When President Bush tapped Ben Bernanke to take over at the Federal Reserve, Sen. Lindsey Graham was very generous with his praise toward the outgoing Fed chair. He told reporters, “I hope [Bernanke] will continue the pro-growth policies Alan Greenspan championed as Fed Chairman.” About Greenspan, Sen. Charles Schumer once noted that “Longevity is testament to [his] excellence,” and his “ability to balance prosperity and inflation are second to none.”
Though he frequently commented on tax and trade policy, the one policy lever Greenspan truly controlled was the dollar. Well aware of Greenspan’s role, both Schumer and Graham made the implicit admission that Greenspan’s manipulation of the dollar’s value helped create an environment in which the economy could grow.
This is notable in light of efforts by both senators to get China to revalue the yuan upward. Graham and Schumer have frequently said the yuan is undervalued, and that the Chinese purposely manipulate the currency to keep it where it is. Still, in arguing that it needs to be adjusted, they’re making the explicit admission that all currencies are manipulated by their issuers, and that China should do the same. Manipulation apparently isn’t the problem — the value of the yuan is.
There is much duplicity to be found within the senators’ specific praise of Greenspan.
Considering the Chinese began fixing the yuan to the dollar in 1994 (seven years into Greenspan’s chairmanship), their current view suggesting the yuan is undervalued rings a bit hollow. If, as Schumer has stated, Greenspan was able to balance prosperity and inflation second to none, how would China’s shadowing of the Greenspan Standard lead to an undervalued yuan?
Rather, Chinese monetary authorities clearly recognized the good works of Greenspan in the way that Schumer and Graham did, and pegged the yuan accordingly. Inflation is a monetary phenomenon. So, if Greenspan managed the dollar’s value in a non-inflationary manner, the yuan must not have been undervalued or overvalued if Graham and Schumer’s praise of Greenspan was sincere.
Thanks to the ability of the Chinese authorities to mimic what the senators deem pro-growth monetary policy stateside, both the Chinese and U.S. economies have grown handsomely since the yuan/dollar peg was initiated thirteen years ago. In that time, total trade between the two countries has risen 500 percent, while U.S. exports to China have grown 367 percent.
China is now the fastest growing trade market for U.S. companies. With the former still closely shadowing the monetary policy of Ben Bernanke — another Fed chairman deemed top notch by Graham and Schumer — it seems the senators’ main problem with China has to do with its economic success on the U.S. Fed standard. Graham and Schumer would clearly like China to abandon its present monetary standard. But if monetary authorities over there aren’t up to the job, have the senators considered the foreign-policy implications of a China mired in recession?
Graham and Schumer might reply that if the yuan’s value were set in the markets, the former would rise in value and all would be fine. Ignoring for now the potential deflationary implications of a substantial rise, have they considered the possibility that the opposite might occur?
The senators forget that a currency’s value is very much rooted in the credibility of its issuer. With authorities possessing no real experience in managing a currency, what’s to say the yuan wouldn’t go into freefall absent the credible guidance of the U.S. Fed? Along those lines, Graham and Schumer would do well to consider how the markets priced the dollar once its relationship with gold was severed in 1971. Lacking the credibility offered by gold, the dollar, as is now well known, plummeted and the inflationary 1970s began.
Schumer and Graham have made it known that they’re only using the threat of tariffs to get China to revalue the yuan. But they fail to assess the potential unintended consequences of such a revaluation. Simply, a floating currency is very difficult to manage, as evidenced by the six U.S. recessions since 1971. If Chinese monetary authorities prove they’re not up to the task, Graham, Schumer, and the rest of Washington might yearn for the days when China mimicked our own monetary manipulations.
– John Tamny is editor of RealClearMarkets. He can be reached at jtamny@realclearmarkets.com.