Monday, January 19, 2009

Must Read by Eric deCarbonnel

Eric deCarbonnel writes a wonderful piece on his predictions for the future of China.
The conventional wisdom on China is dead wrong. Specifically, there is a widespread belief, as expressed by Goldman Sachs, that "China will keep the yuan trading within a narrow range in 2009 due concerns about exporters." Worse still, others are even predicting that China will devalue its currency! The sheer wishful thinking is astounding! The idea that "China will keep the dollar peg to help its exporters" ranks all the way up there with "Housing prices always go up" and "You can spend your way to prosperity".
He predicts hyperinflation in China and a collapse of the US dollar. I disagree with a very little bit of it. For example, it is difficult to criticize "others" for "predicting that China will devalue its currency" when one is arguing that China will begin printing money like crazy and inducing hyperinflation. Same-same, no? But that is okay. Mr. deCarbonnel is clearly not an Austrian. He persistently describes inflation and deflation in terms of prices instead of money supply, which is pretty much a giveaway. He is probably looking at "devalue" in terms of forex rates in isolation, not in broader terms. He's a "straight economist," whatever that may mean. But he does seem to understand foreign exchange and central banking better than most, and his arguments flow logically and are well backed by details and facts. I'm always short of those... He also talks about passing along increased costs, which is an Austrian no-no. One doesn't pass along costs. Higher oil prices, other costs, etc. cannot and do not cause inflation, whether defined as price increases or in terms of money supply. Buyers bid for goods. If they cannot or do not pay, for whatever the reason may be, the seller must lower his prices or forfeit the sale. End of discussion. China will become "less competitive" in US markets, but it cannot force American buyers to part with money they do not have. They might get higher prices for a time, simply out of desperation buying, but this would not be a sustainable market. They will sell at a loss or not sell at all. My guess is that they will not sell, and will lose market share to other suppliers, probably American. So its back to the factories for us, assuming we want to keep buying goods. (I would also wager that overall "consumption" in terms of volume of physical goods will be down, and prices higher as the standard of living for Americans contracts.) The other possibility, of course, is the currency devaluation that Mr. deCarbonnel could not conscien. I will not exclude that as a possibility. It could happen if China determined that it must maintain its export hegemony at all costs. But they would be high costs, as Mr. deCarbonnel points out, and quite possibly politically unsustainable. That's really the choice here: China sucks it up and accepts America's massive default, or China decides it doesn't need American business anymore because it isn't worth the headache and packs it up and leaves. Mr. deCarbonnel seems to be coming down on the side of the second possibility. China's actions hint that this is the way it is leaning. It does seem the more plausible. That does not mean it is correct. It could turn out that a few years down the road China finds out that it cannot go it alone, as its domestically driven consumption needs cannot be satisfied by its own markets (i.e. it needs access to American/foreign financial instruments because it simply cannot produce acceptable substitutes on its own, thanks to, shall we say politely, domestic business practices.) But by then the US dollar will be toast, as will our financial systems. I do not know how China would re-establish a trade relationship at that point. This would mean that China would not be the powerhouse that most are predicting even as the US collapses, just as Mr. deCarbonnel says, though not exactly by the route he lays out. At any rate, this one is definitely well worth the read, even with the flaws.

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