All’s Fair in Love and Currency War

The Fog of (Currency) War
[courtesy Google Images]

The Washington Times

“In a potentially major move for trade and relations with the U.S., China’s central bank has decided to devalue its currency in a bid to shore up its sluggish economy.”

Most economists agree that increased inflation can “shore up” a nation’s sluggish economy.  But modern inflation on the international level is relative to other currencies much like a teeter-totter.  When one currency goes up, the other currency must go down.

If the Chinese yuan is inflated relative to the US dollar, the dollar must be deflated in relation to the yuan.  If the Chinese yuan goes down in value, the US dollar must go up in value.

I’ve argued for years that the US government wants and depends on inflation.  Proof?  Look at your fiat dollar.  It’s lost 95% of its purchasing power since we went off the gold standard in A.D. 1971.  That’s evidence of persistent inflation over a period of 40 years. That’s not a fluke.  That’s evidence of established governmental policy to promote inflation.

In fact, government (being the world’s biggest debtor) may not be able to survive prolonged deflation since it compels all debtors to repay their debts with more valuable dollars.

If my argument is correct, China’s decision to inflate the yuan will force additional deflation of the dollar.  Chinese yuan inflation will presumably help the Chinese economy but, the inflation/deflation teeter-totter will also cause US dollar deflation.  That deflation will harm all debtors, including the US government.  It should push the US economy toward depression.  That deflation might even threaten to impair or destroy all debt-based currencies.

Teeter-totter.  If yuan inflation helps China, it hurts the US.

From that perspective, did China inflate the yuan to “shore up” China’s economy?  Or did China inflate the yuan in order to deflate the dollar and push the US economy closer to depression and the US government closer to insolvency?

Did China inflate the yuan as a benign act of economic self-preservation?  Or did China inflate the yuan as a deflationary attack on the US dollar and US economy?

Or was it both?

• “China’s decision to devalue the yuan sent shock waves throughout other Asian currency markets Tuesday, as China’s neighbors may have to let their own currencies devalue [inflate] to stay competitive withChina.  The South Korean won and the Australian, Singapore and New Zealand dollars all lost ground against the U.S. greenback.”

We’re witnessing a chain-reaction whereby China, by inflating the yuan, has caused a number of other nations to also inflate their currencies.  This currency inflation is being achieved in relation to virtually all other currencies—but occurs primarily in relation to the World Reserve Currency—the US dollar.

In fact, it crosses my mind as pure conjecture that that we might be looking at the Achilles Heel of any World Reserve Currency:

1)  Global economic decline;

2)  Which causes nations compete for falling market shares by inflating their own currencies in currency wars;

3)  Which global inflation (like a teeter-totter) causes the World Reserve Currency to suffer deflation;

4)  Which triggers an economic depression and possible political chaos in whichever country produces the World Reserve Currency;

5)  Which causes the world to seek a new World Reserve Currency and a new issuing-nation to lead them.

In other words, it might be that so long as the global economy is strong, there’ll be no currency wars and the World Reserve Currency will inflate and stimulate the economy of whichever nation issues the World Reserve Currency.  The world will go along with inflating the Global Reserve Currency so long as most of the rest of the nations experience rising prosperity.

But if the global economy slides into recession or depression, the other nations will stop following the World Reserve Currency’s lead, start inflating their own currencies and thereby deflate the World Reserve Currency and push the nation that issues it towards insolvency, bankruptcy and economic depression.

•  Implication: Any nation that issues a World Reserve Currency had better guarantee that the global economy continues to expand.  Once a global contraction begins, whatever currency is the World Reserve Currency will be pushed into deflation and the nation that issues it will be pushed into depression.

Remember, monetary deflation is a hallmark of economic depression.

The dollar has been deflating (growing in value in relation to foreign currencies) on the international level for the past 18 months.  Technically, dollar deflation signals that we may be approaching, or already in, an economic depression.  China’s decision to inflate the yuan will tend to exacerbate US dollar deflation and push us closer to, or deeper into, an economic depression.

Is China inflating the yuan to help China or to deflate the dollar to attack the US economy?

I think the answer is “both”.

•  But there’s a fly foolin’ around in my ointment.

If my theory is true that

1. There’s a teeter-totter relationship between the Chinese yuan and the US dollar; and therefore,
2. if it’s also true that when the yuan inflates, the dollar must suffer some correlative deflation, then after China devalued its currency by 1.9% on Tuesday and reportedly by another 1.6% on Wednesday; then,
3. We might’ve expected the dollar’s value as measured on the US Dollar Index to have increased as evidence of deflation; However,
4. The dollar’s purchasing power as measured on the USDX actually fell by more than 1% on Wednesday.  We’re expecting to see the USDX rise as evidence of deflation but what we actually saw is a fall that’s evidence of inflation.

How’s that possible?  Doesn’t that prove that my “teeter-totter” theory is all hot air?

Maybe.  But, not necessarily.

The USDX consists of seven currencies:  the US dollar as World Reserve Currency sitting all by itself on one end of the “teeter-totter”–and six other currencies (euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc) on the other end of that particular “teeter-totter”.  The USDX does not include the Chinese yuan, so it’s entirely possible that while the dollar is deflating in relation to the Chinese yuan, it’s inflating in relation to the six other currencies in the USDX.

Oh, what a tangled web we weave when first we practice to issue fiat currency in a debt-based monetary system.

Where philosophers once complained about “wheels within wheels,” we now have “teeter-totters” sitting on “teeter-totters”.

Result?  Mind-boggling confusion.

But, just because something is confusing, doesn’t mean that it’s wrong or should be ignored.  Fundamentals should prevail.  I believe the teeter-totter relationship is fundamental to the relative values of any two currencies.  If the yuan is going down in value, the US dollar (in relation to the yuan) must be going up.

•  I’m beginning to suspect that the world will follow any World Reserve Currency so long as the world economy is growing.  Whether that growth is due to dumb luck or the superb leadership skills of whatever nation issues the World Reserve Currency may be irrelevant.

Once the global economy begins to shrink, the nations of the world lose confidence in the leadership of whatever country had been issuing the World Reserve Currency.  Once that confidence is lost, the world will seek a new leader and a new World Reserve Currency that can once again grow the global economy.  The former World Reserve Currency and the nation that issued it will be sacrificed like lepers on the altar of economic depression.

So long as the world economy is growing, whatever nation issues the World Reserve Currency will be allowed to get away with just about anything.  That nation will live like a queen. But, once the world economy begins to shrink, the nation that’s been issuing the World Reserve Currency won’t be able to get away with anything.  It will live and perhaps die like a leper–shunned by all.