Archive for the ‘Economics/Finance’ Category

If the Australian economy ?booms? further, how is it setting the stage for a bigger bust later?

Wednesday, July 28th, 2010

Not long ago, the former Prime Minister of Australia, Kevin Rudd warned that Australia is facing a demographic crunch, which if not solved, will have grave implications on the Australian economy in the long-term. To put it simply, everything else being equal, Australians are getting older and older, which means that the Australian economy will not be able to continue increasing its production of goods and services. That means that the economic growth will slow, stagnate and eventually turn negative. On top of that, the Australian economy seems to have a problem with ?skills shortage,? which is threatening future economic growth (see Skills shortages shaping up as risk to economy).

This article is not free. A payment of 0.97 USD is required to access this article. For those who have already donated to this site, you will receive an email with the full article.

Sign in to see the content if you already bought it (sign-in instructions will be sent via email after payment).

Why central bankers are obsessed with inflation not breaching a certain band?

Sunday, July 25th, 2010

If you follow central bankers all over the world, you will notice that for many of them, their monetary policy (under normal economic circumstances) targets a particular rate of price inflation. In Australia, the RBA targets price inflation to be around the 2-3% band, according to their preferred measure of price inflation. In the US, the band was 1-2% (we doubt they are in the position of targeting price inflation now, given that they are now in the zone of unconventional monetary policy). It is not the same for every central bank though. For example, Singapore?s central bank, Monetary Authority of Singapore (MAS), based their monetary policy on the exchange rate.

By now, you may wonder why the RBA specifically target the band of 2-3%? Why not 4-5%? Why not 9-10%? Why not even higher so that price inflation will ?inflate? away the debt of the masses, as in the 1970s?

Around 4 months ago, Saul Eslake wrote a very insightful article (unusual for a mainstream economist),

 

These inflation targets were chosen because, when inflation is about ”2-point something”, people tend not to notice it. And when they don’t notice it, they tend not to do things to protect themselves against it that are likely to lead eventually to prices rising at a faster rate.

By contrast, when inflation is, say, 4 per cent or higher, experience amply demonstrates that people do notice it – and they start to do things to protect themselves against its adverse consequences, such as seeking higher wages, or (in the case of businesses) putting up prices in anticipation of faster increases in costs.

The inevitable result is that, sooner or later, inflation starts rising at a faster rate than 4 per cent, and the central bank is eventually obliged to raise interest rates to slow the economy sufficiently to bring inflation back down to 4 per cent again. But when it has done so (at some cost in terms of unemployment), people start doing the same things again to protect themselves against the effects of 4 per cent inflation.

In other words, a 4 per cent, or higher, inflation rate is unlikely to be sustainable in the way that a 2 or 3 per cent inflation rate has been. It is likely to result not only in inflation being more volatile, but also in economic activity being more volatile and, probably, slower on average.

You may notice that this is what we implied in an article that we wrote back in December 2008: Demand for money, inflation/deflation & its implication. Once you understand the logic, you will be able to see the application of systems thinking. In other words, once price inflation goes over a tipping point, it becomes a dynamic process whereby money supply will balloon in an ever increasing positive feedback loop, resulting in higher and higher price inflation rate, which if not arrested, becomes hyperinflation.

Keep up spending- Who?s right? Europe or America?

Thursday, July 1st, 2010

Sometime last year, we were discussing with someone in the finance ?industry? about the possibility of a double-dip recession. Back then, the mainstream assumption was that government spending will somehow ?stimulate? the private-sector of the economy. But we argued that this assumption was simply incorrect. As we wrote in August 2009 at Will governments be forced to exit from ?stimulus??,

In fact, the word ?stimulus? is the most misleading word in economics lexicon because it conveys the idea of a surgeon ?stimulating? a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch.

Based on this faulty assumption, the financial market?s expectation is that the worst of the GFC is well and truly over and that the global economy will return to ?trend growth.? But as we wrote in January 2009 at Soft landing hope built on faulty framework assumptions,

Built into the blinkers of the mainstream neo-classical economic framework, the assumption is that the economy is like an elastic band that will spring back to its previous un-stretched state of ?equilibrium? after being stretched by external ?shocks? (e.g. global financial crisis). For those who studied economics at university, you will realise that the phrase ?external shock? is often used in the text-books to describe phenomena that are beyond the scope of economic model. Furthermore, you will find that your text-book are full of simultaneous equations, which implies some sort of ?equilibrium? has to unquestionably happen.

