Nouriel Roubini, one of the few economists who predicted the new depression and understands it, argues that China's exchange rate policy is keeping the U.S., U.K., and some other advanced economies from recovering their economies through net export growth (i.e., reduction of their trade deficits). During a Bloomberg interview with Tom Keene at the Milikin Conference at the beginning of this month, Roubini said (about 5:20 in the video):
In this fundamental exchange rate game, the currencies that should be appreciating are those that are undervalued with large current account surpluses [i.e., trade surpluses]. While the ones that should be depreciating are U.S., U.K. and other countries that had their bubble, then bust, and now need net export growth, given that domestic demand is anemic with balance sheet retrenchment.
The problem is that China is resisting its currency from appreciation, is doing it very, very gradually. China is shadowing the U.S. dollar and that every other emerging market in the world, not just in Asia but those in Latin America, they say, "If China resists appreciation of its currency, I don't want to lose market shares to China in third markets, and I don't want a flood of cheap Chinese goods destroying my own import-competing sectors."
So all of these countries are shadowing China. So the adjustment of exchange rates that should occur, yuan currency appreciating, advanced economies weakening relative to the yuan, so that we have global rebalancing, that is not occurring.
Apparently, Federal Reserve Chairman Ben Bernanke has the same understanding. He has been trying to address this problem by creating massive amounts of money and using it to buy U.S. Treasuries (a strategy known as "QE2"). This strategy gives currency manipulating countries a choice between inflation and currency manipulation.
Since September, when QE2 began to take effect, it has helped U.S. trade, but not enough. The U.S. trade deficit with China is still going up, not down, as shown by the blue line being above the red line in the non-seasonally-adjusted graph below:
But QE2 is not sustainable. Bernanke's massive money creation has been causing inflation in the United States to grow at a rapid half percent per month pace since January, as shown by the graph below:
Bernanke has already announced that the Federal Reserve will end QE2 in June. As a result, the dollar has already been bouncing back against the euro. With the inflation threat in the emerging market countries lessening, they will resume their currency manipulations in order to better compete with China. After that, the rising U.S. trade deficits can be expected to choke off the U.S. economic recovery.
There has always been and will always be a solution to this problem, which would balance trade and get the U.S. economy moving. WTO rules do not require that countries permit trade deficits. The Obama administration or Congress could easily restore U.S. prosperity by imposing a WTO-legal scaled tariff to balance trade. Such a tariff would boost U.S. exports and reduce U.S. imports at the same time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.