World Out of Balance

New York Times web page ^ | November 15, 2009 | Paul Krugman

[RayChuang88]

International travel by world leaders is mainly about making symbolic gestures. Nobody expects President Obama to come back from China with major new agreements, on economic policy or anything else.

But let’s hope that when the cameras aren’t rolling Mr. Obama and his hosts engage in some frank talk about currency policy. For the problem of international trade imbalances is about to get substantially worse. And there’s a potentially ugly confrontation looming unless China mends its ways.

Some background: Most of the world’s major currencies “float” against one another. That is, their relative values move up or down depending on market forces. That doesn’t necessarily mean that governments pursue pure hands-off policies: countries sometimes limit capital outflows when there’s a run on their currency (as Iceland did last year) or take steps to discourage hot-money inflows when they fear that speculators love their economies not wisely but too well (which is what Brazil is doing right now). But these days most nations try to keep the value of their currency in line with long-term economic fundamentals.

China is the great exception. Despite huge trade surpluses and the desire of many investors to buy into this fast-growing economy — forces that should have strengthened the renminbi, China’s currency — Chinese authorities have kept that currency persistently weak. They’ve done this mainly by trading renminbi for dollars, which they have accumulated in vast quantities.

[RayChuang88]

I think Krugman kind of got it right, but there's one additional issue he forgot: China is taking full advantage of how American income tax laws work, which encourages American companies to outsource goods production for income tax avoidance reasons. As such, with also the undervalued Chinese yuan, that's why American companies have so many factories in China, and that explains why Hon Hai Precision Industry, Ltd. (Foxconn) has this GIGANTIC factory complex in Shenzhen just north of Hong Kong employing 275,000 workers to make a long, long list of consumer electronic products for American companies. Indeed, a large fraction of Apple Inc. products are being produced by Foxconn--including (if the rumors are true) the new tablet computer due early in 2010.

Krugman needs to realize if we get MASSIVE tax reform so it encourages personal savings and capital investment staying in the USA, the whole issue of China almost becomes moot because for American companies, tax reform of the type I want would drastically slow down--if not fully stop--the outsourcing of jobs out of the USA, primarily for income tax avoidance reasons.

I think the international banking crowd is scared of any US tax reform that encourages personal savings and capital investment in the USA because such a change would literally suck the life out of banks almost everywhere else on this planet. Under Steve Forbes' flat tax plan or the FairTax consumption tax system, personal savings and capital investments no longer get taxed, and that could result in a GIGANTIC "land rush" of liquidity into the USA because the USA will become in effect the world's largest legal tax haven.

Krugman--despite what all of us think about him--is right on one thing: the Chinese yuan is WAY undervalued, which ends up warping the Chinese economy. If the recession continues this policy will end up causing a very unpleasant financial crash in China with horrible consequences worldwide.

[Nervous Tick]

>> Nobody expects President Obama to come back from China with major new agreements, on economic policy or anything else.

Why not, Paul? We had such high expectations of the manchild! Bambi changes EVERYTHING! Bambi is HOPE!

Bambi is LIGHT! (I’m not talking about his resume either.)

What’s the matter, Paul? Did the unicorn run out of skittle poop?

[wbarmy]

The crash will hurt China the most because it will have to use its reserves of cash (American) to buy the oil and food it needs to survive.

America will be hurt but can actually regain footing if this happens because we will have to start producing the things we need here again. The tax code will have to change to allow this to happen, but that doesn't seem to hard to imagine with the current administration bombing so badly.

There is always a silver lining to every cloud.