Today, there is a lot of talk in the financial markets about the threat of a double-dip recession. The expected (assumed is the more accurate word) recovery in the United States seems to be stalling. China is enacting policies to slow growth. Europe is mired in sovereign debt problems.

But for you, our dear readers, all these should not come as a surprise. As we already wrote in March this year at Black Swans lurking because Uncle Sam has less margin for error,

If the right word is used (e.g. ‘crutch,’ ‘prop up’) to describe the counter-productive government policies of spend, spend and spend, then it will do wonders to increase the economic IQ of the masses (see Are governments mad with ?stimulating??). Consider this very simple chain a logic:

  1. Someone is falling.
  2. You place a crutch to prevent him from falling.

Isn’t it plain common sense to see that once you remove the crutch, that person will crumble? From this, it follows that government crutch (‘stimulus’) lifts government expenditure to a higher plateau. Once we have bigger government, it is very difficult to shrink it as the difficulty currently faced by Greek government shows.

This is the issue that the Europeans are facing right now. If governments attempt to ‘stimulate’ their stagnant economies by spending big, their fiscal deficits will continue to grow, even to the point of no return. Consequently, the financial markets will lose faith in the governments’ debt because it will mean either (1) raising taxes, (2) default, (3) printing money, or (4) some combinations of the three. That’s their motivation for pledging to cut fiscal deficits in the recent G20 Summit.

But the problem is, if they cut their fiscal deficits (i.e. cut spending), their economies as measured by the GDP will shrink. Not only that, a shrinking economy implies a shrinking tax receipts for the governments, which in turn implies that they will have greater difficulty trying to repay existing debts. When that becomes obvious, you will see the bond and stock market reacting very negatively.

But for the Americans, since their government bonds are not yet under attack (given that among other reasons, the USD is still the world reserve currency), their more immediate problem is domestic growth. In fact, demand for American government bonds increased as a result of the flight to ‘safety.’ Hence, Obama was on record to urge the Europeans not to kill growth by shrinking government spending. But as Niall Ferguson said, at this current trajectory, the US will be like Greece in several years time.

So, who is right? The Americans or the Europeans?

Obama could urge for a policy of continued government spending because time is more on America’s side. The financial wolf packs are currently busy with Europe. So, Obama must be thinking that if America can try another shot at ‘stimulating’ their economy, maybe in due time, the government can then let the private sector take over. That will be the time to reduce the US government’s fiscal deficits. Hopefully, that can be done before the financial wolf packs set their sights on America.

Using an analogy, the current situation is like Europe being pressured on two fronts simultaneously with no room to move. America, on the other hand, is facing pressure only on one front. Obama’s plan is to send troops to that front, deliver the knock-out blow before sending troops to face off the looming second front. The plan will fail spectacularly if the enemy arrives on the second front before the knock-out blow on the first front can be concluded.

So, place your bet on whether you think America’s plan will succeed. If you think they can pull it off (i.e. honour their debts), then buy US Treasuries (American government debt). If not, get physical gold.

How to buy and invest in physical gold and silver bullion

Think Greece is bad? Look at China’s provinces

Sunday, June 27th, 2010

We all hear about how bad Greece?s national debt is. We hear about how the rest of the PIIGS countries are threatening to derail the Euro. Then there?s Japan, followed by UK. Also, most of the US states are like mini-Greece (see Inside the Dire Financial State of the States). Worse still, the US Federal Government itself is projected to face bankruptcy. You can see the who?s who list of potentially bankrupt major governments in our previous article- Next phase of GFC is when governments go bust.

But no one looks at China. Since it is the world?s greatest creditor nation, surely its fiscal position must be solid right?

No!

Firstly, China?s US$2.4 trillion of reserves must not be mistaken as ?cash at bank? to be spent (see Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?).

Secondly, many Chinese local government are heavily indebted too. According to Liu Jiayi, the head of China’s National Audit Office, some Chinese provinces have serious debt problems. As this news article reported,

Mr Liu said the ratio of debt to disposable revenues at some local governments was over 100pc and in the highest case it was 365pc.

He said the audited debts of 18 of China’s 22 provinces, together with 16 cities and 36 counties amounted to 2.79 trillion yuan (?279bn) in 2009.

Several observers believe the situation is far worse. The China Daily newspaper, which is run by the government, suggested that the total sum could add up to between 6 trillion and 11 trillion yuan (?590bn-?1.08 trillion).

Victor Shih, a professor at Northwestern University in the United States, believes the sum in 2009 was 11.4 trillion yuan, equivalent to 71pc of China’s nominal GDP.

