We have argued over the last month in several articles that the Chinese boom appeared to be unsustainable at its current levels for a variety of reasons.

With currency revaluation, discussed here, we add another. The post immediately below refers to the approximately $420 billion in bad loans on the books of Chinese banks. If these have to be paid off in more expensive yuan, these loans go from bad to worse. We’d note that Lindsey Graham is one of those mentioning a revaluation of as much as 40% to achieve “fair value.” Such large discontinuities are virtually never good for financial markets.

UPDATE

Larry Kudlow has further thoughts, basically along the same line as ours:

The U.S., however, isn’t helping matters by threatening to launch a currency- and trade-protection war against China. The U.S., Japan, and the rest of the G-7 nations are putting the heat on China to revalue, or “up-value,” the yuan and end its peg to the U.S. dollar. This is allegedly to correct global trade imbalances and stop “cheap” Chinese exports from flooding U.S. and European markets. But any meaningful currency adjustment would have to be a yuan revaluation of at least 25 percent. That would require significant tightening of Chinese monetary policy, which, in turn, would cause a big slowdown in Chinese economic growth.

Is that what we really want?

The threat of a currency war could be an unnoticed factor in the recent U.S. stock market plunge. A much slower China economy would take a percentage point or two off U.S. economic growth, especially in areas like commodities, cyclical industries, tech, transportation, shipping, and trucking. These are the exact market sectors that are getting hammered on Wall Street.

Have the U.S. Treasury, the G-7, and the IMF forgotten the recent history of misbegotten currency manipulation? When several Asian currencies were forced to de-link from the U.S. dollar in the 1990s, world deflation followed. Floating exchange rates were a big mistake then, and could be a big mistake now.

Treasury man John Snow insists on floating rates worldwide, but he forgets that emerging-country currencies don’t float — they sink. Aren’t we yet persuaded that nations cannot devalue their way to prosperity? Or that currency stability is better than currency chaos?

China, remember, has a shaky banking system plagued with bad state-sponsored loans made to failing nationalized companies. A floating yuan might rise in the short run, but it could crash in the medium term as foreign investors withdraw their capital flows for fear of instability.

This entry was posted on Tuesday, April 19th, 2005 at 7:45 am and is filed under China, General, MSM, business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.