The biggest money flow
The US has been accusing China of currency manipulation for the past several years now, with less weight in their accusations as the collapse intensified. The reason is pretty obvious and is something that you will never see printed in big media. Prepare for some wake up call: China owns your future generation’s income.
To fully understand the effect of this duopoly, one shouldn’t stop at this superficial fact . You could say that China started pegging its currency to the US as an indirect way of saying that it is inflating the Chinese Yuan without the negative connotation. Dollar pegging, is the term that countries use when they earn more than they spend, printing money is the more familiar term but it only occurs in countries who spend more than they earn. You can draw a direct equality between the two, except the context is different.
To dollar peg, China buys US treasuries in mass, turning part of the Yuan into US dollars and decreasing the value of the Yuan as dollar drops. The US, seeing this phenomena, initially called China to stop, but realized later that if China were to stop buying treasuries at the height of the collapse the US would be in deep shit. Japanese style lost two decades deep shit. So, without political clout nor the financial power to push, what does the US do? Print money i.e. sell a ton of US treasuries and effectively lowering the interest rates.
China in turn, realized that they just got royally screwed by the US as their huge treasury position got devalued by at least 15% in the past year, so they now look to diversify to other currencies. As a subtle way of saying “hey, we are going to be increasing the value of our Yuan”.
Secondary money flow
The trillions of dollars created above together with the hundreds of billions spent in stimulus resulted in what we are seeing as the “almost zero interest loan”. During a period like this, it is essentially a no-brainer for anyone to get a 0% loan and invest it somewhere abroad where the currency will appreciate. If your investment doesn’t go up, at least their currency value will. I am not sure how much of that money went into China, but I know that a lot of Chinese stimulus ended up in the real estate market there. Since their currency cannot appreciate due to the dollar peg, the properties will. Hence, a housing bubble and China blaming the US for creating the biggest carry trade using US dollars. It’s more of an American way to say “up yours” to China.
So most of these US stimulus got stuck in the US institutions and never made it into the workers. If you follow the news last year, you’ll see the US government simultaneously accusing the big banks of not lending enough while saying that their risky lending is the cause of the collapse and that regulatory policies will need to tighten. They are basically giving the big banks a truck of money and telling them to lend to risky people and not lend to risky people, effectively shifting the blame to the financial sector. Politics is a game of shifting blames. The institutions weren’t idle though. Even if they are not lending to the average Joe, they have enough sense to make money out of the cash. So everyone benefits. Sadly, because these money is not directly spent on real projects, real inflation has not happened yet.
The great unwind
Most governments are targeting June 2010 for the great unwind, with a few whose trades are tied to China having to raise interest rates prematurely. We are hoping for everyone to do it together so that it doesn’t disrupt the currency exchange rate too much. For the US-China carry trade though, the unwinding might happen as a hurricane. While the Yuan is pegged to the dollar, if the US raises interest rate the Chinese will have to sell its US treasuries in order to maintain the peg. By selling the treasuries, it decreases the demand for US treasuries, further driving up the rate. As the largest treasury holder, China’s selling pressure will influence US treasuries the most forcing the US to increase the rate more in order to attract more buyers. Of course, they could just sell less treasuries, thus keeping the rate low, but I doubt that’d be the case because they’ve already committed to huge budget deficits for the next 3 years.
Of course, at one point of the unwind, China will see that they are running out of foreign reserves (US treasury) at an alarming rate which will force them to float the Chinese Yuan. This will make a few things possible in the western world. Inflation and wage increase. Simply because China produces everything that we buy, the increase in Yuan will mean an increase in cost leading to an increase in the wages demanded by the Chinese people in dollar term. This will have the secondary consequences of making hiring in the US a more attractive term for the big corporations. Yes, you can basically thank the Chinese for record low prices on everything after the government force fed 2 Trillion dollars into the economy over 4 years. This trend will not continue and will lead to the next low of the business cycle after we experience the recovery. Currently, I place the probability of this happening in 5 years. Usually, a cycle lasts about 10 years, but I believe the boom and bust cycle has significantly sped up in the modern time.
I get the feeling that this is probably the final US recovery. After this, I will be looking to invest in other countries. Mainly Brazil,Â South Korea and China. At the moment, they are a bit over valued, but I will buy on any dip in their market. Especially Brazil. The western part of American will rise in activity while the eastern part falls in its glory due to the tie that they have to the different continents. The west is a bet for Asian economy while the east is a bet that the European economy will rise in power. I am going to place my long term bet soon and I hope I am not wrong.