Dr. Susmit Kumar, Ph.D.

Published at South Asia Monitor on February 27, 2017.

Recently US President Donald Trump declared China the "grand champions" of currency manipulation, only hours after his new Treasury secretary pledged a more methodical approach to analyzing Beijing's foreign exchange practices. [1]

Nearly all US economists, including Nobel Prize winner in Economy Paul Krugman, do not tell the truth. Krugman has maintained that undervalued Chinese currency is the main reason behind the massive US trade deficit. As per him and C. Fred Bergsten, director of the Peterson Institute for International Economics, "Beijing uses currency manipulation to maintain the value of its currency, the yuan, at an artificially low value, which makes its exports much cheaper and its imports more expensive."[2]. Since 2010, China’s Yuan has appreciated by 20 percent vis-à-vis the dollar, whereas the US trade deficit with China has not decreased.

The truth is that the US dollar is over-valued. Taking advantage of the fact that its currency is the global currency, US just prints its dollar whenever it wants to fund its twin deficits - both trade and budget deficits. Other countries, including India, cannot do the same. If you take Delhi Metro to go from Connaught Place/Rajiv Chowk to Dwarka (30 km) it will cost you 25 rupees, i.e. about one-third of a dollar whereas for same distance in Bay Area, California, the Metro will cost you 8 dollars. In Purchasing Power Parity (PPP) terms one dollar is 10 to 11 rupees only, i.e. the US dollar is six times over-valued vis-à-vis the Indian rupee.

During World War II, US enticed all other countries by claiming that it would keep its dollar pegged to gold at the rate of $35 for one ounce of gold. The US asked other countries to use the US dollar as reserve currency and also for conducting transactions between countries. This resulted in the 1944 Bretton Woods Accord, signed by 44 countries. As per the agreement, you could have asked the US govt to give you one ounce of gold for $35. But in 1971, Nixon de-linked the dollar from gold and since then the US has just continued to print dollars to fund its trade and budget deficits. This has been going on since the Reagan administration. Had the dollar not been the global currency, there would not have been the “Reaganomics”, the much revered economic theory of the Republican party. According to economist Allan H. Meltzer at Carnegie Mellon University, “We [United States] get cheap goods in exchange for pieces of paper, which we can print at a great rate.” [3]

Whatever the US pays to the world for its imports, the foreign countries deposit most of it in the US in the form of investments such as in the US Treasury Bonds and share markets. But recently, for the first time in history, foreigners have started to dump the US Treasury Bonds at record pace – please see the chart below. During the recent decade, the US government has run significant year on year budget deficits now running above $20 trillion. If the foreigners dump significant amounts of treasury bonds, then the government will have to face increasing interest rate. For each one percent increase in interest rate, the US has to pay more than $250 billion a year in interest payment, which will cause either more and more budget deficit or government expenses will have to be cut.

Right now the situation is such that in near future, the US might witness its own “Suez Fiasco” that caused the United Kingdom and France to lose their superpower status. Describing the stranglehold of China over the US economy, Richard Haass, President on Council of Foreign Relations, a premier US think tank, said, “Essentially the U.S. took advantage of Britain’s Sterling problem to exercise economic leverage over the British government, and that led to a hasty retreat in the 1956 Suez War (despite defeating the primitive Egyptian army on all the fronts, the invading forces had to withdraw). So one can imagine a situation nowadays, where, say, there is a crisis over Taiwan between the U.S. and China—which holds a significant number of dollars—and one can imagine the Chinese might be prepared to threaten the dollar, make some comments to weaken it unless the U.S. backs off some of its support of Taiwan.” [4]

After all the Western countries, except the US, Japan and Canada, recently joined the China-led Asian Infrastructure Investment Bank, Lawrence Summers, a noted US economist, ex-President of Harvard University and the Treasury Secretary during Bill Clinton administration, said, “This past month may be remembered as the moment the United States lost its role as the underwriter of the global economic system. True, there have been any number of periods of frustration for the United States before and multiple times when U.S. behavior was hardly multilateralist, such as the 1971 Nixon shock ending the convertibility of the dollar into gold. But I can think of no event since Bretton Woods comparable to the combination of China’s effort to establish a major new institution and the failure of the United States to persuade dozens of its traditional allies, starting with Britain, to stay out.” [5]

If the US dollar goes down to its PPP value, there will be a complete collapse of the US economy, resembling the Russian economy during 1990s. Right now even after massive loss of manufacturing jobs, the living standard of even an hourly wage American is very high as compared to the rest of the world. At even $10 an hour, working in a restaurant, they make $1600 a month, out of which they spend $200-$300 on food, $700 on the room rent (with a/c) and $300 to $400 on a very good car; he can buy a brand new 48" LED TV for less than $400 which is just one-fourth of his monthly income; he can buy a round-trip air ticket to India in less than $700 in off-season and in $1200 in peak season which are less than 50% and 75%, respectively, of monthly income. If two persons (wife & husband) work, then they can have a life better than a middle-middle class Indian family. But if the dollar goes down to its PPP value, there will be complete chaos in the US. Then a brand new Toyota Camry in US would cost $125,000 instead of $25,000, its present price, and it will be out of bound even for the middle class in US. Right now, the moment a person in US gets a $50,000 a year job, he buys a brand new car like Camry.

[1] "China is a 'grand champion' at manipulation of currency: Donald Trump," Reuters, February 24, 2017.

[2] “China’s yuan value hits U.S. economy, two experts say,” The Washington Times, March 15, 2010.

[3] “U.S. Trade Deficit Hangs In a Delicate Imbalance,” Paul Blustein, Washington Post, November 19, 2005.

[4] “Don't be distracted by Greece: Americans must also face financial facts,” The Telegraph (UK), Justin Webb, June 25, 2011.

[5] "A global wake-up call for the U.S?," Larry Summers, Washington Post, April 5, 2015.

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