Strong Chinese Yuan Does Not Guarantee USA/Europe Economic Recovery

Saturday, Dec 31 2012

We are not in the era of 70’s or 80’s. In the early 70’s USD was clobbered as President Nixon decided to cancel the direct convertibility of USD to gold that essentially ended the existing Breton Woods system of international financial exchange. Until then gold was fixed at USD 35 per troy oz. Then, one USD would fetch yen 360, GBP 0.42, Swiss franc 4.30, and Deutsche mark 3.60. Today, the parity versus is YEN 76.87, GBP 1.5545, CHF 0.9389 & EURO 1.2955. 

This suggests that US Dollars weakened substantially during all these years, but the US economy continued to suffer and despite weaker USD, which led to global financial crisis having contagion effect because all the effected economies are faced with similar type of issues.

The major cause behind this suffering is over leveraging and over valuation of assets that was helped by the following………

-Weak regulation
-Allowing Spending to Exceed Revenue Collection
-Rating agencies failure to timely identify the risk
-Allowing changing of Accounting Rules
-Bailing of Failed Banks for their Wrong Doings
-And most importantly Non-Disclosure and Hiding of Real Numbers (e.g BIS in one of its 2009 report mentioned about DERITIVES amount of $ 743 Trillion) There is No News.

Therefore demand for Strong Chinese Yuan is a political excuse by the world leaders to cover their mistakes and gain some mileage.

If we go back to the 1980-90 era the European growth was lackluster ranging between 1% to 2%. Until 1990 Japan’s economy was commonly known as “Miracle Economy”, but it lost its gloss as the economy crumbled into recession, it’s been a decade and yet it is struggling to come out long recession. During this period the Britain’s economy was performing poorly.

In 1980, US Public debt was $909 Billion. Today US debt has reached $ 15 Trillion. Until the mid of 1990, the US economy was considered as the world’s leading economy, but there after cracks started to appear. The hole in the US economy is so large that truly speaking it unlikely to get back on track with the current window dressing approach. Changing accounting rules, Nationalization of large corporate sector, using taxpayer’s money and by maintaining low interest rate combining it with injection of liquidity through quantitative easing is only a temporary solution. Substantial cut in spending and huge revenue collection by imposing tax on profitable business is the only solution to the problem.

European economy too has fell into a trap is facing a similar situation. They too are following the footstep of USA, which has failed to produce the desired result. ECB's independence is questionable, as it had compromised on many issues such as it was not suppose to give concession but allowed to lending to junk grade. It was not supposed to purchase bonds directly but it is buying bonds from secondary market. Earlier Euro zone rules did not allow assistance to governments to finance deficit, but they have been breached. So Europe is required to drastic measures to get out of the mess.

Comparison between China & West

The Western policy of past to shift its business to East for cheap labor has backfired. This has only helped the Western countries to maintain artificially high growth rate and high standard of living, which is no more manageable in real sense without cash money, they are now paying a very high price, because the cycle has shifted. Job situation is getting from bad to worst. Their older generation may have enjoyed the best of times by leaving smaller jobs for immigrants, but immigrants are now a cause of big concern. Although, modernization is one area that West or so called Developed Economies can boast of making gains.

China that had Fx reserve of $ 2 Billion in 1978 during all these years played smart. It was concentrating on growth and was less involved in global politics. The IMF’s, the World Bank and other Global institution was praising the Western policy and criticizing China. Since 1980 with a broad smile on its face was growing between 9-10 pct. It took advantage of its cheap labor and currency and concentrated on exports. Today, unlike desperate West, China enjoys foreign exchange reserves of $ 3.3 Trillion and its economy is still performing well.


China’s growth is based on Western model, but the key to the success is its ability to modify it according to the country’s culture and specification. Chinese leaders that were responsible for launching China’s economic model had the intention to make China big and strong. In 1981 the poverty rate in China was 64 pct that has come down to below 10 pct. The world is struggling to raise its national savings rate. China enjoys a savings rate in excess of 40%. Imagine China’s determination, its ability and future prospect. In 2009, China produced 560 million watches and in the same year Switzerland produced 22 million watches.

China is always keen to discuss new economic models. Today, China has engaged USA in vendor finance, providing money that helps finance the huge US fiscal and trade deficits, allowing Americans to buy more goods than they sell.

However, China’s economic slowdown is now visible and indications are that for the first time since 2001 China’s growth could fall below 9 pct. Strong Chinese Yuan and global slowdown could hurt its exports. 

Furthermore, its banking system is at huge risk, as lending in recent years by Chinese banks has surpassed USD 7 trillion. Evidence of economic slowdown is clearly visible because it’s small to medium size private export business houses are showing signs of nervousness. China’s external debt is not a cause of major concern, but there is an increase risk of default to funding of roughly USD 1.7 trillion that has been provided for construction or infrastructure by local the government could disturb its banking structure. Though in case of solvency, Chinese government would certainly step in to rescue its financial system. In such a scenario the possible risk could be that investment to GDP (size 5.9 Trillion) could be badly hurt, which is roughly over 45 pct and this could be the melting point for the Chinese economy. 

Despite all the difficulties, I still see growth potential in one area that could provide temporary boost to China from absorbing any sudden jerk and i.e. it’s the domestic consumer market due to its 1.3 billion populations. China’s consumer spending is a major contributor to its GDP, which is around 36 pct. 

However, the honeymoon period will not be forever, it all matter of time. Though very difficult to predict the estimated time due to frequent engineering of economy at all levels, but one thing is for sure that I know is that China’s economy will surely burst and the cracks  could start appearing within next couple of years.  

http://www.forexstreet.net/profiles/blogs/strong-chinese-yuan-does-not-guarantee-usa-europe-economic