Wednesday, August 12, 2015

Short Term Bad: Long Term Great

The Yuan / Remembi was devalued yesterday.  The Yuan / Remembi is the currency of China (I don't know why there are 2 names, but it is their version of the dollar).
Story in the Global Post
Now, over the short term this might be an issue for the US.
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Cheaper currency hurts US (and other countries') exports to China and makes Chinese imports cheaper.
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But in another VERY important way, this helps the US.
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You see the US $ is the reserve currency of the world.  If (say) India buys $100 Million worth of planes from Brazil, the transaction goes from Indian Rupee, changed into US $ and then the US $ are changed into Brazilian Real.  That is because there aren't many banks with say 350 Million Brazilian Reals ready to exchange them for 6.5 Billion Indian Rupees.  Everyone prefers to hold dollars, because they know they hold their worth.  Brazilian or India might put currency restrictions on tomorrow (like Argentina and Venezuela have in the past).



Oil is priced in dollars.  Almost everything goes through US Dollars. There are more minor exchanges using British Pounds, Euros or Japanese Yen.  But primarily its dollars.
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This is actually great fore the US in a bunch of ways.  1) It helps make our deficit manageable (people want to buy US Dollar Bonds versus (say) Venezuelan Bolivars.  Because recently Venezuela stopped allow the Bolivar to be converted freely.  It makes our deficit sustainable.
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ALSO, 2) it helps us with sanctions (if we don't use it too often).  For example, we prohibited certain banks in Russia from the US Dollar system over the Ukraine Issue.  That makes it hard for countries / businesses who buy Russian Gas and Oil to pay for it.  You either go through a different currencies (say Hungarian Forients directly to Russian Rubles, but Russian doesn't want Forients) of you find someone who will buy Hungarian Forients for something else - say Euros and then change the Euros into Rubles.  This is not impossible, but it does add cost, time and insecurity to the transaction.  hat is why it is effective.
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So, how does China's recent actions help us?  Short answer - it makes using Chinese Yuan risky - at least versus the US dollar.
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You see, China has a lot of customers and transactions world wide.  There is a fair amount of push to make the Yuan a trade / exchange currency.  If that happens, then (say) New Zealand dollars would go directly to Chinese Yuan, without going through the transaction of US dollars.  This decreases the leverage the US has in the world banking system.  It makes our bonds slightly less attractive.
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But China has manipulated the currency the other day, dropping it 2%.  That doesn't seem like much.  But if the US did it, many many countries would scream.
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For example, Switzerland in 2012 held $190.1 Billion dollars of US bonds.  If we devalued by 2%, they would lose, overnight, $3.8 billions dollars.  Since the US$ is the "reserve currency" of the world, we don't do that. If the Chinese wanted to replace the US dollar as a reserve currency, they would have to be as hands off as we are.  Since they just proved they are NOT hands off, it makes the US more secure as the world's reserve currency.
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So yes, the devaluation hurts us in the short term.  But from a bigger picture view, it helps the US much more.  I have read that our position in the world currency markets probably expands out yearly output by .5 - .75%, which is significant on a yearly growth rate on only 3%.

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