Mr Shih has warned that local governments have also succeeded in rapidly funnelling large amounts of debt off their balance sheet and into public-private investment vehicles.

Mr Shih forecasted that by next year, China?s government debt will hit 96 percent of GDP as ?infrastructure projects continue to eat up cash and produce negligible returns.? According to him,

The worst case is a pretty large-scale financial crisis around 2012. The slowdown would last two years and maybe longer.

The good news is that the Chinese government is doing something about it today. But we doubt it will be painless. Fingers crossed on that one.

Growing structural unemployment in Australia

Thursday, June 10th, 2010

Today, the Australian stock market and the Aussie dollar performed relatively well. Alan Kohler, the financial news commentator in ABC News gave the reason why- China and Germany?s industrial production, Australia?s job ?boom? and so on. Incidentally, this is an example of narrative fallacy and lazy induction as described in our book, How To Foolproof Yourself Against Salesmen & Media Bias. Anyway, we will leave you to follow up on the issue of media bias.

But first, we will look at this news article,

Australian employment jumped a strong 26,900 in May to extend a remarkable run of jobs gains that suggests wage pressure could build earlier than thought and require yet further action on interest rates.

That article was published just before 5 pm. Coincidentally, in the streets of Sydney, another news article reported,

Thousands of protesters marched through the streets of Sydney’s CBD today, waving colourful banners and chanting demands for equal pay for women.

This is the sort of things that the RBA fears and give them a reason to raise interest rates. However, though the falling aggregate unemployment rate looks good, it masks a hidden problem. The problem is of the same nature as we described in Overproduction or mis-configuration of production?,

This is the key insight from the Austrian School of economic thought. Over-production or over-investment is not the problem. Rather, the trouble lies in the mis-configuration of production and mal-investments

In the same way, it is not the aggregate level of unemployment that tells the whole story. Rather, if unemployment is to be a threat to the Australian economy, it will be its configuration that is the cause. Recently, we saw this article, Recovery doesn’t extend to long-term jobless,

LONG-TERM unemployment continues to rise sharply and has increased for 18 straight months, despite the better performance of the economy and the overall improvement in th1e labour market.

A Herald analysis shows that Centrelink payments to people without a job for more than a year have risen by 27 per cent, or nearly 72,000, to 334,244 people in the year to April.

?

While the economic stimulus package has been credited with saving Australia from a deep recession, there remain pockets of deep disadvantage.

This mis-configuration between surplus supply of unemployable labour and shortage of employed labour is what economists call ?structural unemployment.? Also, according to the ABS, the youth unemployment rate in Australia is 3 times the national average. This is another large pool of structural unemployment.

As that article continued,

A senior analyst at the University of Sydney’s Workplace Research Centre, Mike Rafferty, said it appeared that as the economy had improved it was people moving jobs or within jobs that had benefited.

”The people who are benefiting first are perhaps those that already have jobs and are able to move into better jobs or perhaps from part-time to full-time work,” he said. ”It’s not the same picture for the people not in the labour market.”

Since the official unemployment is based on a sample of surveys whereas Centrelink payments is based on the actual number of people seeking welfare, we can argue that the latter presents a more accurate picture of the unemployment situation in Australia.

A rising structural unemployment will increase the drag in the economy as government welfare payment will have to be increased. If this growing trend is not arrested, then this growing pocket of disadvantage will increase, resulting in social problems down the track. Unfortunately, these structural unemployed do not make it to the aggregate figures.

Deleveraging of Australia’s private sector

Thursday, June 3rd, 2010

Back in Significant slowdown for Australia ahead?, we explained how the slowdown in credit growth can suck away aggregate spending in the economy. Today, we will show you credit growth in Australia from January 2000 to April 2010:

Credit Growth (YoY) Australia

As you can see, year-on-year credit growth almost ZERO on November 2009 before bouncing up and then returning down from March 2010 onwards.

As you can see, such a precipitous fall in credit growth should be very painful for the economy. However, the reason why it did not fall into serious recession was due to the crutch of government spending.

If the private sector continues to de-leverage, then the government will have to continue spending in order to prevent the economy from falling into recession. If so, then it means that the budget deficit will have to continue to grow.

