Monday, June 21, 2010

China Revalues Yuan: It Takes Two To Tango

Fractal Finance, Part II will follow on the next post.  I believe China's decision to revalue the yuan merits a post first.
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Following months of wrangling with the United States, during which unsubtle threats of trade war were hurled hither and yon,  China finally announced yesterday that the yuan's peg to the dollar will be allowed more flexibility.  The currency "jumped" 0.2% higher versus the dollar.  If this revaluation seems unimpressive given the intensity and importance of the matter, that's because it is unimpressive.  But, China does things its own way, particularly during its current transition from a command economy to free-market capitalism.  Old habits die hard, absolute power corrupts absolutely, you can't teach an old dog... you get the point.

But the yuan's revaluation is not exactly my subject today.  Instead, I want to focus on something Hank Paulson said back in his final days as Treasury Secretary:  The world, he said, was suffering from a "savings glut" - and pointed at China and the oil producers.

Now, back then I thought his comment was disingenuous, if not downright asinine.  After all,  I clearly saw the problem as a sea of bad debt and the popping of the easy credit bubble.  But,  as if often the case, it takes two to tango and,  in fact, some concepts can only be defined in relation to their matched opposites.  Good requires evil, light makes sense only because of darkness, ying needs yang.

Likewise, for every  incremental unit of savings to exist we must, by definition, create an incremental unit of debt.  Interestingly, however, debt can be, and mostly is, today created out of thin air, a situation otherwise known in theology, cosmology and other such -ologies as creatio ex nihilo.  Furthermore, unlike other matched pairs, the creation of fiat currency debt-savings is strictly unidirectional, i.e.  it is the  willingness (or necessity) to assume debt that creates savings and never the other way around.  I can walk into a bank and apply for a $1 million mortgage, thus putting into motion a process that may ultimately result in, say, the holding of a CMO by a bank in China, i.e. a piece of the "savings glut".

But I can't do the opposite: I can't stroll into a bank and ask it to generate $1 million in savings for me.  That's the crucial - if obvious - difference within the duality of money as debt and debt as money.  In other words, sure it takes two to tango - but there is only  one leading partner on the dance floor: the borrower.

Stop right there, you cry.  Didn't all parties on the other side of the credit bubble, the mortgage and leveraged loan originators, the brokers, packagers, servicers, rating firms, the investment banks.. the whole nearly-criminal gang - didn't they salivate and cry out for ever more "product" to chop and shop around as CMOs, CLOs, CDOs?  What do you make of that?

Well, I say that if people had decent incomes from decent jobs and could thus afford to live a middle-class lifestyle and save a bit on the side, as they did up to the mid-70s, well then they wouldn't need to borrow to cover the most basic necessities of life.  Like a home, an education and medical care.  Who ever imagined it was normal to go into hock for years on end just to pay for a college education, for heaven's sake?

So, to go back to Hank Paulson.  Indeed, he spoke truthfully - from an accountant's point of view.  But oh, what a tangled web of (half)truths we weave, when we set out to deceive.. It's not like a billion Chinese came begging to America to create a trillion dollars' worth of  a "savings glut" for them now, is it?

And how about China?  What is it doing with all that debt-uous  "money" it has piled up over the years?  It is in a lather trying to convert it as fast as possible into "hard" assets, like oil and iron ore deposits, ports, etc.   That's a game of "hot potato" on a grand scale or, quite literally, "pass the buck". 

Maybe now we better understand why there was such an absolute need for the dollar to go up against the euro, the only serious adversary for global reserve currency status, eh?  Particularly since the US is creating another trillion-plus dollars in fresh "savings" this year...

20 comments:

OkieLawyer said...

You left a lot of ground to cover, so let me fill some of the holes in in your wake.

China finally announced yesterday that the yuan's peg to the dollar will be allowed more flexibility. The currency "jumped" 0.2% higher versus the dollar.

It closed up 0.42% for the day.

Well, I say that if people had decent incomes from decent jobs and could thus afford to live a middle-class lifestyle and save a bit on the side, as they did up to the mid-70s, well then they wouldn't need to borrow to cover the most basic necessities of life. Like a home, an education and medical care. Who ever imagined it was normal to go into hock for years on end just to pay for a college education, for heaven's sake?

