Replies

Yazoo,

You touch on a number of discrete topics here.

The Chinese have pegged (through buying and selling in the open market) their currency to the US dollar for a number of years (I believe it was 1994). By allowing their currency to float (removing the peg) their currency will revalue (appreciate) versus the US dollar, which will devalue versus that currency: the markets, without the peg, at what point we know not, will correct any diseqilibrium. Note that it can persist almost indefinitely. Without removing the peg, declining US dollar value would indeed impact the $165 billion portfolio of dollar assets now held by the Chinese.

But it's not as simple as 'not taking more US dollars.' We're on a subject far afield from currency exchange at the local bank branch. The Chinese central bank owns dollar assets (bonds) which of course are liabilities of ours to them. We pay interest on the bills, notes, bonds. That's why economists call this willingness to hold dollar assets 'financing our spending habits,' which their commitment is in a literal sense. Many people think of central bankers as portfolio managers, trying to make the most of their portfolio of reserve currencies. Nothing could be further from the truth. They peg to keep their goods and services competitive, and the price is holding dollar assets.

You're correct in that sourcing is will ultimately benefit us. After all, our most recent data suggests that where 8.2 million jobs are sourced overseas, some 5.4 million are insourced, to all fifty states. We're the most productive, most innovative, most inventive economy in the world, and a net beneficiary of job sourcing. The dollars may indeed by spent here. But they may not. Whatever the case the dollar out there is a liability.

Which brings me to my final point. Alan Greenspan said last year, twice, that our trade imbalance (part of the current account) cannot be separated from our capital account, that there is no unidirectional causal relationship between the trade balance and capital flows. What this means is that foreigners' willingness to hold dollar assets may in turn further our current account deficit.

But make no mistake, our current account deficit and our capital account surplus are both liabilities. And so Tamny is wrong. Some of what he says is of value, to be sure. But he's just plain wrong in a fundamental way.

The wisest people in the game know that the dollar is dramatcially overvalued. And so I would ask: you gonna believe Tamny? Or Alan Greenspan, Roger Ferguson, Ben Bernanke & the Board of Governors of the Federal Reserve, all twelve Federal Reserve Bank's economists, central bankers from around the world, etc., etc.

Your call.

I had forgotten that China had pretty tightly pegged its currency to the dollar (yuan per US dollar - 8.277 (2003), 8.277 (2002), 8.2771 (2001), 8.2785 (2000), 8.2783 (1999). Source 2004 CIA Factbook). You are quite right that China could "un-peg" the yuan, which capital markets would treat as lack of confidence in the dollar, which would depress the value of the dollar, which would depress the value of China $165 billion dollar-denominated portfolio, which would sharply raise the cost of Chinese goods sold to U.S. consumers, which would sharply reduce China's exports to the United States. I'm no economics expert, but I don't think the Chinese would be willing to do that.

My main point was that the Chinese can't immediately demand redemption of their dollars in yuan or immediately foreclose the mortgages on all the FNMA and Freddie Mac portfolios they have purchased over the years (which you didn't suggest but as other Freepers have). The Chinese are stuck with the dollars they have, regardless of their enthusiasm (or, more appropriately, the lack thereof) for acquiring more of them.

You are also quite right that "our current account deficit and our capital account surplus are both liabilities." Read literally, Tamny seems to be saying that if a $165 billion deficit is good, a $1.65 trillion one would be better and a $16.5 trillion one would be better still. Although some Democrats do (occasionally seem to) make that argument, I don't think that's what Tamny is saying. I think he is responding to doom and gloom reportage and pointing out (correctly, I think) that trade surpluses, in and over themselves, aren't all they're cracked up to be.

I think you hit the nail on the head when you wrote "They peg to keep their goods and services competitive, and the price is holding dollar assets." The price of holding dollar assets is just another cost of doing business, like materials, labor, and capitalized costs (as we in the debt-laden West treat interest as just another cost of doing business).

The risk is that as China's cost of doing business rises, its willingness to produce stuff to sell to Americans in exchange for dollars declines. Thereupon, the Wal-Mart haters of the world would rejoice!