Niall Ferguson on fiat money

Tuesday, June 1st, 2010

How to buy and invest in physical gold and silver bullion

Yesterday, at ABC1’s 7:30 Report, Kerry O’Brien interviewed Niall Ferguson, the economic historian who wrote the widely acclaimed The Ascent of Money documentary. In that interview, he discussed the present economic troubles in Europe and compared the future of United States and United Kingdom with today’s Greece. Near the end of the interview (at the 7:13 mark), Kerry O’Brien asked him this question:

What are the outstanding lessons from economic and financial history for Europe and the United States today?

For which, Niall Ferguson replied:

Well, let’s say there are three things… one is that we may be living through the end of the age of paper money, which began with the break-up of Bretton Woods in 1971…

Even as early as five years ago, if someone suggests that on mainstream TV, he will be ridiculed as an odd-ball.

There are more to what he said. You can watch the entire video of the interview below:

The good news for Australia, as he reckons, is that in terms of the government’s budget position, it is in a relatively much better position than the US and UK. But before we rest on our laurels, should Australia be hit by a home-grown banking/credit crisis, thus resulting in the government bailing out the private sector, the government’s budget deficit will blow out in an instance.

Significant slowdown for Australia ahead?

Sunday, May 30th, 2010

How to buy and invest in physical gold and silver bullion

Recently, we noticed a trend emerging in the Australian economy- retail discretionary spending seems to be falling off significantly. As this news article reported,

But conditions in the retail sector are savage. Consumers are buying less, despite one of the most ferocious discounting wars in history. With the two department store heavyweights, Myer and David Jones, battling it out for customers, the smaller retailers are caught in the crossfire, forced to match the prices or do better.

The latest Australian Bureau of Statistics figures show the household goods sector posted a sharp fall in prices, down 3.6 per cent, making it the second-biggest quarterly fall over the past 11 years. The first-quarter CPI showed particularly large price falls for furniture and furnishing, down 3.8 per cent, and audio visual and computing down 5.9 per cent. The next figures will be even uglier for retailers, whose margins are being cut to ribbons.

Elsewhere, Virgin Blue suffered a big fall in share price as it warned that

… earnings could plunge as much as 75 per cent due to a ”rapid deterioration” in demand from leisure travellers.

It seems that the retail industry is doing it tough. Sectors of the Australian economy related to consumer spending are in pain. Like the US economy, most of the Australian economy are related to consumer spending (say around 60%). Therefore, this trend, if continued, indicates that a major slowdown in the Australian economy is coming. A recession cannot? be ruled out.

The mainstream media will quote mainstream economists and put the blame on rising interest rates, Greek contagion and China? slowdown and so on. Blame will be laid on these “shocks” to the economy that cause consumers to “lose confidence.” That implies that to reverse this trend, consumers will have to be brainwashed to be ‘confident’ in order to spend their way to economic prosperity.

This is an example of voodoo economics for the masses. If this is the correct diagnoses for the ills of the economy, then we have a better idea for an economic ‘stimulus’ package (that will be much far more effective than the Rudd government’s $900 cash splash during the GFC)- distribute $900 worth of Myers/David Jones vouchers (that? will expire in 3 months time) to the masses. We can guarantee that within 3 months, consumers will regain their ‘confidence’ and spend, spend and spend.

Since consumer ‘confidence’ is the wrong diagnosis, then ‘stimulation’ is the wrong cure.? As we wrote in Will governments be forced to exit from ?stimulus??,

In fact, the word ?stimulus? is the most misleading word in economics lexicon because it conveys the idea of a surgeon ?stimulating? a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch.

What is the root of the problem?

Remember, back in Australia?s credit growth is still falling, we wrote that

… for an economy that is addicted to debt, all it needs to tip it into a recession is for credit growth to slow down- no contraction of credit is required. Also, as Professor Steve Keen explained, at this stage of the debt cycle, the aggregate spending in the economy is made up of income plus change in debt.

To understand why, consider this highly simplified hypothetical situation in the economy:

$80 (income) + $20 (change in debt) = $100 (Aggregate spending)

As you can see, of the $100 of economic activity, $20 is the result of an increase in debt. Assuming that next year, the situation looks like this:

$83 (income) + $15 (change in debt) = $98 (Aggregate spending)

Income goes up, but people decide to borrow less. Note that when there’s less borrowing, it does not mean that the total amount of credit in the economy has declined. Instead, it means that credit is still growing, but it is growing at a slower pace.

As you can see from this example, if income remains stagnant and credit growth slows down, the total amount of aggregate spending in the economy will decline, tipping the economy into recession (unless it is the government which increase the spending to fill the gap).