The policy that led to people (like me) who were forced to borrow for their college education was that if we provided a full public education, it created a moral hazard for the recipient of that education. In other words:

1: The student will have no incentive to finish his education, because he is not paying out of pocket; and

2: The student will not appreciate the education that he gets because someone else will have paid for it; and

3: It will encourage students to study degrees which will maximize their earning potential after their education is over (less liberal arts majors and more engineers, CPAs, lawyers, doctors, etc.).

So people like me end up borrowing $100,000 plus interest (consolidated over 30 year repayment period) with a house payment so that we can "appreciate" our education. Voila! No more "moral hazard."

Then there is the chapter 11 (corporate or rich person) bankruptcy rule that allows the top management to take a worker's pension and health care funds for their own benefit.

There is a lot of problems with the system we have now. People get cheated all the time. I can't believe that working people just keep taking it and accepting it as just and fair. (Don't they realize that we normally would call this embezzlement?)

So, to go back to Hank Paulson. Indeed, he spoke truthfully - from an accountant's point of view. But oh, what a tangled web of (half)truths we weave, when we set out to deceive.. It's not like a billion Chinese came begging to America to create a trillion dollars' worth of a "savings glut" for them now, is it?

The idea was that money needed to be shifted to developing countries because (and you still hear this) American workers are overpaid and this is just part of the the "global wage arbitrage."

It is also important to understand the "Starve the Beast" policy of the American neo-conservatives. (If memory serves, this is "neo-liberal" in Europe.)

Of course, I'm not sure any of this is directly related to China's valuation policy, maybe you could follow up on this and create a "string theory" that will tie them together?

Dink said...

Great article, Hell. It gives a "big picture" view which is really helpful to those of us not classically trained in the Dark Arts (finance, economics). It'd be interesting to know what hard assets China is buying and where. And how they plan to keep ownership if the locals get snarky.

But I digress. And to digress further, more of the speeches from Thai's service have been posted on Remembering Thai.

Tiago said...

@Okie: I don't want to be seen defending the globalization pattern (and wealth capture that goes with it).

But I do think that Americans (and Europeans) are overpayed. In the sense that we have a standard of living that is unsustainable (could not be extended to the whole population within the planet's resources). I mean, our purchasing power in terms of what we can get from the planet is too high.

Don't get me wrong, I think we can get mostly "free" education and healthcare (i.e. payed by society via taxation), but we over-consume in general and our life standard needs to go down a bit...

Peter said...

It is intriguing to see the yuan finally moving, but I don't know how long or how much it will move. I have heard 2-3% over the next year, which would not be a huge change in my opinion.

Free financial advice said...

You said it man! with the industrialization of the world, people are getting more opportunities and better jobs, and thus better income and better life.

I strongly believes that the root of all evils are the lack of money. once you get enough money, you will get more human.

Hellasious said...

Thks. for the filling in Okie.

Don't we all love the word "moral" being thrown in, in these situations? Evoking reflex images of burning in hell, fire and brimstone forever after, guilty of the unspeakable sins of Free Education, Comprehensive Medical Care, Unemployment Benefits..

Meanwhile it is, of course, perfectly saint-like to induce people - force them, even - into debt slavery for their entire REAL lifetimes.

....

Debra said...

I like this post, Hell, and agree with Dink (!! lol) that it is very readable and pedagogic.
You're getting closer to "The Merchant of Venice" all the time...
On the subject of how money measures value, maybe you would like to go into the problem of how prices are arrived at ? Something tells me that classic economic theory is way off on this one. Like in... cloud cuckoo land, for example..
Okie, your comment reveals certain... theories about money. Theories that I attach, rightly or wrongly.. to the Protestant take on money.
I am a totally dependant woman. Mommy and Daddy did not go into debt to pay for my education, way back when, and I definitely appreciate it. More than... society appreciates that education, as a matter of fact... And I appreciate it... even though it has not enabled me to earn a living either.
Saying that "the student will have no incentive to finish his education because he is not paying out of pocket" is a subtle example of... the idolatry OF money, and not the value of WHAT is being paid for, isn't it ??
So.. are you starting to understand why I am demonstrating again in the streets ? While our government keeps saying... WE DON'T HAVE THE MONEY to pay for retirement pensions when there are not enough jobs for our young to enter in order to FINANCE the system, and retirement is STILL financed by labor revenues (not finance revenues) ??
Idolatry of money, I say...
Tiago, if I thought for one minute that... the sacrifices WE are being called on to make would REALLY improve the lot of people living in the more economically depressed countries, that would be a different story.
But... I don't believe things work that way.
And I don't believe that by accepting impoverishment in OUR daily lives we will be helping the poor in those developing countries.
The poor share a lot of common traits ALL OVER THE PLANET, you know. Poverty is globalized.

