The Yuan And The Failure Of Diplomacy

Source from: Asia Times Tuesday, 2010-06-29

When the Federal Reserve Open Market Committee meets on Wednesday, no one expects it to raise the federal funds rate - the overnight bank rate that now hovers below 0.25%. However, businesses, politicians and prognosticators are eager, perhaps inappropriately so, to hear clues about when it will begin raising short-term interest rates to a more normal level.

Through the boom years of the last decade, Beijing printed yuan to purchase hundreds of billions of dollars in foreign exchange markets. That made the yuan and Chinese products on US store shelves artificially cheap, and imports from China, coupled with higher prices for imported oil, pushed the US trade deficit to more than 5% of gross domestic product from 2004 to 2008.

During the boom, China facilitated such folly by using its dollars to purchase US Treasury securities, and that kept US long interest rates artificially low, even in the face of Federal Reserve efforts to rein in spending. From 2003 to 2006, easy terms prevailed on mortgages, homeowner lines of credit, car loans, and credit cards even as the Fed raised the federal funds rate. Americans borrowed against their homes, pushed real estate prices to unreasonable levels, and spent on Chinese goods at Wal-Mart until the credit bubble burst in late 2007 and 2008.

China continues to recklessly print yuan to buy dollars and US Treasuries, and all those yuan are creating inflation and real estate speculation in China that Beijing can't contain.

This past weekend, Beijing announced it will permit some more exchange rate flexibility but we have heard those words before. China will likely permit the yuan to rise slightly against the dollar - much less than 6% a year - while the true value of the yuan rises much more, thanks to Chinese modernization and productivity improvements.

China's announcement is a cynical ploy to assuage critics less than a week before Group of 20 meetings, and without a substantial one-off revaluation of the yuan Beijing's words are hypocritical and selfish.

China's yuan policy makes the Fed nearly irrelevant but for crisis management - bailing out big banks and European governments that make fatal mistakes.

Worse, President Barack Obama's failure to take strong action against Chinese currency manipulation - for example, a tax on dollar-yuan conversion to make the price of Chinese products reflect their true underlying cost - crippled the jobs creation effectiveness of his US$787 billion stimulus package and delivers ineffective his broader efforts to resurrect the US economy.

Obama's exclusive reliance on diplomacy forfeits US monetary policy to Beijing, renders impotent US fiscal policy, and visits enormous pain on American workers.