What if next year, everyone decides to stop borrowing (i.e. total credit remains the same)? The equation will look like this:

$83 (income) + $0 (change in debt) = $83 (Aggregate spending)

If aggregate spending falls from $100 to $83, it will be a depression for the economy. What if everyone decides to save, and thus repay their debts? The equation will then be:

$83 (income) + $ -5 (change in debt) = $78 (Aggregate spending)

The situation is worse!

Thus, you can see that for an debt-addicted economy like Australia, if wage growth is constricted, the only way for the economy to grow well (in nominal terms) is for debt to grow at faster and faster rate. Obviously, this is unsustainable because if debt grow faster and faster than wage growth, it will be only a matter of time before the entire economy becomes sub-prime. When that happens, there will be an almighty crash, which in Australia’s case, is likely to result in a currency crisis (see Serious vulnerability in the Australian banking system).

If the government decides to borrow to supplant the private sector’s decline in borrowing in order to maintain economic growth, then the budget deficit will continue to grow. Again, this cannot go on indefinitely because Australia will end up like the PIIGS countries.

One more point, up till now, all these growth are in nominal terms. But what about in real terms?

As we know, it wasn’t long ago that there were media reports of “skills shortage” in Australia. Also, it is clear that Australia requires more “nation building” due to lack of infrastructure. This means that Australia is at the limits of its productive capacity. That means that even if Australia somehow manages to grow in nominal terms, it will be achieved at the expense of higher price inflation. That will attract more interest rate hikes from the RBA. As we wrote two years ago in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

The Australian economy was already running at full steam. Accelerating price inflation is a sign that there are insufficient resources in the economy to allow for all investment projects to succeed and all consumptions to carry on. If this trend is not arrested, the economy will run out of resources, resulting in a crash. Therefore, in order to put the economy back into a sustainable growth path, consumptions and investments have to slow down in order to allow for the economy to catch a breather for the rebuilding of its capital structure. The rebuilding of capital structure is necessary for the economy to replenish its resources for the future so that growth can continue down the track. Unfortunately, this rebuilding itself requires resources now. Therefore, current wasteful consumptions have to be curtailed and mal-investments have to be dismantled to make way for the rebuilding. The curtailment of consumption involves consumers spending less and saving more, while the dismantling of mal-investments involves retrenching workers, liquidating businesses, e.t.c. These involve pain for the people of Australia.

As we all know, the RBA raised interest rates 6 times already and that is the probable reason consumers are de-leveraging (i.e. borrow less and/or repay debts).

To put it simply, a glass ceiling is blocking the Australian economy. If you can feel that the quality of your life is also hitting the glass ceiling, then you know this is the reason.

Why interest rates policy can have opposite effect in China?

Thursday, April 22nd, 2010

In highly indebted countries such as ours, we associate lower interest rates with higher consumer expenditure and higher interest rates with lower consumer spending. The reason is simple. Since it is the norm for people to be indebted, lower interest rates implies lower debt servicing obligations, which implies greater borrowing capacity for spending.

Indeed, this was what happened in Australia when the Reserve Bank cut interest rates in 2008 to pre-empt any potential fallout from the GFC. The whole point of the interest rate cut was to help families repay their debt faster, which many did. But when the government dangled the higher First Home Owners? Grant (FHOG), many young people took this opportunity to borrow more. Lower interest rates certainly made it easier for these people to do so (which flowed on to the rest of the economy as increased consumer spending).

In countries like China, where the savings mentality is highly ingrained, lower interest rates have the opposite effect. To understand why, consider a typical Mr Wang who is saving for his son?s university education in say, 20 years time. Also, Mr Wang already has a substantial cash balance at the bank. When interest rates go up, Mr Wang will be earning greater returns on his cash at bank. With that, he can put aside less of his wages for savings, which implies that his spending can increase. When interest rates go down,  his returns on cash at bank reduces. Mr Wang will then feel that he needs to put aside more of his wages for savings, which implies that his spending have to decrease.

That explains why the Chinese consumers (especially the older generations) are so reluctant to spend. In fact, higher price inflation pushed many of the older folks to spend less in order to counter higher prices.

Remember, this is just our theory- that due to cultural differences, the demand for money in China is much higher than in Western countries (see Demand for money, inflation/deflation & its implication).

