Why the IMF Won’t Make Our Day

So where we last left off…we have a currency manipulator on our hands, I said, but what are we going to do about it?

The fact is when it comes to currency manipulators, you have to ask: Who isn’t one?

With that said, buckle your seat belt for Part II.

If this Fair Currency Act does become law, it won’t take effect until January 2008. Only in spring will the process even begin, with Hank Paulson’s “findings.” Then we have 180 days to wait for China to respond with correcting policies. But if it doesn’t (and why would it) we must enlist the IMF.

On IMF’s heels would follow formal proceedings with the World Trade Organization. The WTO’s legal approval of our trade penalties would not happen until late 2010.

Now hear this: The IMF’s role is essentially null. It hopes to “shame” any currency-manipulating nation into changing its practices. Shame? That’s right. Despite a recent review of IMF procedure for monitoring monetary policies, it neglected to adopt new methods of enforcing its rulings. In the IMF’s June press release, it only announced a tightening up of the definitions set down in haste during the Post-Bretton Woods fallout in 1973.

Not having any widely excepted economic theory on how to manage exchange rates is a big part of the problem. And in fact, the same Articles of Agreement the senators wish to invoke are written so broadly that they give immense leeway for how countries choose to handle exchange rates. The only mechanism the IMF has in its arsenal is the “supplemental consultation.” This is a special investigation of a country’s interest rate problems.

Moral Suasion: Pressure Without Force

The supplemental consultation has been invoked only two times in 29 years: Sweden in 1982 and South Korea in 1987. The result: not successful. The U.S. failed to get the IMF to agree that South Korea’s account surplus should be reduced by half, from $10 billion. And post-IMF consultation, that account surplus actually grew to $14 billion.

In today’s case, the IMF does want the yuan to move, but says the timing should be left to China. All in all, the only tactic the IMF has is “moral suasion.” A consultation with Investopedia offered a stunning definition replete with examples: “closed-door meetings with bank directors, increased severity of inspections, appeals to community spirit, or vague threats.” Those last two are my favorite. The “good example” they provided: When the Fed chairman speaks, stocks fly or fall. Wow, and do we ever cave in to that pratfall.

Too bad the IMF’s suasion won’t be so effective. Especially since our own stance on IMF intervention is confounded. We, against the majority of Europe, championed the idea that China (as well as India and Turkey) needed to have more power in the IMF…not less.

This struck me as counterintuitive until I read the rationale of one Treasury undersecretary, Timothy D. Adams:

“I would urge that by re-engineering the IMF and giving China a bigger role, China will have a greater sense of responsibility for the institution’s missions.”

Now, it strikes me as just plain stupid (however much an appeal to “community spirit” that it is). That’s like saying our founding role in the U.N., with all its attendant power, makes the United States more likely to feel its responsibility to all the members of the U.N. and to its unified cause and mission.

So shame and responsibility are to save the day? That’s like saying corporations should have “feelings” simply because they are legally classified as “persons.”

But the decision to give China more veto power doesn’t fall into our lap. It belongs to the likely successor to the current IMF managing director: Frenchman Dominique Strauss-Kahn.

So how’s the preliminary “shaming” going? Back in April, the People’s Bank of China rejected the IMF’s yuan advice — emphasizing the importance of stability within member countries. So I wouldn’t hold my breath for IMF action. And in fact, our legislative pressure hardly seems to bristle the Chinese media.

How China Reacted to the Fair Currency Threat

Frankly, Xinhua made it seem about as consequential as swatting a fly. Before the Senate legislation gained its finance and banking following, the general line was that Hank Paulson knows the real story. The legislation is foolish. Hank is on our side.

Then, on Aug. 8, Mr. Ambrose-Evans-Pritchard screamed the headline, “China Threatens ‘Nuclear Option’ of Dollar Sales” from his privileged U.K. Telegraph view. The source was “state media.” But none of the phrasings of the officials he cited ran quite that way. The finance chief at the Development Research Center, Xia Bin, called the foreign reserves a “bargaining chip.” And that, folks, is simply moral suasion right back at you.

Supposed “NUCLEAR OPTION” Would Be Sinocidal

Call me a fool, but I believe the People’s Bank of China officials were speaking the truth when they resoundingly denied a huge treasury sell-off in response to Mr. Pritchard’s outcry.

After all, it’s really NOT in China’s interest. And since China has yet to return to true “empire” status, it doesn’t have the swollen balls to make a point outside of fiscal interest…

When you’ve got $1.33 trillion in greenbacks, you’re not going to sell them off en masse. It would be “Sinocidal.” China could only dump a tiny fraction of the reserves on the market, or else its remaining reserves would take a huge hit in value. Secondly, the yuan is not yet unpegged from the dollar, which is why buying Treasury reserves works so well for China in the first place. This limits the yuan from rising — by propping up the dollar.

