Federal Reserve

This Is an “Inside” Job

By David Stockman  |  October 12, 2018

The U.S. has a huge trade imbalance with China. And it is a problem.

The Donald is right about both parts. After all, U.S. imports from China grew from $20 billion in 1993 to $530 billion in 2017.

Yes, there can be large trade imbalances between countries. Natural causes include comparative advantage and specialization. And then there are run-of-the-mill protectionist practices that actually do no harm in the aggregate.

But imbalances this freakishly large and persistent can’t be attributed to either economics or mercantilism.

And nothing grows by 27 times in barely two decades in the natural order of markets – certainly not when we’re already talking about the “law of big numbers.” It’s especially peculiar because the U.S. exports a tiny 25% of what it imports.

Nope, this is about easy money gone malignant.

This is about monetary central planning.

This is about the Federal Reserve.

The decades-long project in debt explosion accompanying this unbalancing had a massive “wealth transfer” effect, too.

Wall Street and Imperial Washington are toughing it out these last couple days. But the Acela Corridor is well fixed by these developments.

Main Street, on the other hand, is devolving.

The People’s Bank of China was a major contributor to the explosion of central bank balance sheets since the late 1990s. The Chinese simply pegged their currency – the yuan – to the dollar. It was a “rigid” peg from 1995 to 2004 but only “loose” since then.

The goal is to prevent their exchange rate from soaring in the face of huge trade surpluses with the U.S. and the rest of the world.

In the process, China acquired huge foreign exchange reserves – or assets denominated in currencies other than the yuan, mostly the U.S. dollar.

This accumulation, in turn, fed the massive expansion of China’s own domestic banking and credit system. Obviously, they had to print yuan in order to “buy in” dollars and other foreign currencies as part of their pegging operation.

Among the consequences, of course, was a massive explosion of China’s debt, which grew from $500 billion in 1995 to $40 trillion in 2017. According to Keynesians and monetarists alike, that’s their problem, not ours.

But China’s pegging practices totally blocked the natural adjustment of trade balances.

 

We sure would have seen it under a gold-based, “sound money” regime. The U.S. would have lost massive amounts of gold reserves. And that would have caused the domestic banking system to contract. Credit would be curtailed. Wages, prices, and costs would decline. Imports would abate, and exports would rise.

It might have happened had our floating-currency regime been supported by an honest free market.

The Chinese yuan would have appreciated, massively, versus the U.S. dollar. That would have dramatically reduced the competitive advantage of China’s cheap labor. And it would have opened the door to more U.S. exports.

In either case, China would have maintained a material trade surplus with the U.S. It does, after all, have the inherent advantages of low-cost labor, new manufacturing plants, and other fresh infrastructure.

But it would have been nothing like the aberration above.

China’s “dirty float” – massive and chronic currency market intervention – is another symptom of our malignant-money-driven trade disaster, like the offshoring of American industry.

Here’s the thing: This all started on the U.S. side, during the Greenspan Era at the Federal Reserve. “Bubble Finance” is monetary central planning in action.

We had a preview of what happens when you mess with the natural order of markets on Wednesday and Thursday.

Wall Street can barely suffer the beginning of the end of easy money.

We snapped back at the open today. But that dead-cat momentum withered before lunchtime.

And this isn’t even the hard part…

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR