What Does Snow Know?
Daan Joubert
Reuters this Monday morning is carrying a story with a Madrid byline entitled, "U.S.'s Snow sees China ready to reform yuan".
In this 'opinion piece', authored by Secretary Snow and published in the Spanish financial daily, Cinco Dias, Reuters wrote:
"U.S. Treasury Secretary John Snow said in an opinion piece published on Monday he had few doubts China was ready to reform its monetary system and that he saw the risks of delay far exceeding concerns about immediate reform."
and a little later also, quoting from the opinion piece,
"What we demand is an immediate measure that reflects the underlying market conditions and allows a smooth transition, when timely, to a total flotation,"
The wish on the part of Secretary Snow and the Bush Administration to have China relax the dollar-peg of their currency is well known and often expressed. That fact is not new. Congress is already standing ready to penalise China if it does not revalue soon. Yet the above quotes trigger a few thoughts on the US policy towards China.
We know the Chinese are a proud nation, where people place a tremendous amount of value on 'keeping face'; on maintaining public honour and composure, demanding it for themselves and in return treating others with due respect. If you were among the Chinese leadership, how would you (wish to) react to 'demands', like the above, from a foreign power and expressed in the public media of a third country?
A question is whether the use of the word 'demand' was a slip of the pen or perhaps a deliberate provocation?
Further, there is a saying that one should be careful what one wishes for - the wish may be granted. Along similar lines we have the Law of Unintended Consequences.
This brings up the $64000 question about potential consequences should the Chinese acquiesce to the demand from Secretary Snow to revalue
As many commentators have noted, if the Chinese currency should revalue, it would have some ramifications that will be significant for the US. These include:
- The Chinese would no longer be under as much pressure to recycle the dollars from their trade surplus into the purchase of US Treasuries etc
- Other Asian central banks no longer would be under pressure to keep their own currencies competitive; they too would begin to buy smaller amounts of US dollar assets, or even stop buying Treasuries and Agencies, as Japan has already done
- Under these circumstances of decreased demand for Treasuries etc, it seems most likely that yields on US bonds would rise substantially; so too would US mortgage rates - which would bring an end to the property bubble and with that to the source of much of the funds supporting the consumer spending that has kept the US economy afloat
- Another casualty of reduced demand for dollar based assets would be the US dollar, which would resume its long term bear market. This, in turn, would mean higher prices for consumer goods on the shelves of Walmart and other US retailers, higher inflation and upwards pressure on interest rates and then a debt crunch for US households
One can continue with the litany of woes that would strike the US once the Chinese revalue their currency, ending with speculation whether the end result would be just a recession or would it spill over into a lasting depression.
However, the pressure from the US to have China revalue its currency - be it the yuan or the renminbi (like with a rose, the name does not matter) - raises another question: to what degree is the Bush Administration prepared for the consequences? There are three possibilities:
- It is not expected that the serious consequences listed above to materialise, in part perhaps because terminating the purchasing of US securities (funding the trade deficit, amongst others) would hurt the Asian countries themselves
- It is believed that the consequences can be dealt with in time, as a small price to pay for the political advantages at home that will arise out of being seen to act against China
- Thirdly, the consequences of a reduction or break down in foreign purchases of US securities will not materialise, as there are already measures in place to ensure that some friendly foreigners will keep on buying US securities should the Asian countries reduce or curtail their purchases
Number two here is not a good guess. The consequences of a significant decline in the funds flow into the US are so dire they outweigh any political advantages that might accrue. Number one means leaving the outcome totally in the hands of the Asian central banks and their masters - that is not the way to go.
Which leaves the third one as the most feasible explanation for sustained pressure from the Bush Administration on China to revalue. Assuming the logic here is correct, it is left to the reader to explain the reason for the confidence that there are enough friendly people with very deep pockets in some foreign location who can step up to the plate if Asian countries do decide to reduce their purchases of US securities.
daan joubert
June 2005
daanj@kingsley.co.za
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