China's devaluation of the yuan is an ominous move: Steve Forbes

The roller-coastering dollar is wreaking economic havoc in just about every nation and provides fuel for 1930s-style currency wars and protectionism

China's devaluation of the yuan is an ominous move: Steve Forbes

China’s devaluation of the yuan underscores the ongoing, dangerous, growth-retarding mess of US monetary policy and, indeed, the fundamental deficiency of modern economic thinking. This intellectual bankruptcy threatens the ability of economies to grow and will consequently breed more political turmoil here and around the world.

Long term, it means the dollar’s days as king of all currencies will be over unless the next President knows enough to reverse the greenback’s decades-old slide in value. Some key points:
● China’s move isn’t your traditional devaluation. Rather, it’s a response to the dollar’s recent (but temporary) surge in value. Dollar instability wreaks havoc, whether it’s strengthening or weakening. On a trade-weighted basis the yuan had surged 22 percent, since mid-2012, before Beijing took action.

● The dollar’s strength will likely continue. Unless the Federal Reserve changes policy on interest rates and bank regulation, bank lending won’t be strong for consumers or small and new businesses. The Fed has effectively frozen bank reserves, which means that the very thing it and every other central bank ostensibly fears—deflation—will continue. The yuan, despite Beijing’s reassurances, will likely experience small, continuing devaluations. Commodities, such as oil, gold and copper, will experience more downward pressure.

● China’s move won’t be without consequences. A number of Chinese companies and local governments in recent years have taken on dollar-denominated debt. The current upheaval will spur even more capital outflows from worried, well-to-do Chinese. The uncertainty will hurt domestic investment by internal entrepreneurs and will cause foreign direct investment to slow. Political tensions with the US—already heating up (both Democrats and Republicans are upset with Beijing’s assertiveness in claiming disputed waters and ocean real estate)—will be exacerbated. None of this bodes well, short term, for a vigorous resumption of growth.

● Beijing may use dollar instability to set up a yuan-centred trading and monetary bloc with some of its neighbours, especially Indonesia, to reduce US influence. The roaring greenback is increasingly wreaking currency and economic havoc in countries like India, Indonesia, Malaysia, Thailand, South Korea and the Philippines. Combined with Obama’s slashing of US military strength and his deliberate weakness vis-à-vis Iran, ISIS and Russia, the dollar turmoil gives Beijing the opening it needs to begin patching together an Asia co-prosperity sphere that would isolate Japan and freeze out the US. This is a recipe for deadly instability.

● If monetary policy today were a company, it would be declared insolvent. Today’s economic nomenklatura think money is a tool to drive and control economic activity. That’s about as accurate as saying that manipulating the way scales measure weight can drive down obesity levels. Money is not wealth. It measures the value of products and services, just as scales measure weight. Fixed weights and measures are essential to a smoothly functioning marketplace. So is money that has a stable value. Unstable money hurts investing. After all, why take a risk if you don’t know the value of the currency in which you’re going to get paid back? It shortens the investing time horizon. The longer the wait period, the more risk of chaos.

By suppressing the market price of borrowing and lending dollars, the Fed has reduced the volume of bank lending. The decision of the US Treasury Department and the Federal Reserve in the early part of the last decade to gradually weaken the dollar has cost the global economy billions of dollars in lost growth. The weak greenback set off a commodities boom that sucked up billions of dollars in investment. The thinking was that if prices were going up that could only mean we needed more of those things. But the price signals were wrong; they weren’t a reflection of scarcity but of dollar weakness. This was even more glaringly evident in the false housing boom.

Overseas, surging commodity prices led to impressive prosperity in such countries as Brazil, Russia and South Africa. Now, however, these countries are suffering economic contraction, made worse by the strengthening dollar.

The roller-coastering dollar has hurt just about every nation, which is hardly conducive to sound domestic politics or constructive global behaviour. It provides fuel for 1930s-style currency wars and protectionism.

China's devaluation of the yuan is an ominous move: Steve Forbes
Image: Chaitanya Dinesh Surpur

Will China Boom Again?
Is China losing its mojo? Some see its currency devaluation as an anxious effort to stimulate exports and boost lagging economic growth rather than as a defensive response to the surging dollar. Other worrisome moves:

● Beijing’s pending strike against online financial services. At the apparent behest of the country’s state-owned banks, the Bank of China is readying rules that would severely restrict third-party online payments, dealing a severe blow to such online sellers as Alibaba and Tencent. The real target? These and other companies’ online financial services. Alipay, a part of Alibaba, has a money market fund with almost $100 billion in assets. An online banking system has been rapidly evolving that can effectively, and cheaply, serve consumers and small businesses.

Most of China’s 40 million-plus nongovernment-owned enterprises are ignored or ill-served by China’s mammoth legacy banks. Online retailers, in contrast, have a wealth of information about the creditworthiness of hundreds of millions of people and tens of millions of small businesses that mostly reside in a legal and banking twilight zone. These firms usually pay exorbitant interest rates from “shadow” lenders. Thanks to high tech, a financial system to meet their needs has burst upon the scene almost overnight. Consumer lending services are arising, too.

Incumbent big banks aren’t happy. Online services, under the rules being foisted on them by the big banks, will be crippled. There is one exception: The online services offered by big banks! If regulators accept these proposals, China would have delivered itself a major economic blow.

● The curse of Keynes. In response to the 2008–09 economic crisis Beijing went on a stimulus binge. The splurge of construction spending kept China’s GDP humming, but a huge amount of this capital was wasted on at least ten major ghost cities and other white elephants. Overall indebtedness exploded. Contrary to Keynes, who thought make-work was great, capital wasted at the government’s behest doesn’t create a strong economy, and China is now paying the price.

● This blunder led to others. Beijing actively stoked the recent stock market boom, which went spectacularly bust. This, in turn, led the bewildered government to freeze much of the market. The original theory was that rising stocks would encourage companies to sell equity to redress their debt-heavy balance sheets. The response was massive borrowing to buy stocks.

The current regime strikes some observers as once again favouring state-owned or politically well-connected companies, thereby falling into the kind of statism that ultimately stultifies an economy. Also creating uncertainty is a major anticorruption drive that many see as a political purge.

So is China headed for a Japan-like era of economic stagnation? Unlikely, and the reason is the survival of the Communist regime. A prolonged slowdown would be catastrophic for the Party; the economic boom that has existed since 1978 gives the regime its legitimacy. Soon, President Xi will have to push through reforms. These will have to include major tax cuts and simplification, pulling back restrictions on the rise of online financial services, easing the process of starting a legal business and pushing harder—and more consistently—to liberalise capital markets. Then those overlooked small businesses will once again make China an economic juggernaut.

Steve Forbes is Editor-in-Chief, Forbes

(This story appears in the 02 October, 2015 issue of Forbes India. You can buy our tablet version from Magzter.com. To visit our Archives, click here.)

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  • Deepak

    Great read.Thanks!

    on Sep 21, 2015
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