December 17, 2006 – This past week, U.S. Secretary of Treasury Henry Paulson was in China, urging the government to let market forces determine the direction of the Yuan. U.S. Federal Reserve Chairman Ben Bernanke has also gone on record as urging the Chinese to let the Yuan rise from its current levels. The obvious reason is because a stronger Yuan and an even weaker dollar would help close the trade deficit between China and the United States. Remember, a couple of months ago, when I blogged about the U.S. economy depending on the unwinding of global surpluses to return to the U.S. in order for the U.S. economy to stay afloat? Well, this is Bernanke’s and Paulson’s effort to see that this happens.
However, there always seems to be an inordinate amount of focus on China when it comes to trade surpluses, investment opportunities, and any global economic discussion. The reduction of all economic discussions to just the U.S. and China is analogous to all significant discussions about race that are distilled into black and white issues with an absence of any meaningful discussion about issues that afflict Latinos and Asians. China’s trade surplus is estimated to be about $200 billion while the trade surplus of emerging oil-exporting countries are estimated to be about $500 billion. Still, there is almost zero public discussion regarding the significant effects that the unwinding of the petrodollar surplus will have on the U.S. economy.
The reasons that there haven’t been much focus on the petrodollar surplus of oil-exporting countries are two-fold.
One, if we look at the countries that dominate that list- Saudi Arabia, Kuwait, Russia, and Iran — it is not a pro-U.S. bloc of countries. Not that China is, but China seems to be the scapegoat for most of Congress regarding problems with the U.S. economy, thus, for now, focus is on China. However, this may very well change as rumors have been circulating throughout the Iranian media that Iran has started to trade its oil in Euros, a change it has been lobbying for since this past March. When Venezuela sent its Finance Minister to Russia to discuss the feasability of selling oil to Russia in Euros, there were consequences to face for such actions. Whether Iran will suffer similar consequences remains to be seen.
So while emerging oil-rich countries actually have more influence on what happens to the U.S. dollar and our trade deficit than China, China is the more convenient political card to play. Number two, in the Middle Eastern bloc of countries, much of the petrodollar surplus is held in government oil-stabilization and investment funds, and not reported as part of their “official reserve” figures. Thus, many economic analysts miss these huge petrodollar surpluses, and overlook them.
But back to the unfounded claims that Chinese protectionism is largely responsible for the out-of-control U.S. trade deficit. Has it contributed to it? Sure. But is it responsible for the lion’s share of the American deficit? Hardly. It is important to note that the massive U.S. trade deficit was not caused by the Chinese or by Russia or by Saudi Arabia. Its origins started decades ago with irresponsible domestic fiscal policies. Furthermore, what country, the U.S. included, does not protect its domestic interests? Senator Charles E. Schumer (D-N.Y.) and Senator Lindsey Graham (R-S.C.) proposed a 27.5% tariff on all Chinese goods imported to America unless China allows the Yuan to appreciate. “If the Yuan does not rise further”, Schumer said, it could damage the “increasingly fragile consensus for free trade”.
Free trade is often defined as:
(1) International trade of goods without tariffs (taxes on imports) or other
trade barriers (e.g., quotas on imports)
(2) International trade in services without tariffs or other trade barriers; and
(3) The absence of trade-distorting policies (such as taxes, subsidies, regulations
or laws) that give domestic firms, households or factors of production an
advantage over foreign ones
However, free trade in the political world is often leveraged by many countries to gain entry into new foreign markets for domestic companies, not for the more benign implications of its liberty-invoking name. If free trade exists in the U.S., then Mexican cement would have already flooded American markets to the detriment of American cement producers. Instead, U.S. legislation has enacted harsh, protectionist, import taxes on the Mexican company Cemex for years that have made their considerably cheaper cement more expensive for U.S. builders (though this tax is finally being reduced over a period of years). Furthermore, significant agricultural subsidies and corporate welfare that There is no country in the world that lets free market forces dictate how the majority of their economy operates.
Every country, whether North American, South American, European, Asian, or African, will seek to preserve its self-interests at the expense of other nations, though some are much more able to do so than others. Countries lobby for free trade when it serves their economic interests, yet will refuse to apply free trade concepts if it will hurt their interests.