Watch April 15 2010: simmering tensions between US and China

Tuesday, March 23rd, 2010

April 15, 2010 is a day worth watching. It will be the day when the US Treasury will issue a report, designating whether China is a “currency manipulator” or not. While the repercussions of China being labelled a “currency manipulator” are worrying, this issue is hardly new. In fact, as we wrote in US shooting own foot with tariff on Chinese goods three years ago,

At present [April 2007], the US Congress is simmering in antagonism against China for her trade surplus against the US. They see China as a convenient scapegoat for America?s economic woes, accusing her of misconducts that includes currency ?manipulation,? unfair trade practices and so on.

For the past three years, both sides seem to be going round in circles regarding the Chinese currency peg issue. It seemed that China was repeatedly on the verge of officially being accused of currency manipulation, only for that charge to be withdrawn from the final assessment. Based on statistical probability, the chances for that charge to be issued again are slim. But as our long-time readers know us, we are no fans of using statistical probabilities to ‘predict.’

One thing is clear: the pressure for officially labelling China as a “currency manipulator” is much strong today than three years ago. Firstly, President Obama is more inclined towards that than former President Bush. Secondly, the US economy today is at a more advanced stage of deflation (i.e. unemployment, fall asset values, economic stagnation) than three years ago. Thirdly, mid-term elections are coming and consequently, there are a lot of domestic pressures for Obama to get tough on China.

In the face of further economic stagnation, the US is sliding downward towards mob rule. With a clear understanding of Irving Fisher’s debt deflation theory of the Great Depression, we can easily understand that for an economy heavily addicted to debt, all it takes for the economy to slow down is a slowdown in credit growth. As we wrote in Australia?s credit growth is still falling,

Marc Faber once said that for an economy that is addicted to debt, all it needs to tip it into a recession is for credit growth to slow down- no contraction of credit is required. Also, as Professor Steve Keen explained, at this stage of the debt cycle, the aggregate spending in the economy is made up of income plus change in debt. In the absence of income growth, a slowdown in credit growth implies declining aggregate spending by the private sector.

Currently, the US is in the midst of a generational shift in culture/mindset from borrowing to saving. That is, in economic terms, the US private sector is de-leveraging. The symptoms of de-leveraging will be asset price deflation, economic stagnation, rising unemployment and so on, which will be counteracted by increase in government debt and spending (which itself is limited by market’s confidence in government debt).

In lay-person’s terms, the US is suffering because they are on cold turkey from debt. In contrast, the Chinese are postponing their pain by going further into debt (i.e. policy of inflation and force-feeding of credit into the economy). This result in an illusion that America is suffering while China is ‘prospering’ (which is worsened by Chinese government’s propensity to doctor the figures to look good in order to save ‘face’).

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China’s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America’s unemployment rate. By implication, it is perceived that with China’s official unemployment rate much lower, China is ‘prospering’ at America’s expense.

The problem is that if China is to acquiesce to America’s demands today, it will not solve the America’s problem tomorrow. In fact, the immediate effect will be to worsen America’s (and China’s as well) economic woes. Price inflation will rise and market based interest rates will go up, worsening America’s debt deflation problem. The reason is because the Chinese currency control had been in place for too long and that resulted in long-term structural changes to both the US and China’s economies. Removing the control immediately means that both economies will have no time to adjust, compounding the current level of pain for both sides.

For China, if the words of its Vice Commerce Minister Zhong Shan are accurate, the profit margins of many Chinese exporters were less than 2%. By appreciating the yuan, many Chinese exporters will go under, which by implication will have serious impacts on unemployment in China, and by extension, on social stability.

SEO Secrets e-bookBut as we wrote before in Chinese government cornered by inflation, bubbles & rich-poor gap, China has their own inflation problem that will eventually threaten social stability. They are already taking tentative steps to rein in inflation (see Is China going to allow its banks to fail in the upcoming (potentially gigantic) wave of bad debts?). Letting their yuan appreciate is very likely part of their overall plan to re-balance their economy. It will happen eventually. But the problem is, the Chinese wants to do it gradually. But the US politicians, on the other hand, want China to do it quickly in order to appease their electorates. Already, we have American economists like Paul Krugman (who is of the same ideology as Ben Bernanke with regards to money printing to solve economic problems) writing inflammatory articles and egging for a economic fight with China.

So, April 15, 2010 will be an interesting date to watch. If China gets labelled as a “currency manipulator,” then trade tensions jump up a level. If left unchecked, that will result in trade war. If trade war is left unchecked, the gloves will come off and there will be more unsportsmanlike actions from both sides (i.e. covert dirty war). If dirty war goes unchecked, there is a risk of shooting war. We are not saying all these things will happen- our point is that there will be a time and sequence for things to happen.