Debt Loops Rationale and Effects Positive and negative effects of China's devaluing of their currency
Debt Loops Rationale and Effects
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- Now that we have a general layout in our minds of
- how all of the mechanics are fitting together,
- what I want to do in this video is discuss a little bit about
- why the different actors would do what they are.
- How they could benefit or get hurt from this cycle.
- And really, why it's so hard to unwind each of the actors,
- why it's so hard for them to unwind themselves from the scenario.
- Where I finished off this last video,
- I talked about more cash being in American pockets
- because of essentially, debt being cheaper,
- government can spend more money, lower taxes.
- And I said that's more money to buy Chinese products,
- but it's in general more money just for Americans to spend on each other.
- They might buy each other's houses
- or buy each other's services.
- So in a lot of ways, it does stimulate the economy.
- For any Keynesians out there, the more you spend,
- that will stimulate the economy, lower taxes.
- For more conservatives, that also can stimulate the economy.
- And in general, debt being cheaper, lowers interest rates,
- all of these things stimulate the economy.
- Now, normally when you're stimulating the economy like this,
- and you have all of these factors,
- you have the risk of higher inflation.
- But remember, inflation, or at least price inflation,
- is just the price of all of your goods.
- But notice, we're buying more and more cheaper goods,
- and interest rates are low.
- So to some degree this whole cycle also keeps--
- I guess you could say,
- the surface growth that the average American consumer experiences
- looks very positive
- and inflation stays slow,
- so we can also save money to buy each other's services.
- Now with that said, let's think about
- why the different actors want to do this.
- So let's think about it from the Chinese perspective.
- So if you are China and you're starting off,
- you are a real Communist country maybe 30 years ago.
- And then you start to have market-based reforms
- and you really want to enter the developing world.
- But you don't have the industrial base in the late '70s or early '80s
- to really compete with the Germanys, and the Americas, and the Japans--
- and when I say Americas, I mean United States-- on their terms.
- So one advantage of export-led growth is
- when you're just beginning to develop, you have a less-developed society,
- you have less of an industrial base.
- So when you have export-led growth, you can actually build,
- you actually will encourage investment in factories
- that can go and produce things for the developed world.
- And by keeping your currency low--
- by artificially keeping your currency low-- and let me be clear.
- With just standard free trade, labor costs are going to be cheaper
- in a place like China or India that has a lower standard of living.
- So there would be just straight-up free trade with no manipulation of currency.
- You would have things that would move offshore,
- manufacturing and services that move offshore.
- But if you super charge it,
- if you make it even cheaper to manufacture,
- to do business in China,
- it'll just accelerate the investment in production in China.
- So this export-led growth--let me put it this way.
- Artificially suppressed currency--
- and this also happened with Japan after World War II--
- artificially suppressed currency, and to some degree we wanted that,
- because we want to Japan to become intertwined with the United States.
- We wanted it to be successful.
- We saw what happened to Germany after World War I,
- where it was so economically unsuccessful
- that it was very easy for a character like Hitler to come to power.
- So we learned our lesson.
- We said, you know, it's never good for another country
- to not have an economic recovery.
- So we actually, to some degree, many people think,
- encouraged it in Japan.
- But anyway, you artificially suppress a currency,
- it makes your exports cheaper,
- and which then encourages more investment in production at home.
- And in this case, when I'm talking about home,
- I'm talking about China or Japan.
- And more production at home means more investment at home.
- More investment.
- If you're producing more in China,
- you're going to have to build more factories.
- And this means literally more jobs and, to a large degree,
- capital for the Chinese people.
- More jobs and capital.
- And as you become more efficient
- and as you go down that development curve,
- you'll become more and more competitive over a whole series of industries.
- And the idea is, once your people get developed enough,
- you will have enough capital at home.
- You will have enough of a consumer base at home that
- some of this extra capacity can then be turned back to your own people.
- That you can then use these goods to sell to your own people
- to increase their standard of living.
- So at first, you are building washing machines and refrigerators
- for the United States and Europe.
- And because you're building those washing machines,
- those are jobs for Chinese and eventually, once they have enough money,
- once there's a critical mass of a middle-class Chinese,
- that same capacity could be used to
- sell washing machines and refrigerators to the Chinese,
- and it would raise their standard of living.
- So it builds a manufacturing base and a home market.
- Let me put it that way.
- So from China's point of view, it looks unambiguously good.
- It builds manufacturing base, and a domestic consumer market--
- which just means people in China,
- once they have jobs and they have capital,
- will be able to buy the goods themselves-- and domestic consumer market.
- Now where is the negative here?
- You could imagine, if you are the developed country that is buying these goods,
- they would be cheap to begin with,
- but now they're even more artificially cheap.
