China's Nuclear Option

It's been a stated goal of my blog not to comment on the feasibility of the political promises made by the candidates because in a way, it's all "window shopping." But at the same, it is borderline unethical to criticize the Bush administration for failing to address China's continuing yuan-dollar peg. As much as I've criticized Secretary Paulson for prematurely claiming that the housing crisis had been "contained", to his credit, he has confronted the Chinese on their currency manipulation, which has keep their exports inexpensive, despite the falling dollar. And last year, Congress did threaten to impose tariffs unless the pegging ceased. China's response?

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress . . . .

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.

Xia Bin, finance chief at the Development Research Centre (which has cabinet rank), kicked off what now appears to be government policy with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US. . . .

He Fan, an official at the Chinese Academy of Social Sciences, went even further today, letting it be known that Beijing had the power to set off a dollar collapse if it choose to do so.

"China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency. Russia, Switzerland, and several other countries have reduced the their dollar holdings.

"China is unlikely to follow suit as long as the yuan's exchange rate is stable against the dollar. The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar," he told China Daily.

It's shameful that our leaders won't admit this to us publicly; after all, how do you say that China has basically emasculated us, with the ability to dump $1T of our treasuries bonds. A massive sell-off would have the affect of driving up the cost of borrowing everything from mortgages to student loans. Both parties have been sleeping at the wheel, since it's been three decades in the making. One on hand, it's hard for the GOP to extol the virtues of the free markets when this is the result. And on the other, this situation renders much of the Democrat promises fiscally impossible, unless Congress wants to drive the value of the dollar even lower.

Game, set, match; we're out of bullets. Tariffs are out. A stronger dollar won't work because of the peg. So the question is how to prevent American consumers from purchasing goods made in China? Ten years ago, when China was seen as a low-quality producer, it would have been easier, but now they manufacture everything from Bibles to prescription medication.

Yes, our foreign policy is dictated by a foreign nation because of our addiction to all things cheap.

Lesser of Two (or More) Evils

According to Paul Krugman, the Fed's obsession with fixing the liquidity crisis and staving recession has led to out-of-control inflation.

You see, fears of a 1930s-style financial meltdown are apparently out; fears of 1970s-style stagflation are in. And the Fed stands accused of being soft on inflation.

The emerging conventional wisdom, if what I heard is any indication, is that Mr. Bernanke has been fighting the wrong enemy all along: inflation, not financial collapse, is the real threat. And to head off that threat, the critics say, the Fed has to reverse course and raise interest rates — never mind the risks of recession.

Trust me, I don't envy Ben Bernanke. First, he's staring in the face of a financial collapse, in which the banks themselves are not honest about the depths of their problems, from understating LIBOR to trickling billions of dollars in write-downs. Then, he has Congress breathing down his neck to rescue the student loan market, asking the Fed to take student loans as collateral. And, in an election year, recession is always a political liability; the stimulus package may have just exacerbated inflation. As a result, these efforts have simply unleashed a pool of money that has flooded to the commodities market, causing the current run-up in oil, food, metals, etc.

For what it's worth (although I did see the run-up in commodities last fall), I think that we need these higher prices to continue for a bit longer. Trust me, I have no love for investment banks, and I know that some people are truly hurting. I just think that the higher prices will force America to re-calibrate some of its nonsensical ways. I'm not just talking about SUVs, but also $5 Starbucks lattes and $90 Lacostes.