Brian woods said...

China is a dangerous mecantilist state. They (Chinese rulers) are totally, absolutely and completely consumed with China. Period. The 'rest' of us are merely commercial fodder and will be left twisting in the wind when we are no longer needed.

The 'unpegging' is merely an invisible stitch in the emperors invisible jock strap. Its a joke - and a bad one! If, and its an iffy If, the Yuan is re-valued by at least +25% - now your getting somewhere.

Keep an eye on commodity prices (and by extension, their ready availability). I have a hunch that China might be charging into a commodity swamphole. Time will expose their predicaments.

Brian P

Payday loans said...

Wow,nice, one of the best read posts so far.

fajensen said...

once you get enough money, you will get more human.
I think that you become more yourself - for the better or for the worse.

Tiago said...

@debra: What is poor? Are middle class Europeans poor? I am middle class (on the way down, I suspect) and enjoy a very nice lifestyle.

I suspect there is now way the whole world could enjoy (on average) my lifestyle. We needed a few more planets...

Interestingly people ask for more, more, more.

If greed is the request, than our current society is a very good answer.

Don't talk about the poor, you are not one. It is about your life and mine? Are they sustainable (in fair way for the other billions)?

Anonymous said...

OT:

Good read from Yves Smith at Naked Capitalism....

http://www.nakedcapitalism.com/2010/06/mike-konczal-underwater-and-the-strategic-default-pr-campaign-what-we-got-when-we-didn’t-get-cramdown.html

Best regards,

Econolicious

Anonymous said...

"......The economic system works by monopolizing wealth and power at the expense of those who have the least, and of the middle classes that dream - ever more vainly - of hoisting themselves into the cocoon of the present financial oligarchy...."

Herv Kempf

The Rich Stand Accused
By Louis-Gilles Francoeur
Le Devoir

http://www.truth-out.org/article/louis-gilles-francoeur-the-rich-stand-accused

"Capitalism is the source of social and environmental crises."

Best regards,

Econolicious

Anonymous said...

and finally, the Eco Doctrine:

Environmental views are a by-product of religious and economic beliefs and attitudes. You will find that both the left (progressives) and the right (conservatives), exist on a horizontal plane as it relates to the economic and religious components of their genetically induced mechanisms for self-preservation and self interest. Thus, the fidelity of the denial of climate change, is far more receptive to the dogmatically inclined receptors of "Americanism".

We must stop viewing the issues of sustainability and climate change as good or evil and we must stop viewing this planet Earth as a servile entity, a slave that we can dominate and beat into submission. If we don't criminalize the battering of the planet and coerce the ignorance that allows this battering into submission, we risk the loss of our species on this planet. The survival of our species on this planet can not be achieved through democratic means. This planet Earth, is simply not going to allow us the timeframe to build consensus and vote for solutions to this problem.

We can either step up to the plate "right now" and conserve, preserve and reclaim the damage we have done to this planet by whatever means are necessary and recruit the receptive, persuade the skeptic, coerce the ignorant and eliminate the recalcitrant, or we can leave it to the wisdom of our natural environment to eliminate our entire species, both the so called good and the so called evil, in the same fashion that we eliminate viruses that endanger our species.

Best regards,

Econolicious

Dink said...

"If we don't criminalize the battering of the planet and coerce the ignorance that allows this battering into submission, we risk the loss of our species on this planet. The survival of our species on this planet can not be achieved through democratic means. This planet Earth, is simply not going to allow us the timeframe to build consensus and vote for solutions to this problem.

