The hidden consequence of collapsing Chinese exports

March 3, 2009

Many economists have long known that Chinese consumer demand must rise eventually to balance the excessive trade surpluses of previous years, but the government in Beijing has been actively preventing a shift in trading trends by manipulating the exchange rate through dollar recycling. Their intent is to maintain attractive prices and encourage further American consumption of their products; however, now that American demand is drying up despite cheap prices, there is no longer a reason to maintain an artificially low currency. It hurts China unnecessarily.

The de-coupling theory has always been dependent on a dramatic appreciation of Asian currencies. I have always been a little skeptical of their intent to allow such an appreciation, which is the reason I generally avoided too much exposure to their equities, however my mood is beginning to shift on this issue. The herd that rushed into China 2 years ago has now been wiped out and my gut is telling me 2009 will be a pivotal year in world history. Some day people will ask, were you born before or after 2009? The status quo can not continue indefinitely, something must change.

It has been widely reported that China is pressuring the American government to “protect” their “investments”. Translated, that’s a warning not to inflate away their debts, but it’s becoming increasingly clear that quantitative easing (“printing money”) is around the corner, if not already here. It could be the only way to save politically connected banks and insurance companies from insolvency. Even Warren Buffet, the guy who famously declared he couldn’t care less about macro-economic issues is now warning of a possible “onslaught” of inflation.

If America debases the US dollar to wipe away excessive debts (much of which is owed to China) what will they do to retaliate? There is no guarantee China will shift to a more confrontational policy, but at least now there is a path to appreciation that didn’t previously exist. Whether any of these plans or retaliations will succeed is another matter, but the probability of de-coupling in the near future is now higher than at any time in recent history. Sentiment couldn’t be more bearish for emerging economies, that’s the sign of a bottom, not a top.

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