If Treasury Secretary John Snow would leave well enough alone and quit attacking the Chinese yuan and Japanese yen, investors could look forward to an optimistic worldwide scenario of rising stock markets and economic recovery. The major central banks have poured in new liquidity to end their deflation woes, and many countries — especially the U.S. — have cut taxes to stop investment drag. But Secretary Snow and other representatives of the Group of Seven industrial nations stood firmly in the way of these positive developments with their new push toward “flexible” currency exchange rates and their move away from the old policy of exchange-rate stability.
This new G-7 policy is a little piece of trade-protection mischief orchestrated by Snow (and the White House political office) at the request of the National Association of Manufacturers. The NAM wants a cheaper dollar so they can make their goods less expensive for export. A rising yen and yuan works toward this selfish aim.
Why selfish? A cheaper dollar also raises the cost to businesses and consumers for goods and services purchased abroad. But that’s beside the point for political interest groups like the NAM (or the steel and farm lobbies).
Currency manipulation has an ugly history. Back in 1986-87, the NAM persuaded then-Treasury Secretary James Baker to pick a fight with Japan and Germany in order to make their currencies more expensive and the dollar cheaper. That piece of financial handiwork led to the October 1987 stock market crash and temporarily signaled the end of the Reagan boom.
In the late 1990s, the International Monetary Fund put big pressure on various Asian tiger economies to float their currencies. As soon as the tigers caved in, their currencies collapsed, along with their economies. The virus of financial disarray spread worldwide.
The White House, of course, is worried about creating new jobs in the manufacturing sector, a development that will come naturally as the U.S. economy moves ahead in the production of new inventories and capital equipment. But on the first trading day following the G-7 agreement both stock and bond markets sold off worldwide in a clear vote of no confidence.
There’s an age-old rule that comes into play here: The currencies of emerging nations don’t float — they sink. Newly developing countries need reliable money in order to attract desperately needed foreign investment. Without new capital they cannot grow. But new capital depends on a steady currency. Economist Arthur Laffer called this the “moneyness of money,” a necessary condition for economic growth.
China is a great example of this. For ten years the Chinese yuan has been pegged to the dollar, prompting billions of dollars worth of foreign investment to flow into China’s emerging market-oriented economy. Even during the Asian fiasco in the late ’90s, the Chinese steadfastly anchored their money to the U.S. dollar. At the time this was regarded as a big plus for world financial stability.
Integrating China’s modernized economy is not only important for world growth, it gives the Chinese a comfortable seat at the high table of international diplomacy. Badgering China’s money and undermining their 10 percent growth rate will not help the U.S. deal with nuclear-threatening terrorist outlaws in North Korea.
Since it costs about $1,200 per person to create a new manufacturing job in China, compared to $26,000 in the U.S., a modest appreciation of the yuan is not going to solve anything. But it could destroy a nascent prosperity, both there and here. Same in the case of Japan. The yen has been slowly appreciating as a result of Japan’s improving economy. Pushing them toward a faster currency adjustment, however, could cause worldwide financial instability.
In order to stabilize their currency rates, Japan and China have purchased $96 billion of dollars on currency marts in the first half of 2003, and reinvested them in U.S. Treasury debt. Effectively, these nations are financing the Iraq war. Why would the U.S Treasury prevent this? Meanwhile, a major loss of dollar value could lead to an unholy interest-rate spike that would completely unhorse the current stock market rally and business recovery.
If worldwide dollar demands keep falling, then the new overhang of unwanted dollar liquidity circulating at home and abroad could trigger a new bout of inflation. Gold prices are marching toward $400, a level that some economists believe is a signal of excess liquidity and higher future inflation.
When it comes to international currencies, the best thing that can be done to promote world recovery and President Bush’s reelection is absolutely nothing. Tax cuts and steady money will do the trick if left to their own devices.
Why anyone would wish to throw a monkey wrench into global recovery is hard to understand. If it ain’t broke, don’t fix it.
— Mr. Kudlow is CEO of Kudlow & Co.