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...