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Victor Hugo: Debt problem will determine who wins, dollar or gold

Section: Daily Dispatches

By Christopher Mayer
Tuesday, May 4, 2004

The monetary world is one of competing devaluations,
currency blocs, exchange controls, political posturing and
jawboning -- in short, a sort of serial economic conflict.
Where once all money found a common denominator in some
metal, today's currency is fragmented money with an added
layer of political instability on top of the natural
uncertainty of free market prices.

This added uncertainty is not without consequence. Capital
as a financial concept is defined by the price of money.
Monetary calculus takes place in dollars, or yen, or euros,
amongst a myriad of other monetary symbols. When that money
price no longer reflects the realities of supply and
demand, becoming distorted -- as is often the case when the
political mixes with the economic -- you have the
ingredients for a crisis.

Currency manipulation is effectively a cloaking device,
where political ambition seeks to change the natural
pattern of the market. Today, it is frequently in the news,
as America continues to suffer job losses to nations that
can produce the same for less. Chief among the new habitats
for these migrating jobs is China.

The Chinese yuan is linked to the dollar, as are other
Asian currencies -- the Hong Kong dollar, and the Malaysian
ringgit. Japan, while not officially pegging the yen to the
dollar, has joined its Asian neighbors as a large purchaser
of U.S. dollars. As James Grant noted in the April 9 issue
of Grant's, "The pell-mell purchase of dollars for yen,
renminbi, and other Asian currencies constitutes the largest
exchange-rate manipulation in the history of the world."

By absorbing America's prodigious production of dollars,
the finance ministries of Japan and China, in particular,
have helped to bolster the dollar's value. The Asian
countries follow this path to keep their own currencies
from appreciating against the dollar, thereby protecting
what they perceive to be the key to their own prosperity --
namely, exports.

In times when the paper monetary emissions of a nation's
government were redeemable in specie, such a charade had a
definite life span that was circumscribed by its gold
stock. Eventually, the offending treasury's gold reserves
would start to dwindle, and the inflation would either have
to be brought to heel or the gold standard suspended (which
happened frequently enough). Either way, the jig was up.
Not so in today's accommodating monetary marketplace, which
allows for evermore widespread and extended inflations.

Nonetheless this, too, will end, as all manipulations end,
in disaster. It will end in devaluation, as tremendous
purchases of dollars cannot be sustained. That is the way
of all unsustainable trends. They go on for longer than
most people think likely, eliciting elegant theories to
rationalize them... and then the trends stop, usually to the
surprise of many and to the detriment of their portfolios.

The relationship between these Asian countries and the
United States is such that the Asian countries seem to have
ceded their discretion over monetary policy to the United
States. Ludwig von Mises observed that the monetary policy
of one nation voluntarily becomes a satellite of a foreign power
when it pegs its own country's currency rigidly to the currency
of a monetary "suzerain-country." Under such an arrangement,
the pegged-currency country is bound to follow all the
changes the "suzerain" brings about in its own currency,
against other currencies and against gold.

Today, it is not hard to discern that the United States is the
suzerain. China, for as long as she cares to link her
currency at a fixed rate with the dollar, is forever at the
mercy of U.S. dollar policy.

The media highlights China's advantage, however ... derived,
they say, chiefly from the fact that her currency is
deliberately fixed at a cheaper value than the market might
independently appraise. But China's policy in this regard
is hardly wholly beneficial to China. China sells its
exports for dollars. These dollars have gotten cheaper and
will likely get cheaper still. China sells, and in return
receives notes that, in a sense, will never be repaid at
par value.

But the cycle doesn't stop there. Devaluations are often
followed by more devaluations, as each nation is deluded
into thinking that the way to prosperity is to destroy the
native currency to stimulate exports and to preserve jobs.
"At the end of this race," Mises warned, "is the complete
destruction of all nations' monetary systems."

Whatever the advantages put forth by advocates of
devaluation, Mises pointed out that they were at best
temporary, resting entirely on the fact that adjustments to
currency changes take time. Temporarily, exports are
stimulated by devaluation, as that nation's goods and
services suddenly appear cheaper to customers overseas and
abroad. But ultimately, devaluation simply means that those
bound by the currency must work that much harder to
purchase the same quantity of foreign goods that they were
able to purchase before for less work. Devaluations make
one poorer, not richer.

Any manipulation of exchange rates, devaluation or
otherwise, creates imbalances and tensions that foment
crisis and economic ruin. China, by continuing to allow for
the cheap accumulation of yuan with overpriced dollars, is
doing U.S. consumers a favor that cannot last.

When China stops, and when the rest of Asia follows suit,
the end result ought to be higher interest rates and a
cheaper dollar ... not to mention painful economic


Christopher W. Mayer is a veteran of the banking industry,
specifically in the area of corporate lending. His essays
have appeared in a wide variety of publications, from the Daily Article series to here in The Daily
Reckoning. He is also the author of "Capital and Crisis," a
recently launched investment advisory for contrarian-minded
financial observers. For details, see:

Capital & Crisis


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