black-market currency exchanges would develop as well. Holding the exchange rate by proclamation just won’t work, as the idiot-king of Venezuela, has repeatedly demonstrated.

Part of the solution is for the Communist Party to command the Chinese state-owned firms – almost all of China’s big companies and the most important part of the economy – to trade their dollars at the official rate at a state owned bank, even if it is a lousy deal for their minority shareholders, many of whom are Americans (likely you if your 401k is in an “emerging market fund”).

The second part is to vacuum up enough of the dollars in the open market and dump enough new Yuan into the system to keep the Yuan / Dollar in a targeted trading range. Private firms and individuals have to be compensated for their collusion in this process and so the Chinese government, which has no real need to borrow money, with its $2Trillion in reserves, lures and sometimes compels them to buy short term Chinese government bonds. These bonds can only be purchased with US dollars, but pay back capital surprisingly high interest rates in – you guessed it – Yuan.

Now to manage the process of any market you need to work at the margins; this means you don’t need to buy up all the US Dollars in the market in order to keep the American currency artificially high (vs. The Yuan) but rather you need to get rid of just enough. Buying “just enough” dollars been getting harder and harder as our trade deficit grows and the US continues to try and “stimulate” a dead economy. Economist Peter Morici suggested – at our event last week at the National Press Club – that China is now spending as much as10% of their GDP or about 35% of their export revenue just buying up dollars.

So, now that the Chinese government has these dollars, what can they do with them? They can’t trade them for other currencies or buy products elsewhere as they’d again end up being sold on the open FOREX market resulting in a declining dollar. Like Tolkien’s ring of power the only way to destroy dollars is to return them to the place where they were created. Hence, China buys our debt in the form of US treasury bonds.

Now let’s take a moment to savor the irony here: Our Federal Reserve is accommodating the Treasury by buying up bonds to create new money in the euphemistically labeled “Quantitative Easing” process while China is busy collecting the new dollars and returning them as fast as possible to undo the very stimulus that the fed is trying to achieve! LOL (or is it OMG?)

And the punch line to all this is that China pays a higher interest rate on the short-term bonds it sells at home to collect the dollars than it gets from the treasury. It’s the world’s largest money losing operation even before you take into account the very serious risk premium that now accompanies US debt. A risk that bond king Bill Gross has pointed out, is nearing same level as that of Greece.

The results of this are not so much stimulus as inflation in China – because of all the Yuan they print to soak up the $ – and of course great piles of debt in America. It’s a lose/lose situation with only one purpose: Destroy America’s industrial base.

To achieve this strategic goal – let us never doubt that everything Beijing does is part of a very careful set of long-term calculations – China is willing to inflict very serious pain on their own people in the form of reduced purchasing power. So while Americans lose their jobs, Chinese families cannot afford vegetables and Chinese truck drivers can’t afford fuel.

That’s the way we see it. The alternative hypothesis – the one that Treasury and our great “think tanks” – would apparently have you believe is that China actually wants to purchase our bonds because, one must assume, they see them as a “good investment” or maybe they just like us? LOL for sure.

As the saying goes, “follow the money” and in this case the think tanks that are constantly promoting the stay the course with China policy, like The Brookings Institution on the left (supposedly),The Heritage Foundation and American Enterprise Institute on the right (supposedly) are essentially underwritten by the same multinational corporations (or their big shareholders and associated private foundations) who are offshoring your job, the retailers who sell us subsidized Chinese products, as well as the financial institutions that benefit from all the – in the end – pointless machinations of the bond process. The question – to be addressed in a future posting – is why the interests of these multinationals no longer align with those of America or liberty in general.


–       Greg Autry teaches Macroeconomics at the Merage School of Business, UC Irvine and is co-author (with Peter Navarro) of the new book “Death by China” www.gregautry.us

*40% is a consensus estimate of the difference between the peg and a fair market price from economists that we find most believable. Wen Jiabao and even many US China apologists will make unsupported assertions that “The Yuan is fairly valued.” If so, then why the peg? Obviously printing piles of Yuan and buying dollars isn’t moving the dollar down. Until they float, the burden of proof is on those who manage the currency.