The Pros and Cons for a True Value Yuan

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I understand the Chinese Yuan's valuation is a very convenient smoke screen and scapegoat, a handy political soundbyte. But does Washington really want CNY to rise in value against the USD?

First of all, a rise in CNY is a de facto devaluation of USD. Devaluing USD has its lure; it's an easy way out of mounting external debt. In fact, my bet is still that it's a path Washington cannot avoid going down. But here I try to temporarily escape political reality and hope for the best. As the rest of the world is not quite as stupid as some would think, devaluing the USD would make it much harder for the U.S. to sell debt. So it's not as easy as it first seems. But more importantly, the status of the U.S. rests squarely on the stability of the USD. Some may say it's the U.S.'s military power but military power is derived from economic and financial power. I'll not argue here whether the persistent erosion of the USD for the past decade-- until the 08 crisis- is a cause or effect of the decline in U.S. power. But either way, it says one thing loud and clear: Devaluation of the USD is a bad thing for the U.S. Furthermore, external devaluation would lead to internal inflation and a declining living standard.

Of course, as we've seen repeatedly over the past decades, and especially the past two years, a world in trouble is a sure support for USD. But how long can we play with this fire before we get seriously burned?

Japan trick won't play in China

Some in Washington may be tempted to pull the same trick on China as they did to Japan in the 70's and 80's. It's not going to happen. Let's not kid ourselves. Japan was, and still is, not a sovereign. But China is not Japan. In the 80's certain powerful factions in China wanted to align it strategically with the U.S. But the U.S. took a short-sighted utilitarian view of China after the Berlin Wall collapsed. This is one of the ultimate reasons the pro-western faction in Beijing lost, if not permanently then at least for a generation to come. Nobody in Beijing wants to be the enemy of the U.S. But the mainstream consensus is decidedly focused on strategic independence. For this reason, all the talk of Yuan appreciation in Washington is nothing more than a domestic political talk show.

The Prince Party agenda

The irony, as I've argued for years now, is that it is in China's best interest to let CNY appreciate gradually. Some in Beijing certainly realize this. But the export sector, especially the export of labor-intensive, low value-added products, is dominated by the 'Prince Party' members, an unofficial but universally (in China) known slang for the loosely knit aggregate of descendants of former high officials.

It's a de facto institutionalized power succession model: Top officials stay clean while they're in power. Then, after they step down, each family gets to control a sector of the economy. Furthermore, Prince Party members have been increasingly shifting their income to hard currencies in recent years (and storage thereof started much earlier). CNY appreciation would mean a direct hit to their wealth in Yuan terms.

The Prince Party has been the most powerful lobby against CNY appreciation. But as one can easily see, the Prince Party power succession model is not sustainable over the long run. There'll be more and more factions among the Prince Party and their interests will more and more frequently come into collision. In fact, there've been a few signs in recent years that the factions for CNY appreciation have been gaining ground. If you think for a moment that the CNY appreciation a few years ago was due to external pressure, then sorry, you don't know anything about Chinese politics. External pressure was used as a bargaining chip in the internal debate, that's all.

China needs to 'grow up'

China needs to migrate up the value chain. It needs to gain more independence in various core industries. While infrastructure in China has enjoyed tremendous improvement over the last 20 years, the need for investment in some areas is still huge. And perhaps most importantly, it needs to attract talent from all of humanity. A depressed CNY value makes all the above much more difficult than necessary.

So there you have it. US and China each argues for and urges the other to do the best for the other. What selfless love. What a Valentine's Day story.

Oh, Happy New Year everyone! Here's a Confucius Says on the Year of the Tiger: Bulls get slaughtered, bears get slaughtered, but the Tigger just keeps bouncin' and bouncin' and...

Disclosure: None