Memo To: Treasury Secretary John Snow
From: Jude Wanniski
Re: The Yen and the Yuan
I do know you were chosen to succeed Paul O'Neill at the Treasury post because you had become a true believer in supply-side tax policies, which O'Neill never understood. Unhappily, John, you never had the opportunity to learn supply-side monetary policy, which is why you are now traipsing around Asia complaining about the "artificially weakened yen and yuan," as James Brooke of the NYTimes reported this morning from Tokyo. You are further inhibited in learning about monetary policy because you are only supposed to talk about the exchange rate of the dollar and foreign currencies and forbidden to discuss the Federal Reserve's management of the domestic dollar. A silly convention, I think. I should also tell you that when I met with Secretary O'Neill in 2001, to warn him of the problems of monetary deflation caused by Fed policy, I also warned him against the appointment of John Taylor as Undersecretary for International Affairs. Taylor is a nice fellow, but thoroughly inept in the international post, and as you have chosen to keep him on, he is now at your side infecting you with his incompetence on the exchange-rate issue.
Let me explain: When China decided to fix the yuan to the dollar in 1994, the dollar/gold price was $385. In 1997, when there was an increase in demand for the dollar because of the tax cuts passed that year, the Fed failed to supply the needed liquidity and the dollar became scarce relative to gold. The price of gold began to decline, falling and falling and falling until in hit $250 in mid-2001. Commodity prices fell in dollars and because China was pegged to the dollar, they also fell in yuan. And because Japan was trying to keep its currency stable against the dollar, it also had to deflate even more than it had been deflating since 1990 for other reasons. The Chinese economy was punished severely because of its dollar link, but it held firm in the belief that had little choice but to keep in step with the United States, its chief trading partner. At the time, nobody in our government made a peep about China's "artificially weakened yuan." In order to keep its economy from collapsing under the weight of the burdens deflation puts on debtors, the government propped up its banks and waited for relief in the international economy.
The relief came, John, when the geopolitical risks associated with 9-11 caused American businessmen to pull in their horns -- and their demands for dollar liquidity. The weakened economy that followed was accompanied by a steady rise in the dollar/gold price, from its low of $250 to its current $370. In other words, the deflation ended in China and its economy is once again growing like mad, a powerhouse in Asia. The complaints you are getting from the textile manufacturers in the Carolinas and the garment workers' union in New York and other industrial states represents a complete misreading of China's recent success and rapid growth rate. All you really have to do in China when you get there this week is encourage the government to use more of its reserves in foreign currency -- now more than $300 billion -- to further fuel its domestic economic expansion.
By that, I mean instead of buying dollars with yuan to keep the exchange-rate fixed, they should issue more yuan bonds in order to finance the infrastructure projects it needs to bring rural China into the growth rates enjoyed now by the urban areas. To keep the yuan/dollar rate fixed, if it still wishes to do so, the People's Bank of China should buy and sell yuan assets the same way our Federal Reserve does with dollar bonds. Believe me, it would work like a charm. China would grow at a faster rate and with its new policy the growth would become import-led, not export-led. There are lots of people in the Pentagon, the civilians I mean, who do not want China to grow fast and would love you to feed them bad advice. But I don't think the Chinese would go along with any of that. They watched the neo-cons poison the USSR with "shock therapy." If you need to confirm what I'm telling you here about the exchange-rate issue, you should at least have a chat with Alan Greenspan, as he well knows China does not have to keep its currency stable against the dollar by buying dollar bonds. It can achieve the same effect by buying (or selling) yuan bonds. The net effect would be more Chinese workers working and earning higher wages. The complaints would soon stop coming from the Carolinas. Or they would not be so loud. No kidding. Check it out.
Sincerely, as always,