- Well you lose your manufacturing base.
- So if you look at it from the U.S. point of view,
- you lose the manufacturing base.
- And it's very clear that this has been happening,
- whether you want to point to Japan or in general,
- we've been losing our manufacturing base to other countries.
- And some people view this as a good thing.
- Some people say, hey, we are further down the development curve.
- We shouldn't focus on manufacturing,
- since manufacturing always tends to go to
- whoever can do it for the cheapest price.
- We should focus on knowledge things,
- whether it's pharmaceutical industry or the IT industry.
- So there's maybe an argument there.
- But the other reason why this is maybe compelling to the United States
- is its lower costs.
- So this looks like a negative, and it is really a negative on some level,
- but the one I guess you could call it a superficial positive
- is lower cost for American consumers.
- So if you're not one of the people who lost their jobs at the manufacturing plant,
- and you are the great majority of the rest of Americans,
- it seems like a good thing.
- Things are cheaper for you,
- it's cheaper to buy clothes for your kids.
- It's cheaper to buy a car.
- It's cheaper to buy a refrigerator.
- It's cheaper to buy an air conditioner.
- Now the problem is, when and how does this end?
- Because this whole cycle that we create,
- it might sound good for China.
- In theory it sounds good.
- You suppress you currency, your goods are cheap,
- more production at home, more investment at home,
- more capital and jobs eventually,
- point that capital, point that investment back at your own home market
- and now you are a developed country.
- Seems to make a lot of sense,
- but it's easier said than done.
- In particular, it's not a trivial thing
- to make that whole market be as consumptive or as consumer-driven
- as maybe some of these developed markets abroad.
- The other problem is this whole time,
- remember what's happening.
- You're just accumulating this mass of, in this case, U.S. dollars
- and you're using it to go essentially lend to Americans,
- to lend to the government,
- and it essentially gets lent to the American people.
- And the minute that you stop doing it,
- think about what happens.
- The minute that you stop, let's not even talk about unwinding this,
- let's say the minute that you stop buying dollars,
- your currency will inflate and the holdings--
- these trillions of dollars of assets-- will drop in value,
- because the minute you stop buying dollars,
- the currency markets will allow the yuan to appreciate,
- the dollar to drop and so stopping buying leads to drop in value.
- And that's just if they stop buying.
- If they actually ever tried to unwind this situation,
- as soon as they start selling these, that would drop the value of
- whether you want to call it the dollar or the U.S. Treasuries even more,
- and so everything else they're holding
- would drop in even more value.
- So the whole time, in order to keep their currency propped up,
- they've been buying these assets,
- they've been buying these dollars.
- But the very act of unwinding it will-- I won't say make it worthless--
- but it will make the value of their holdings go down dramatically.
- So you have a very hard situation for the Chinesese.
- It's a hard situation to even get out of.
- And it's just as hard for the U.S. because if you think about it,
- a lot of people in the U.S. would look at this
- and they'd say, hey, this is horrible.
- This is why our manufacturing base has gone away
- and it is partially true.
- And so they'd say hey, let the currencies just do what they will.
- No more artificial distortions,
- no more manipulation by government.
- Let the currencies be freely trading.
- But what would happen then to the United States?
- The minute that China stops doing this,
- stops artificially supporting their currency, or even worse,
- the minute they start unwinding all of these dollars that they've accumulated,
- what's going to happen?
- They're going to start selling U.S. Treasuries,
- there's going to be lower demand for U.S. Treasuries
- because they're not even buying it, they might be selling it.
- Interest rates are going to go up,
- long-term interest would go up in the United States.
- Now when long-term interest rates go up,
- that means that borrowing is harder,
- that people will want more interest to lend you money,
- that credit card rates will go up
- and in general, the entire United States economy will go down.
- Why are we in this recession right now?
- Because it is harder to borrow.
- We were so dependent on cheap debt,
- and when that debt got a little less cheap, everything kind of ground to a halt.
- That would be even worse
- if the Chinese stopped buying our debt and allowed interest rates to go up.
- So we are kind of locked in this very perverse cycle,
- where although it looks like the Chinese are unambiguously I guess,
- benefiting from this, they are accumulating these assets
- and the minute that they try to stop accumulating those assets,
- the value of those assets are going to go down.
- And even though the United States looks like
- it's getting their manufacturing base depleted-- and that is true,
- it is getting its manufacturing base depleted because of this--
- it is keeping interest rates low.
- And if you're a politician, you like that.
- It makes the overall environment look superficially positive.
- I'll leave you there and let you think about this whole situation for a little bit.
- In the next video, I'll try to do a little bit of analogy
- to think about where all of this might go.
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