The Dangerous Course of Pegged Exchange Rates

Simply put, a policy of pegging of the Yuan by China is insane and will cause a great deal of global economic disruption, perhaps for decades. In my opinion there has already been considerable damage.

In fairness to China, I have reason to believe that the leaders there somewhat unknowingly built an unsustainable situation through fixing currency exchange rates to essentially protect businesses (mostly exporters) that have extremely thin profit margins. It will be impossible for Chinese leaders to reverse this policy without a wave of insolvency, a sharp reduction of economic growth, and the strong prospect for widespread civil unrest. However, it is important to note that Chinese leaders are responsible for their own actions, intentional or unintentional. As those in power often state, it is an internal Chinese issue and no other country should interfere. Unfortunately, "internal" issues have an important effect on the US and other countries.

This morning, I have read the following WSJ article with great interest:

Hilsenrath, Jon, 2010. Bernanke takes aim at china. The Wall Street Journal, Nov. 19.

These two quotes sum up the situation:

"By keeping their currencies artificially weak, Mr. Bernanke argued in Frankfurt Friday, China and other emerging markets are allowing their economies to overheat, preventing trade imbalances from adjusting and worsening what he called a 'two-speed' global recovery."

"Their 'strategy of currency undervaluation' is preventing more 'balanced and sustainable' global growth, he warns, echoing a view expressed by Obama Administration officials."

For years I have been expressing similar concerns relating to pegging and balance of trade.

Perhaps what bothers me most is that many American corporations made outsourcing decisions based on currency exchange rates that were manipulated. The full extent of the manipulation perhaps was not known until recently. This is underhanded.

In his speech, Mr. Bernanke goes on to make the following statement:

"On its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for years," Mr. Bernanke warned. "As a society, we should find that outcome unacceptable."

I think there is no "risk" of structural high unemployment. I believe it is now a reality that America needs to face. Many predict that the earliest America will reach 100% employment might be 2015.

From a policy perspective, I think the two high priority issues for the US Congress to debate and for the President to ponder involve the structural US Federal government deficit and China's pegging policy.

I do not believe that China will change its pegging policy. This is reckless. In its own way the Fed is dealing with the situation.

Tea Party members might want to reconsider some of their statements about domestic inflation and the dangers of Quantitative Easing II. Current American monetary policies are a direct reaction to the pegging of the Yuan.