Lawson for Congress

Fellow seeker criminyjicket wrote:

The Chinese would love to see [Ron Paul elected President]. Ron Paul’s free trade stance would make the deep water ports they are building in Mexico a cash cow when our Southern border becomes as porous for Chinese goods as it is currently for illegal immigrants. Free Trade is the new Chinese mantra. The use of slave labor, ignoring International environmental laws, and incredibly lax quality control standards on exported goods make them the world leader in death exportation, and they are doing it with an aplomb that would make Kruschev jealous. Unchallenged by our current leaders, their trade practices would be encouraged by a Ron Paul administration.

My responses to his post were really too long to be Comments, so I’m using them to kick off this spiffy new blog. Here goes:

If anyone wants to understand what China is doing, and why, you really should read these insightful essays. They take you on a deep and well-documented dive to understand the “why” and the “how” of what China is doing vis-a-vis the U.S. in its managed currency float and export-driven growth. Additionally, it explains what factors can/will change this trend over time.

Basically, it explains that China is artificially keeping its currency (RMB) low to drive economic growth through exports. It does this by limiting purchases of RMB, and fixing the price at which RMB are exchanged for USD.

Practically speaking, when an exporter in China sells plastic trinkets to Wal-Mart and is paid in USD, the People’s Bank of China (PBC) forces the exporter to exchange those USD for RMB at the fixed rate. The PBC then “sterilizes” those “inflows” by selling a bond for an equal amount of RMB as is given to the exporter. That bond is typically bought by a Chinese bank or insurance company. Simply put, the bond buyer exchanges existing RMB for a bond that pays a (low) interest rate, and that bond goes on the books of the bank as a reserve asset. The result of this sterilization is that the conversion of incoming USD into RMB received by the exporter does not result in new net RMB in the monetary system — thus reducing the immediate inflationary impact of continuing to receive all of our paper dollars.

But then the PBC has to do something with those USD that it just bought at an artificially high price from the exporter. It’s easiest to buy our Treasury bonds. Lather, rinse, repeat a trillion times… and China has a massive foreign exchange surplus comprised largely of our debt.

But what’s the endgame? Since our Federal government is proving incapable of living within its means, EVENTUALLY we will overwhelm our trading partners’ (in this case China’s) appetite for our bonds. China knows they will not be able to keep their currency pegged this low forever — they’re already fighting inflation despite sterilizing inflows, as those bonds they issue become reserve that allow banks to make loans and further increase their money supply.

When you read the paper above, you’ll see that China’s goal is entirely pragmatic — they have a few hundred million people who are un/underemployed (imagine 2/3 of our country just sitting around with nothing to do…), and they need to turn them into productive, taxpaying citizens. So for the moment, the selective and highly managed application of foreign direct investment (FDI) allows them to develop more mature capital markets and the management and technological skills to use that capital effectively. Additionally, by keeping their currency artificially low, they prolong the amount of time that FDI can profitably exploit their people — thus maximizing the overall number of jobs created and the acquisition of intellectual capital.

What is resulting over there is a tremendous growth of their middle class. Within the next 4-10 years, the growth of this middle class as a domestic market will eclipse our importance as an export market. As that happens, China will be gradually less concerned with supporting the export business, and currency controls will be further relaxed.

As the Chinese middle class begins competing with us for goods, and as the RMB strengthens against the USD, China as an exporter of cheap goods will turn into China as a voracious consumer. Everything we need to live (food, energy, and plastic trinkets) will be more expensive, because we will be competing with 1.3 billion consumers *and* competing with a weaker currency in global markets.

Like it or not, this is our current trajectory. It has absolutely nothing to do with Ron Paul, Barack Obama, Hillary Clinton, or Mitt Romney. It has to do with China, in its totalitarian government’s rational self-interest, encouraging the prolonged exploitation of its un/underemployed people in order to maximize job creation and growth of their tax base. In other words, if China DIDN’T aggressively manage its currency, and DIDN’T aggressively manage foreign direct investment, the huge disparity in labor and other manufacturing costs would have disappeared in a manner of a few years at most… and fewer net jobs would have been created. Again, don’t just take my word for it… read the above paper and additional references, and draw your own conclusions.

Ironically, some analysts smugly think we’re “winning” as we trade our paper dollars for China’s manufactured goods. It seems like a free ride, but in the end, the joke is on us. You see, the intellectual capital and know-how we’re exporting along with our foreign direct investment is fair compensation for the declining value of China’s dollar reserves. If it wasn’t, why would China continue willingly down this path?

So where does Ron Paul come in? Short of a military or trade war, we can’t change what China is doing. But isn’t this situation serious enough that we should consider a war, if only a trade or economic one? Indeed, some folks in Congress who don’t understand this situation are agitating for a trade war right now. What these august leaders don’t realize is that if we start a trade war, we will lose. Badly.

In a trade war, China has two retaliatory options: stop purchasing U.S. treasuries, and selling its existing dollar holdings. If China stops purchasing our debt (which our government keeps selling to the tune of $1-3 billion per day to fund operations), the Federal government won’t be able to fund its operations and interest rates will increase. If China actually starts selling, the situation is even more severe — not only does the dollar plummet, but interest rates will go through the roof. Mind you, China is not incented to initiate these hostilities — after all, their retaliation would make their dollar holdings worthless, and disrupt their growth — but we’re currently living in situation that’s best described as mutually-assured (economic) destruction.

But if we even want to TRY and change what China is doing with respect to the environment and human rights, our government’s inability to live within its means and the continued debasement of our currency further weaken our position in trade and diplomacy. A sound, and strong, currency with a free market economy is the only way to slow the capital flight that’s moving jobs and opportunities overseas. If we embrace the entrepreneurial spirit that encourages equal competition domestically as well as internationally, stop having a government that serves corporate interests, and radically reduce our tax burdens, we won’t be worried about job growth. People will be more empowered to become owners, as opposed to just employees, and instead of worrying about job growth, we will be worried about finding workers.

Having such an economy will give us a powerful platform for diplomacy to advance the cause of freedom and human rights. What better way to stand for freedom than to have an economy strong enough, with so many jobs and opportunities, that we can open the door to appropriate LEGAL immigration, and again become a refuge for huddled masses yearning to breathe free and create value?

This entry was posted on Sunday, August 12th, 2007 at 4:40 am and is filed under China, Ron Paul, free trade. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.