Exciting stuff, Econolicious! I think I'll post it at the saloon along with some outrageous edicts that would bring down several industries and see if anyone will fight with me. The weekend is coming and we all need stimulating entertainment ;)

Debra said...

Well, Econ...
Nice to know that when the boot comes down on my head, YOU will be wearing it...
Ah.. it feels SO VIRTUOUS to be able to tell oneself that one's beliefs are... the truth, the whole truth, and nothing but the truth.
And... generations of people have been telling themselves this, too. Since Western society got off the ground, one generation to the next has burned people at the stake, or other less than savory practices for not believing in the speaker's "truth"...
The more it changes, the more it stays the same, as the man said.
And don't you bet for a minute that I am a Bushie, or a member of the Republic right, cause I'm NOT.
Geez... all these people who just GLORY in the idea of telling each and every one of us what to do, or what to believe. For our own good, of course. There are more and more of them every day, it would seem...
Snort.
I don't like this kind of talk.
I find it extremely.. COUNTERPRODUCTIVE, as it turns out.
What lots of people don't seem to realize is that in a sneaky way they are really MORE interested in being right than in having things change.
You better believe it. Being right... is a passion, I say (and I am well placed to state this, believe me... ;-) )
Where is your.. DELICATE HUMOR right now, Hell ??
I think it is just what the doctor ordered...
Tiago... I am scaling down my lifestyle too, but I don't particularly relish going back to the nineteenth century, you know.
Do you want to see your kids working as chimney sweeps, or in the factories ? 15 hours a day ?? (Factories ?? WHAT factories ??...) What do you think is going to STOP this evolution if we don't demonstrate and say no ?? (God, at this point, maybe we're gonna have to tout pickaxes in order to get the people in power to back down a little...)
Y'all already know that I have complicated ideas about work... I'm not hostile to meaningful work, and I believe that man is happier when he is occupied in such a way as to feel that he is contributing to the GENERAL GOOD, but the idea of EVERYBODY having to slave away as drudges in order for us to be worthy of our MONEY, well, I think that idea sucks.
Time to get rid of it, I say.
"Genetically induced mecanisms for self preservation and self interest"...
IS THAT YOU ? What YOU believe ?
That is unadulterated determinism.
Under determinism... no change is possible, we just mecanically reproduce what we are PROGRAMMED to reproduce.
May as well go out and put bullets in our heads with deterministic ideas like that.
What's the point of living if it's all decided ahead of time anyway ??
Most of the time people who say stuff like that (hope it's not you, Eco...) secretely think that... OTHER people are determined, but THEY miraculously escape the fate of all the other brutish louts on the planet.
Best not to believe in determinism.
In my opinion...

Anonymous said...

Debra:

It's either or..... I personally prefer the or....

I don't see anything in the middle, if you do enlighten me....

Also, I hardly think that you will need anyone to place their boot on your head, least of all me.... :-)

Ciao,

Eco

Debra said...

It's the coercion part that I'm not keen on.
I know, I know... I don't sound very charitable, I will grant you that. Mea culpa.
Over there on naked capitalism they would pat me on the head if I attempted to go into why either/or creates a society based on increasing exclusion of ALL of its members, and why the AND word IS SO MUCH MORE RATIONAL, you know ?
It's called... live AND let live.

Anonymous said...

"Likewise, for every incremental unit of savings to exist we must, by definition, create an incremental unit of debt."

I am sorry, I do not understand. Imagine a steady-state, truly sustainable economy with stable population, where no new money is ever printed, the interest rate is permanently zero percent, People save only for a rainy day, and money is not perishable by design. Does your statement hold in such a world? Everyone saves, no one has debt. Correct?

Debra said...

I'm afraid that all steady state theories of economics, for example posit PEOPLE whose behavior is solely rational.
Models are fun, and it is fun making them, but, when their basic hypotheses are flawed, well, it seems to me that their conclusions will be flawed, too.
Of course, I agree with the quote that Hell has stuck in the margins of this blog, about the (un)predictability of the markets.
Which is based on.. the unpredictability of the human being. Logical...