Recent Examples in Currency Manipulation

This is the sixth post in a series entitled Currency, Money and the Economy.

One of the more interesting examples in currency manipulation involves the Japanese. When both the stock and real estate markets crashed in the early 1990’s, Japan faced a major deflation issue (similar to the Great Depression). Remember, in order to combat deflation, you need weaker currency (more currency in circulation). Therefore, the Japanese tried the following solution. They printed 35 trillion yen out of thin air. They traded all of it on the FOREX market for US dollars, thereby deliberately watering down their own currency. Then, in turn, Japan turned around and loaned those US dollars back to us for 30-year US treasury bonds paying way higher interest than they were getting in their own country. Then they printed more yen for their own circulation purposes. This is known as the Yen-Carry trade and up until now was working with some effectiveness. Unfortunately, Japan did not anticipate that the United States would eventually go through the same thing a decade later, so now they are trying to unwind their own trade.

China has been in the news recently for supposedly violating international currency trading rules. However, China is manipulating their currency in a different manner. China has a nation of savers; therefore, their biggest fear is inflation. Since the United States is nation of spenders, its biggest fear is deflation. Therefore, China has artificially pegged the value of the Chinese Yuan relative to the US dollar in order to keep inflation in check. As long as we keep in inflation in check on our side of the Pacific, China is perfectly content going along for the ride. China also buys every US Treasury bond they can to avoid selling US dollars on the FOREX market, which would make the US dollar weaker relative to the Chinese Yuan. This allows China to keep exporting inexpensive goods that the American consumer cannot live without.

The United States want China to comply with currency trading rules by removing the peg. However, some warn the government be careful what it wishes for. Think about a person who has slipped into a frozen river. When you pull the person from the river (still alive), the medical advice is to warm the extremities first, then the heart. The reason is that if you warm the heart first, it will fool the rest of the body that it has returned to normal temperature and send all of the cold blood back to the heart, causing cardiac arrest. So with all the debt that China has collected on the United States, what if they decided to send that avalanche of US dollars back through our door all at once? That's correct, we would be dealing with inflation not seen since the early 1980’s. China will eventually remove the peg at its own pace anyway. How do we know this a certainty? Because at some point the US dollar will become so worthless with the debt they are piling up that China will have no choice but to disassociate itself from the United States and take their chances out in the real world.

So what does all of this currency manipulation really mean anyway? We’ll discuss the consequences in the next post.