DummySpots.com

Asian Currency Manipulation: Keeping their products cheap and our bond yields low

25 September 2006

As promised, I’ve worked out my Photoshop doodle showing how the Chinese and Japanese governments have “intervened” to keep their currencies- and therefore their products- cheap for us prodigal spendthrifts in the U.S. Their actions have served as a secondary National Bank to our economy (our Federal Reserve being the primary one), flooding the dollars we send them right back into circulation over here at virtually the same value as when we sent those dollars overseas (the repatriated dollars would normally be weaker).

Their actions also help to explain the seemingly paradoxical fact of our Treasury yields remaining low as the Fed raised the Funds Rate from 1.00% to 5.25%. As the foreign governments have used the dollars we send them to purchase U.S. Treasuries, they have created an exaggerated demand for those Treasuries, thus inflating the price and depressing the yield.

The first image is of the “normal” (if somewhat simplified) flow of goods and money internationally and how the free market adjusts currency rates to maintain a balance. Click unless you’ve got a magnifying glass:

The second image is of how the Chinese manage to prevent their currency from appreciating and our dollar from falling by buying U.S. bonds instead of exchanging the dollars for yuan (the Japanese government do the same with the yen):

Why do I think this is important? Because at any point the governments of China and Japan could decide to reduce the rate at which they purchase our Treasuries or, God forbid, actually start selling those Treasuries rather than accumulating them.

What would happen then is a rapid devaluation of the U.S. dollar, and (paradoxically) a rising bond yield at the same time. If our economy were anything less than rock solid, we could see an uprecedented economic collapse, and our Fed only has a few points of room to “ease” and try to add liquidity.

How rock solid is our economy? Look at the rate of inflation brought on by our tepid economic growth. We’ve killed it with a Funds rate of only 5.25%. Look at the bond yields. Inverted, and yes it does matter. Look at REAL ESTATE! Home sales falling with 30-year mortgage rates below 6%!! What would happen if mortgage rates went to 12% in a matter of a couple of years?

I’m concerned. That’s why I keep hoping for these PPI and CPI numbers to show some more impressive growth. I’m afraid this big 747 is trying to stall on us.

note: due to its seeming to attract loads of comment spam, I’ve had to close comments on this article