Video: Keynes on Britain's Departure from the Gold Standard

As Predicted U.S.-China Economic War Heating Up

Another prediction which is coming in right on schedule: this Presidential political season the one thing Republicans and Democrats can agree upon (the generally conservative Senate voted 79-19) is that China is manipulating the value of its currency to make its exports more price competitive.

We're still in the early rounds of the latest Congressional flare-up over China's currency policy, so stay tuned.

Video: Niall Ferguson on China's Fundamental Problem

More clips from Professor Ferguson's Big Think interview can be viewed here.

U.S.-China Currency War: Should America Fight Back by Defaulting?

A little less handshaking, a little more action?

China-U.S. relations have dominated this week's headlines with Hu Jintao's official state visit to America. And there is much to talk about with respect to what is arguably the world's most important bilateral relationship.

'Bleeding-hearts' types will no doubt want to focus on human rights issues, such as China's not so secret effort to wipeout Tibetan civilization and the ongoing imprisonment of China's recent Nobel Peace Prize winner, Liu Xiaobo.

As the NY Times opinion page put it, "how can one Nobel Peace Prize laureate be silent when meeting the man who imprisons the next?"

And those concerned with the military balance of power can point to concerns about Chinese espionage, secret development of sophisticated weaponry like a Chinese stealth fighter, and China's navy contesting free navigation in the South Sea.

The Renminbi Runaround

There is also the matter of U.S.-China economic relations. As far as the U.S. is concerned, the big one is the exchange rate of China's currency, the renminbi (yuan). It is widely agreed that China's currency is undervalued by as much as 20-40%, providing China with an unfair trade advantage. Much has been written about this issue previously here.

Former Secretary of State and and National Security Advisor, Henry Kissinger, appeared on Charlie Rose this week to discuss relations with China. Not surprisingly, Kissinger argued for a diplomatic solution to the renminbi. While acknowledging that he is not economist, Kissinger believes there should be some way to bring the Chinese around on revaluing the renminbi by offering something in return. My question is hasn't the U.S. already tried that ad nauseam?

Throughout modern history the world's trade and currency order has always followed a set of explicit and implicit 'rules of the game', so to speak. Over the last two decades China has benefitted significantly from first having access to the world's markets and later gaining entrance into the World Trade Organization. While WTO rules do not cover exchange rate manipulation, one of the hallmarks of our current semi-free trade system is floating exchange rates. China exercises heavy control over its exchange rates in a manner completely unlike other major trading powers, such as the U.S.

The key question, put simply, can be expressed as follows: why is there one set of currency rules for China, and another set for everyone else?

Continue reading the full article published on SeekingAlpha here.

China: 2011's Biggest Question Mark

China just shut down Skype, the free/cheap internet phone calling service, by making it illegal.

While attention grabbing, the Skype move is hardly a surprise as Facebook, Twitter and YouTube are already blocked in China, and Google shut down its Chinese servers last year after government pressure.

Its very hard to see how this type of thinking on the part of China's communist party leadership will serve the country's economic interests over the longer run. China economic historians are well aware of how inward turns have worked out for the middle kingdom in the past. During the Ming dynasty, China largely shut itself off from the rest of the world, and the country's subsequent economic development suffered.

While China's technology blocking moves have more to do with the country's longer-term competitive position, two factors are weighing heavily on China's immediate-term prospects:

1. Trade tension between China and the U.S. has been on the rise, leading to talk of a U.S.-China economic war.
   
2. The Chinese real estate market, which according to legendary Enron short-seller Jim Chanos accounts for 60%+ of China's economy, remains in a frenzied bubble even with recent government moves to reduce lending activity through increased interest rates, reserve requirements, etc.

One of the biggest question marks going into 2011 has to be China and whether the country can manage a soft landing, or if in fact the mother of all bubbles will finally burst. If the latter is the case then there will be significant knock-on ramifications for perhaps nearly every investment sector (particularly commodities) around the globe.

Chimerica Rap Video: U.S.-Sino Currency Rap Battle

U.S.-China Financial Relations Explained by Saturday Night Live

Bank of Japan Intervention: What Happened Last Time? What's Next?

