September 27, 2016, 4:30pm EST

The debate last night was entertaining.  It’s sad to see how the media manipulates facts and cherry picks quotes to fit their narrative.

But that’s what they do and it ultimately shapes views for voters, unfortunately.

Today, I want to focus on China and Trump’s comments on China’s currency manipulation.  Everyone knows the U.S. has lost jobs to China.  Everyone knows China has become the world’s manufacturer.  But not everyone knows how they did it.

Is it just because the labor is so cheap?  Or is there more to it?

There’s more to it.  A lot more.

China’s biggest and most effective tool is and always has been its currency. China ascended to the second largest economy in the world over the past two decades by massively devaluing its currency, and then pegging it at ultra–cheap levels.

Take a look at this chart …

In this chart, the rising line represents a weaker Chinese yuan and a stronger U.S. dollar.  You can see from the early 80s to the mid 90s, the value of the yuan declined dramatically, an 82% decline against the dollar.  They trashed their currency for economic advantage – and it worked, big time.  And it worked because the rest of the world stood by and let it happen.

For the next decade, the Chinese pegged their currency against the dollar at 8.29 yuan per dollar (a dollar buys 8.29 yuan).

With the massive devaluation of the 80s into the early 90s, and then the peg through 2005, the Chinese economy exploded in size.  It enabled China to corner the world’s export market, and suck jobs and foreign currency out of the developed world.  This is precisely what Donald Trump is alluding to when he says “China is stealing from us.”
Their economy went from $350 billion to $3.5 trillion through 2005, making it the third largest economy in the world.

This next chart is U.S. GDP during the same period.  You can see the incredible ground gained by the Chinese on the U.S. through this period of mass currency manipulation.

And because they’ve undercut the world on price, they’ve become the world’s Wal-Mart (sellers to everyone) and have accumulated a mountain for foreign currency as a result.  China is the holder of the largest foreign currency reserves in the world, at over $3 trillion dollars (mostly U.S. dollars).  What do they do with those dollars?  They buy U.S. Treasuries, keeping rates low, so that U.S. consumers can borrow cheap and buy more of their goods – adding to their mountain of currency reserves, adding to their wealth and depleting the U.S. of wealth (and the cycle continues).

The U.S. woke up in 2005, and started threatening tariffs against Chinese goods unless they abandoned their cheap currency policies.  China finally conceded (sort of).  They agreed to abandon the peg to the dollar, and to start appreciating their currency.

They allowed the currency to strengthen by about 4.5% a year from 2005 through 2013.  That might sound good, but that was a drop in the bucket compared to the double digit pace the Chinese economy was growing at through most of that period.  Still, the U.S. passively threatened along the way, but allowed it to continue.

With that, the Chinese economy has ascended to the second largest economy in the world now – on pace to the biggest soon (though it still has just an eight of the per capita GDP as the U.S.).  But China’s currency is a bigger threat, at this stage, than just the emergence of China as an economic power.   The G-20 (the group of the world’s top 20 economies) has had China’s weak currency policy at the top of its list of concerns for a reason.

The current global imbalances are the underlying cause of the global financial crisis, and China’s currency is at the heart of it.

And without a more fairly valued yuan, repairing those imbalances — those lopsided economies too dependent upon either exports or imports — isn’t going to happen.  It’s a recipe for more cycles of booms and busts … and with greater frequency.

Are big tariffs the answer?  Historically that’s a recipe for disaster, economically and geopolitically.

What’s the solution?  I’ve thought that the Bank of Japan will ultimately crush the value of the yen, as the answer to Japan’s multi-decade economic malaise and as an answer to the stagnant global economic recovery.  It’s an answer for everyone, except China.  A much weaker yen could crush the China threat, by displacing China as the world’s exporter.

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