China’s Reserve Currency Strategy

In two previous posts, I discussed a fishing village in which some of the men in the village were required to sit on the bank and not fish because the fisherman from the other village were willing to fish for them at a lower cost.  The eastern village in that story represents the Asian economy, with its powerful core being China, which is willing to accept and some say manipulate undervalued exchange rates in order to grow through exports. But is China manipulating its currency?

Assuming China’s industry has identical productivity to the U.S. and the Chinese worker is conditioned to accept $3,000 annual wages to our worker’s $43,000, then China could conceivably sell anything to the U.S. for a lower cost than we can produce, cover the costs of direct foreign investment, and yet make a profit. If China chooses to keep its profit in hard U.S. currency and build a war chest over time, why would the Yuan need to revalue? China is setting the rate at which it will provide value to the west, and we as consumers are accepting their price. 

The world is flooding China with capital, allowing it to continue this wealth accumulation strategy at the United States’ expense. We are countering by quantitative easing to devalue their store of U.S. value but in the process are exacting payments from all countries that hold dollars as reserve funds.  And now the experiment of the Special Drawing Rights reserve currency has begun.   Countries are banding together to end America’s reign as the provider of reserve currency When that finally occurs, we will have lost a strategic advantage.

We have continued to devalue our currency over the years and holders of our currency have lost value each year as a result.  Nevertheless, developing nations have increased holdings of our dollars as a hedge against downturns in their economies.  Our continuous devaluing through the years could be argued as an appropriate payment for our military’s defense of worldwide peace that has allowed unprecedented trading wealth for all countries. But it’s a stretch to charge the world for our inability to surge real growth during the last quarter century to support the demographical spending desires of our baby boomers and our lack of regulatory oversight of the financial shenanigans of Wall Street.