On Tuesday the yen traded at ¥82.88 yen per dollar, its highest level since May 1995. As predicted the Japanese government decided it had seen enough and instructed the Bank of Japan (BOJ) to 'intervene in the currency market' (aka print money). This caused the yen to quickly fall back to ¥85 per U.S. dollar level.

The BOJ also confirmed that its intervention -- reported to be in the ¥300-¥500 billion range ($3.61-$6.02 billion) -- will go unsterilized, which means that the BOJ will not seek to withdraw the new yen it has 'printed'.

Currency Traders Now Have an ¥82 Yen Bullseye

Via Bloomberg, Japan’s Chief Cabinet Secretary Yoshito Sengoku communicated two very important pieces of information:

1. ¥82 yen per dollar is "the line of defense to prevent currency strength from harming the economy"
2. "The government is seeking to gain the understanding of the U.S. and Europe for the intervention"

We now know the Japanese government's pain point (¥82 yen per dollar). Providing the market with an exact target -- not unprecedented for Japan (see below) -- could prove to be a mistake.

We can also infer from the "seeking to gain the understanding" comment that the BOJ's intervention was not only uncoordinated, but also without the consent of other central banks. It would be surprising if the Fed and ECB signed off on the BOJ's intervention. Europe, the U.S. and other nations are mired in a slow recovery and seeking export led growth. Japan's currency intervention makes U.S. and European goods more expensive in Japan.

What Happened Last Time the BOJ Intervened?

It was six years ago when the Bank of Japan last intervened in the currency market. In 15 months through March 2004, the BOJ sold ¥35 trillion yen ($421.7 billion) for dollars. What was the BOJ trying to accomplish? As noted back then Economy Trade and Industry Minister Takeo Hiranuma said "a dollar at ¥115.00 is the ultimate life-and-death line for Japanese exporters".

Two comments:

The Yen: A Little Less Conversation, A Little More Action?

The value of the yen just hit its highest level against the U.S. dollar since Nov. 27 at 85.32, which is close to its 15-year high of 84.82.

While recent news from Japanese exporters has been relatively positive, a higher value yen could threaten Japan's fragile economic recovery. A strong yen makes the price of Japanese exports less attractive in key foreign markets, such as the U.S.

In the past simple jawboning by Japanese officials has proven effective at 'talking down' the yen. On cue Yoshihiko Noda -- Japan's eighth Finance Minister in the past three years -- said that he is “closely watching” the currency market and that the yen’s current movement “is a little one-sided”. And as I write the yen is trading off a bit to 86.24.

However, given the serious discussion of QE 2.0 or QE Lite in the U.S., will talk alone be enough to keep the yen from rising this time?

Some Japanese exporters already appear to be looking for 'a little less conversation, a little more action' from the Bank of Japan. Yesterday Nissan Motor Co. Chief Operating Officer Toshiyuki Shiga said "with the current rate there would be an impact on our orders for export. I hope each country will cooperate to minimize the impact of the yen’s strength, and I hope the government (Japanese) will make such efforts.”

The last time the Bank of Japan intervened in a significant way was in 2004. I recently interviewed Axel Merk, portfolio manager of the $500 million Merk Currency mutual funds. Merk contrasted the Bank of Japan's currency prowess with the recent ineffectual efforts of the Swiss National Bank (SNB), which failed miserably in its attempts to halt the rise in the Swiss Franc against the Euro. Unlike the SNB, the Bank of Japan can "do real damage" to the value of the yen. Earlier this year Merk removed the yen from his list of "hard currencies" when it appeared the government might finally get organized enough to put pressure on the Bank of Japan to devalue the yen.

I wouldn't expect Bank of Japan intervention unless the yen breaches the 84.83 level for a sustained period. For investors, there are several yen ETFs to choose from.

In the meantime, here's Elvis:

Is a U.S.- China Economic War On Its Way?

The tone of U.S.-China relations, as evidenced by General Electric CEO Jeff Immelt's provocative “colonization” remarks, are deteriorating rapidly and signaling trouble ahead. Given the importance of this relationship it is important to understand what's at stake and how events may play out.

