Why Peter Morici Is Wrong About China, Gold and the Dollar

Peter Morici is very correct that the dollar has served as the "reserve central banks hold to back up national currencies", and he's also correct that the amount of the gold in the world is limited. The problem lies in his assessment of relative currency values, the role of gold in shaping them, and his pre-classical view that trade is somehow harmful.

First up, it is precisely because gold is limited in supply and that it has very few industrial uses that it is such a worthy measure of money. With nearly every ounce of gold ever mined still with us, there's a massive disparity between the gold stock (roughly 137,000 metric tons) and gold discoveries (flow) that frequently reach 2,000 metric tons per year.

The result of the above is that with annual discoveries very small relative to supply, gold's real price is highly stable. Neither central banks nor individuals can credibly move its real price over the long-term precisely because there's so much gold held in diffuse hands. This is why gold has historically served as money par excellence, to paraphrase Karl Marx.

Morici argues that there's not enough physical gold to back every currency, and while true, that's not the goal of most who desire a return to a gold standard. In truth, if the U.S. Treasury were to define the dollar in gold terms, it realistically wouldn't need to hold very much gold in Fort Knox to do so.

Indeed, money is an interest bearing asset, whereas gold must be stored at a cost while generating no interest. That being the case, if Treasury made plain that in the future dollars would be redeemable at a set gold price, there would be very little incentive for dollar holders to exchange them for the physical commodity.

So long as the redeemable standard was credible, redemptions would be low. Importantly, under this kind of gold exchange standard, markets would communicate to U.S. monetary authorities how many dollars should be in the system. Put more simply, a rising gold price alongside redemptions would signal the need for the Fed to extinguish dollars, while a falling gold price would serve as a signal from the markets that the economy needs more money.

Morici pines for a currency world characterized by floating currency values, but in seeking what is realistically an absence of policy, he misreads the historical, pre-1971 role of money. Simplified, money is merely a concept, much like a foot ruler is a foot ruler. If we were to float the foot we could still build houses, but we'd build less of them while making a lot more building mistakes.

Currencies must be seen in the same way. When they float, they distort the real money prices of all manner of investments. Much as a floating foot would lead to all manner of asymmetric and ugly living spaces, floating money leads to all kinds of faulty investing; the rush to housing wrought by a weak dollar the latest and most impoverishing example.

Had the dollar been stable, the money illusion that drove up the nominal prices of homes would not have revealed itself, and the world economy wouldn't have collapsed due to a flight to the real. The weak dollar is what made housing so attractive, and is what props up nominal prices to this day.

This is important when Morici's views on China's currency policy are considered. Specifically, Morici posits that "since 1995 China has maintained an undervalued currency by selling huge amounts of yuan for dollars to merchants and currency traders." Morici is correct that China seeks to maintain a stable dollar/yuan price through the currency markets, but it does not do so to hold down the price of the yuan.

More realistically Chinese monetary authorities have long understood that lacking any modern history as currency overseers, it would be dangerous for them to conduct policy absent a credible currency anchor. In that sense China's monetary policy is similar to that of myriad other countries around the world who peg their currencies to better known, and more credible monetary concepts. For good or bad, and bad at present, China has since 1995 outsourced its monetary policy to the United States.

Morici sees China's sliding dollar peg as an attempt to hold down the prices of its goods, but basic anecdotal evidence proves otherwise. Indeed, to produce goods for the world, China must import massive amounts of commodity inputs which are priced in dollars, and which have spiked in price due to the dollar's debasement. While money is surely a veil and can't change the real price of anything, if China wanted to reduce the nominal price of its goods, it would drive the yuan up much higher so that its commodity inputs would become less expensive in nominal terms.

Digressing somewhat, Morici makes the case that Japan has similarly pursued a weak currency strategy against the U.S. In that case, Morici is blatantly ignoring the facts. In 1971, a dollar bought 360 yen, whereas today it only buys 90. The idea that Japan has held down the yen versus the dollar is empirically bankrupt, and arguably not worth mentioning.

Back to China, the main reason for it maintaining a dollar peg beyond has to do with trade. Put simply, when currencies gyrate relative to each other, cross border trade is victimized due to the uncertainty it creates among consenting merchants. In that sense, we need only ask ourselves how very much interstate trade would plummet within these fifty states if there were fifty currencies. The collapse would be disastrous.

Much the same would reveal itself if the yuan and dollar had no stable relationship. Morici sees trade as war, but in truth trade is the simple and wealth enhancing process whereby individuals - as opposed to countries - exchange what they're best at. We produce in order to consume (trade), and stable currency values make this possible.

Looking at cross border trade between individuals in China and the U.S. since 1999 alone, the results have been profoundly good. U.S. exports to China over that timeframe have rocketed up 429 percent, while Chinese exports to the U.S. have risen 312 percent. Trade is once again the sole reason we work, and the dollar/yuan relationship has enhanced our incentive to be productive.

Morici believes that it's problematic that the Chinese produce without consuming, but in suggesting this he ignores basic economic logic. For one, as anyone who's visited China has noticed, individuals there are major consumers as evidenced by China being one of the world's largest car markets, to name but one item.

But assuming they weren't, as in assuming the illogical whereby the Chinese produced in order to remain impoverished, this would in no way harm the U.S. economy. That's the case because no act of saving ever detracts from demand. If the Chinese decide to bank all their gains from exports, the money saved will simply be lent to businesses eager to expand and to consumers eager to spend. China's allegedly excessive savings rate is an absurd canard that merits no serious attention.

Morici ties rising U.S. unemployment to our trading with countries like China, but in doing so he ignores the fact that the U.S. has had a trade "deficit" for as long as it's been in existence, and that despite a globalizing world, the U.S. labor force participation rate (from 60% in 1970 to 66% in 2005) has been rising for nearly forty years. Cross border trade hasn't so much killed jobs as Morici supposes without evidence as it's changed the nature of our work. Whereas we used to be more reliant on agriculture and manufacturing for work in the States, we've done as countries have always done whereby we've let low value work migrate elsewhere in order to do higher value, service-oriented work.

In the end, it must be said that the China/U.S. trade relationship is the greatest story never told by mercantilists of the Morici variety. As opposed to a signal of our decline, the massive amount of Chinese imports that reach the U.S. (fostered by relative currency stability) are a major compliment to our productivity first, and to our desire to let others make for us what's not in our interest to make so that we as individuals can achieve our own comparative advantage.

In an economic system of individuals, there are no trade deficits. Morici believes otherwise, however, given his blinkered view that trade is war between countries. Here's hoping his views will carry no weight beyond his substantial role in the economic commentariat. If not, as in if the Moricis of the world achieve barriers to exchange where there presently aren't, lower standards of living are just around the corner.