Truth is China doesn’t have to do much of anything. Aren’t we already imploding?

Don’t Place the Entire Trade Deficit on the Yuan’s Doorstep

My personal favorite post-Senate approval remark comes from the chief economist of Hong Kong’s BNP Paribas Peregrine Securities. It didn’t get much press:

“They have stuck to their anti-China stance simply to win over voters.”

With this, the Asian chief economist shrugged. His conclusion: This nation of deficits will suffer from its own detrimental behavior, no matter what happens with China.

What “We the People” don’t fritter away on higher-cost consumer goods from China we’ll lose snapping goods up from lower-cost nations. And besides, China’s labor costs are so low that there will be no shot in the arm for American manufacturing. It’ll go to China’s increasingly competitive neighbors!

So what really is all this China business but a waving of a red flag in front of a bull? (That is, a flagging bull coming to the edge of easy-money pastures.) How else to divert Americans from the clear and present dangers in the economy? For example, the recent $120 billion liquidity injection from our fearless central bankers? Instead, we ask for a good old “enemy.”

Because surely the recent “consumer confidence” numbers for August at their “highest in five months” aren’t enough to keep us buoyant. Nor do we see in them the chastisement I think we deserve.

Exercise Your Way to a Healthy Economy

Hmm…our less than 1% savings rate compared with China’s personal savings at 40% of an individual’s income. Believe it or not, we have some liberty to “vote” with our dollars.

Hillary Clinton recently got her panties in a bunch over this yuan game, preaching the prevention of America’s being “held hostage to economic decisions being made in Beijing, Shanghai, or Tokyo.” What you’re not allowed to say on the campaign trail is the truth: “You are held hostage by your own purchase of gewgaws, SUVs, and houses you couldn’t pay for…”

Sure, you can say, “We were tricked into thinking they [the houses, at least] would appreciate so much.” But you, dear reader, surely needn’t be pointing that finger.

And if we all acted like Sara Bongiorni, the business writer who penned A Year Without “Made in China”: One Family’s True Life Adventure in the Global Economy, at least we could have a high horse to ride into the China Currency War on.

Bet you could do it. One of Ms. Bongiorni’s big complaints was not having a coffee maker once the old one broke. Try boiling water in a saucepan on the stove. Add grounds. Strain if desired. Or better yet, forget the coffee. Take a shot of good ol’ American bourbon whiskey — we’re gonna need it in the coming months.

I agree with the Hong Kong economist. Don’t let the congressmen yank our chains. To take the words straight from the China Currency Coalition’s press release on the Fair Currency Act of 2007:

“American manufacturing workers, their industries, and their communities are counting on Congress to act.”

But as I hope we’ve uncovered above, this is an act promising no action. Let’s not forget that Bush is keen to veto it anyway. This would be one of the better moves in the twilight of his presidency.

To paraphrase the character Vizzini, from my generation’s cult classic film The Princess Bride: The most famous classic blunder is never get involved in a land war in Asia…And (I add) only slightly less well known, never get involved in a currency war where you have no weapons — just IOUs.

Here’s how that battle unfolds. Send out a spokesman, say, Treasury Deputy Assistant Secretary Mark Sobel. This ersatz “rear admiral” tells Congress:

“While China’s currency policy is critical to the United States and to China, currency movement alone will not significantly reduce China’s trade surplus nor eliminate the distortions in the Chinese economy. China’s trade surpluses are rooted in the structure of the Chinese economy and are not solely the result of currency policy. China needs to restructure its economy so that household consumption, rather than exports and excess investment, powers growth…Vibrant domestic consumption is key to the welfare of the Chinese population and is the only way that China can grow without generating huge trade surpluses.”

In fact, that’s exactly what Sobel said in May 2007, in his testimony on how currency manipulation affects U.S. workers. Hmmm…that’s all he’s got?

How far are we really going to get by telling China to become like America? We, with our oh-so-well-oiled economic machine.

Since currency talk has “gone nuclear,” let’s call America’s weapon of spreading the gospel of household consumption “bioterrorism.” Because the urge to consume, nicknamed “keeping up with the Joneses (or Chens),” is surely the result of some overactive gene.

So let’s leave off with the revised headline “Bioterrorist U.S. Bids China CONSUME.”

Till Congress makes its next blunder,
Samantha Buker

August 24, 2007

The Daily Reckoning