Hypothetically speaking, if the Yuan was free-floating and still weak, Paulson would instead be urging the Chinese central bank to intervene and artificially strengthen the Yuan, just because it serves American interests. But this isn’t particular just to the United States. Every country in the world operates in this manner, looking to pressure other countries to do what is best for their economy. If free market forces truly dictated the values of all international currency, then central banks wouldn’t consistently intervene to raise and drop interest rates to artificially create stronger and weaker currencies — policies that by the way, have historically been forceful enough to send other country’s economies into recession in the past.
Likewise, if free trade truly exists today, then when I visit Seoul, 90% of the cars I see wouldn’t be Hyundais, and foreign-made cars would be able to compete more freely for market share. If free trade conditions truly existed, then a U.S. imposed economic embargo on Cuba that is three decades beyond any semblance of a logical explanation would not still be enforced, and the price of sugar would have been infinitely cheaper for decades now. Every single country in the world enacts legislation to protect their companies and their markets from foreign competition despite the repeated misnomer of “free trade” and “free markets.”
Likewise, to believe that central banks just allow market forces to dictate their domestic currencies’ values irrelevant of the wishes of the elite bankers that control central banks is hardly believable. Yet this is what Henry Paulson claims, and wants the Chinese to believe as well. And if you read my previous blog that Central Bankers never have the welfare of its people at heart when they enact fiscal policy but just those of the moneyed elite that control them, think of what Paulson is asking for in his current plea to the Chinese government to allow the Yuan to strengthen.
Many economists have estimated that if the Chinese allow the Yuan to freely float that it may strengthen by as much as 30% to 40%. Sure a weaker dollar will increase demand for cheaper American goods and help close the enormous U.S. trade deficit, but a weaker dollar also means higher inflation rates and a loss of purchasing power at home for Americans. American critics of China claim that China’s artificially depressing the Yuan gives Chinese manufacturers an unfair edge against its American competitors. But that is also normal behavior when it comes to fiscal policy for any country, not just China.
It all depends on what side of the fence you sit on as far as if you side with the Chinese or U.S. government on this issue. If you believe that central banks manipulate the strength of domestic currencies, then what China is doing is only natural because it is to their advantage to have a weak Yuan that stimulates their economy. China’s central bank would claim that their decision is not that different than the Bank of Japan’s actions over the past several years when they chose to drop their interest rates to zero in order to stimulate the Japanese economy out of a recession. Thus, China, would conclude, these are the consequences of free trade. Our labor is cheaper, our money is cheaper, and therefore, cheaper Chinese goods will hit American markets.
The U.S. on the other hand, would argue that this is not free trade. They would argue that because China is manipulating their currency that they are not playing fair, that only until Chinese goods become more expensive versus American goods can free trade be implemented? The U.S. would argue, our currency is weak against the Yuan but needs to be much weaker. However, we don’t have the ability to strengthen our currency significantly because a leap in interest rates could trigger recession in our country. So therefore, China, you must strengthen your Yuan. So who is right in this argument depends on what filter you view this situation through. And more attention should be given to how emerging markets plan to diversify out of their petrodollars anyway.
Free markets only exist in some Alice in Wonderland fantasyland. Once you understand the perpetual manipulations that affect “controlled markets” and “controlled trade”, your investment decisions will become much better.
Just as influential global government leaders wish to dupe the masses through repeated use of terms like “free trade” and “free markets” that in reality don’t exist, a martial artist can engage in similar deceptive behavior to gain an upper hand. Free trade and free markets imply that the playing field is level for all participants and that supply and demand will set true prices. Perhaps in a land called Freetopia, but not in the real world. As an investor, you must dig below all the rhetoric of free trade and free markets to understand what entities are given the upper hand by “free trade” agreements and will thus blossom under such arrangements. Do so, and your investment success will rise signficantly. However, if your idealistic nature leads you to believe that all companies have equal opportunities to seize a piece of the pie under free trade agreements, then your investment decisions will suffer.
Likewise, in marital arts, we often apply the illusory concepts of “free trade” by allowing an opponent to spot what appears to be a carless opening of our guard. However, it is just a deliberately planned way of luring an opponent to attack a vulnerability that really does not exist. Once the opponent attacks, a counter-attack is executed and the attacker becomes the victim. Just as in real life, there is no free trade within martial arts. One person in a conflict will eventually always gain the upper hand, and sometimes use feints and deception, to gain it.
J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.