The race to the bottom – Beggar thy neighbor 2.0

The yuan/dollar peg has forced a huge imbalance in world debt levels and fomented asset bubbles. In the 90’s, China had an immature economy and banking system, but as economic reforms took root in China, cheap labor piled into the factories and made cheap goods for export. The Chinese government kept the value of the yuan low to foster these export.  Paid in dollars for these goods, the Chinese faced a flood of the American currency, which they promptly reinvested in U.S. Treasuries, corporate bonds, Fannie Mae and Freddie Mac.

The rapid re-investment of these dollars was the major force (aided and abetted by Alan Greenspan of course) that drove U.S. interests rates down for almost 3 consecutive decades – low rates that blew up the (speculating with borrowed money), housing (speculating with borrowed money), and banking (speculating with borrowed money)  bubbles.

Bubbles came and went as the once insignificant Chinese economy mushroomed into an export powerhouse. American bought cheap Chinese exports with money borrowed via low-interest rates enabled in large part by Chinese themselves.  For years it seemed mostly a win-win for both sides.

Now it’s becoming a win-lose, or even lose-lose.

Right now, said asset bubbles have popped and the world’s major economies are deflating. They are broken down economies with debts that are too high to pay off.  With everything deflated, everyone is keen to jump-start exports to revive their economies.  Everyone wants to devalue their currencies (print more money) for 2 reasons: 1) to make their exports more attractive to foreign buyers and 2) to pay off debts with debased money.

Problem is, not everyone can do this simultaneously. Every exporter needs an importer. Additionally, creditors don’t like getting paid off with debased money, be it Yen, Euros, or dollars. They don’t want to get ripped off.

Nonetheless, all will try to a greater or lesser degree.  Tensions over capital movement, exchange rates, and monetary policy will lead to friction in the form of tariffs and competitive devaluation – or both. It now seems we have what amounts to a  race to the bottom.  Could we really be in a situation  where the country that can devalue their currency the fastest without sparking a revolution, hyperinflation, or war will win?

Everyone will be devaluing (printing) when they have an excuse to do it.  It’s beggar thy neighbor 2.0 people.

What does this mean for a little guy like me? Higher prices for just about everything. Of course this isn’t going to do much for world peace either.

From an investment standpoint, short-term this bodes well for gold and commodities, things that will have value despite a falling dollar.   There’s a trend developing: the value of paper money is going to bounce up and down in fits and starts, but over time, is likely to worth less and less. Long-term, I don’t think anyone really has a clue.


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