Janet Goes to Beijing
Janet Yellen is heading to China tonight and there is plenty of speculation about what is going to be discussed regarding China’s exchange rate policy.
When thinking about the relationship between the US and China and the $/CNY exchange rate, it’s important to remember that history often rhymes:
“There is considerable evidence to suggest that the Plaza exercise was more than a strategy to buy time. At least from the US perspective, it was a strategy to combat protectionism in the Congress (short-term strategy), to maintain world economic growth by stimulating domestic demand in Japan and West Germany (medium term strategy), and to ease the burden of debt service of the United States depreciating the dollar (long term strategy).” —Managing the Dollar: From the Plaza to the Louvre; Yoichi, Funabashi (1988)
If you replace Japan and West Germany in the lead up to the Plaza Accord in 1985 with China today, you can see plenty of similarities. And what took place in the run up to the Plaza accord as well as the the following 18 months was a highly coordinated, significant devaluation of the US$ against JPY and DM. Will history rhyme again?
China’s trade surplus is massive and continues to grow as they are able to purchase cheap energy from Russia and Iran, radically improving their competitive advantage, particularly against those countries that are not purchasing energy from Russia (especially in Europe). The US continues to complain about the China dumping products onto global markets, warning recently that the US and its allies will take action if China tries to ease its industrial overcapacity problem by dumping goods on international markets (according to the FT last month). Support for protectionist policies against China is one of the few items in DC that both sides of the aisle can come to a consensus on.
The world is also looking for China to engage in domestic stimulus to help rebalance its economy and support global growth. China is being asked to lower its trade surpluses and invest more in the domestic economy, shifting the balance of growth from exports to local consumption. So far, these efforts have been too slow for the rest of the world to accept.
Lastly, the idea that the US needs a weaker dollar to help its debt service is something I have been talking about for a couple weeks now, as the notion of fiscal dominance seems to be the reason for the Fed’s desire to start cutting rates this year despite economic data that would suggest this economy needs no further accommodation. A weaker dollar could help lower hedging costs for foreign buyers of USTs, supporting the Treasury’s efforts to finance the deficit.
Overall, it appears that most of the world now needs a weaker US$ but most importantly, the US government actually recognizes that it needs a weaker US$ in order to fund its growing deficits and to pay for domestic reshoring of manufacturing. As long as a weak dollar policy doesn’t lead to imminent inflation re-acceleration (a big if, in my opinion), the administration desires a weaker US$ in order to improve competitiveness and to help rebuild crucial supply chains at home in America.
As the US$ weakens and USTs are slowing being removed as the sole global settlement asset for trade, particularly given the US decisions to sanction and expropriate Russian reserves in the spring of 2022, I believe an alternative, multilateral currency world with Gold as neutral reserve settlement asset is being established and is to the benefit of the entire world. More “Multicurrency Mercantilism” (h/t twitter.com/Kathleen_Tyson_) will help improve global growth, lower inflation and rebalance the global order. The question is really whether the US is really ready to push this process along.
The UST selloff in late fall of 2023, which accelerated after the BRICS meeting in August, seemed to scare Treasury and the Fed into a policy pivot and brought US leaders to the negotiating table with a BRICS cohort that is growing in size, power, oil export share and geographic significance. Cleaning up the streets of San Francisco in November for Xi and MBS for the G20 meetings now looks like a step in that direction. We will see if this momentum in the US continues. Yellen heads to China where the topic of FX and China’s UST holdings are sure to be on the table.
Churchill’s quote comes to mind: “You can always count on Americans to do the right thing – after they’ve tried everything else.”
Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.
