U.S. vs. China Currency War…Why We Will Eventually Lose

 

There’s quite a story going on between China and United States in respect to what each country believes the other should be doing with its interest rates, debt, and currency.

U.S. Treasury Secretary Timothy Geithner will be meeting this week with Chinese Vice Premier Wang Qishan. Here’s what the two want of each other…

Geithner will prompt China to raise interest rates to push up the yuan, which the U.S. says is kept artificially cheap. (You can see the U.S. argument easily. A higher priced yuan will make those Chinese goods more expensive to Americans.)

The Chinese, on the other hand, have been complaining that lax U.S. monetary policy and record U.S. annual budget deficits have lowered the value of the dollar, while spurring global inflation.

Bottom line: each country wants the other to have a stronger currency. If I had to pick a winner, the U.S. is the winner right now in the currency fight, but in the long term it will also be the loser.

China has raised interest rates four times since last October. One-year deposits in China yield an interest rate of 3.25%, while the one-year lending rate is 6.31%. Here in the U.S., a one-year T-bill continues to yield a pathetic 0.16%. If interest rates in the U.S. were what they are in China today, we would be facing deep economic problems again.

Yes, by keeping interest rates so low, running huge deficits and keeping the printing press running overtime, the U.S. has been able to emerge from the worst recession since the Great Depression.

However, the Chinese are right in that the existing U.S. monetary policy is causing inflationary pressures to rise worldwide. According to the Food and Agriculture Organization, a United Nations entity based in Rome, Italy, world food prices rose to a near record in April on soaring grain costs.

The U.S. is the winner today in the fight against the Chinese over currency valuation, but, as I say above, it will be the loser in the long term, as those short-term interest rates that are artificially low, huge deficits, and overtime money printing come back to haunt us in the form of a devalued currency and the rapid inflation that the Chinese are complaining about.

China sat on $1.15 trillion in U.S. Treasuries at end of February. A devaluing greenback and inflation are already paying havoc with the real return of U.S. Treasuries.

Michael’s Personal Notes:

Speaking of the “real return” of an investment, it has been months now that U.S. Treasuries have been delivering negative real rate returns.

A typical investor looking to park cash buys a U.S. Treasury yielding 1.86%. If we take an inflation…

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