Sizing Up the Sino-American Relationship

The U.S. has the world's largest economy and the U.S. Dollar is the world’s reserve currency. China has the world’s fastest growing large economy, and it has proven comparatively resilient in the wake of the ‘Great Recession’. China recently passed Japan to become the world's second largest economy, and Goldman Sachs has forecasted that China will overtake the U.S. by 2027.

While the export of manufactured goods to countries such as the United States has been a key driver of China’s growth story, benefits have accrued on both sides of the Pacific. Large U.S. government deficits have been underwritten in part by the thrifty Chinese, and U.S. consumers have snatched up voluminous quantities of low cost Chinese imports.

This seemingly symbiotic relationship, which Harvard Professor Niall Ferguson has termed ‘Chimerica’, avoided close scrutiny during the credit boom years. But amid high U.S. unemployment and a mounting public debt Chimerica is now under a microscope.

China’s “Unfair” Currency Policy

China has been accused of manipulating its currency by pegging the renminbi to the U.S. dollar at an artificially low rate, thereby allowing China to gain an unfair trade advantage. Critics point to China’s more than $2 trillion in largely U.S. dollar denominated foreign exchange (forex) reserves as prima facie evidence that the renminbi is grossly undervalued. Market participants have speculated that if the renminbi were allowed to freely float it would appreciate by 20-40% against the U.S. dollar.

Emerging market and EU officials have joined the U.S. in criticizing China's currency policy. Under pressure, China’s recent announcement that the renminbi would be allowed to float was initially greeted with widespread enthusiasm. However, since the announcement the value of the renminbi has moved within a narrow 0.5% range, remaining effectively unchanged. This has led some critics, such as NY Times columnist Paul Krugman, to accuse China of “playing games”.

A U.S.-China Economic War?

One of history’s unfortunate reoccurring themes is the tendency on the part of political leaders to create foreign scapegoats, particularly when faced with challenging economic times and an uncertain electoral environment. From this perspective surging, recalcitrant China makes for a nearly ideal political target.

Candidates for office can blame the U.S. unemployment problem on “unfair” China competition and the undervalued renminbi. China's large U.S. treasury holdings (estimated at up to $1 trillion, or roughly 20% of all foreign holdings) will also make a convenient target for fear mongers pointing at foreigners as the source of the U.S.’s troubles. Expect increasing criticism of China (reminiscent of 1980s Japan bashing) from politicians, labor groups, talk radio, etc. through this November's mid-term elections and through the next presidential election cycle.

What is the likelihood that the U.S. will go beyond rhetoric and take action? Seeing the renminbi revalued upwards is one of the few policy areas with bipartisan support. President Obama may feel pressure to appear strong and stand up to foreign powers to preserve the American economic way of life. Calls to “do something” will only grow louder in the face of the projected slow employment recovery. In short, formal trade action against China cannot be ruled out.

How would China respond to overt moves by the U.S.? The Chinese government detests foreign pressure. At the same time China's leadership, emboldened for example by the failure of The West to prevent the financial crisis and Google's recent blink, is growing more confident. Looking to flex its new economic and geopolitical muscles, China would almost certainly retaliate in some fashion against any U.S. trade action.

Looking Ahead

Both the U.S. and China possess numerous incentives to avoid a serious breakdown in relations. The economic and political consequences would be devastating for both countries and the rest of the world. The central question is will the U.S. and China be able – or willing – to find a path towards compromise which is also congruent with their respective interests?

It is human nature to underestimate the probability of seemingly unlikely, large-scale events like a U.S.-China trade and currency war. However, students of history know this to be an all-too-frequent mistake.

In considering whether such a conflict can be successfully avoided it is important to remember that policymakers often fail to properly diagnose and head-off the really big problems, such as war and financial crisis. Assurances by officials shortly before the near collapse of the financial system that the subprime problem was "contained" is but one recent example.

What could lead to a more serious escalation of tensions? A WTO ruling, U.S. Congressional action, China’s sale (or further purchases) of U.S. Treasuries, or an Asia Pacific geopolitical event (i.e., Taiwan, North Korea, etc.) are just a few of the possible triggers.

With China in the U.S.'s political crosshairs investors would do well to continue to closely monitor the world’s most important bilateral economic and political relationship. And given the stakes, let us hope that the current U.S.-China trade and currency war doesn't escalate further, for even a mild economic war could be devastating.