Geithner's China Bashing Bodes Ill for Stocks
Much of the secret of United States wealth lies in the fact that the inhabitants and firms of each state in the Union have been able to specialize along the lines of comparative advantage, without interstate barriers. – Robert Mundell, Man and Economics
Where trade is concerned, the long-held presumption by classical economic thinkers has been that international trade is merely an extension of domestic trade given a single currency definition that erases exchange-rate risk. As Stanford Professor Ronald McKinnon observed in The Rules of the Game, when countries maintain a uniform fixed exchange rate, “each national economy gains from more efficient specialization in international goods markets” and “also gains from better monetary stability than it could manage on its own.”
All of the above takes on greater prominence in light of Treasury Secretary Tim Geithner’s statements about China last week. After mouthing the increasingly meaningless line bludgeoned to death by George W. Bush’s Treasury’s secretaries that a “strong dollar is in the national interest”, Geithner added that “President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency.” Geithner’s statement bodes ill for the dollar, and as a result, for future stock performance.
To begin, Geithner’s desire that China’s central bank revalue the yuan is an explicit admission on his part that he would like China to continue to manipulate the yuan’s value; albeit to a higher level against the greenback. Sadly for dollar holders, investors regularly key on the comments of Treasury secretaries, and the dollar price of gold has skyrocketed over $60/ounce since Geithner spoke. Sure enough, one way to increase the yuan’s value versus the dollar is for the dollar to fall, and investors are so far accommodating our new secretary’s wishes.
Worse, in jawboning the Chinese about the value of the yuan, Geithner is showing an impressive misunderstanding about why we produce in the first place. Put simply, we produce so that we can consume. In that sense, the only number that matters when it comes to trade between the U.S. and China has to do with how much we’re trading.
In that sense, the mostly tight link between the yuan and the dollar since the ‘90s has been a boon for wealth-enhancing trade between producers in each country. From 1998 to 2007, exports from China to the U.S. increased 351 percent, and from the U.S. to China they’ve risen 355 percent. And while the protectionists in our midst might eagerly note that China has exported a great deal more of goods in total dollars to the United States during the time in question, this merely speaks to the truth that a lot of the dollars we send to China come back as investment; investment not counting in trade figures.
What’s important is that currency stability between the two countries has been wealth enhancing for producers in each country engaging in their economy specialty. Just as comparative advantage within these fifty states has fostered all manner of U.S.-based economic specialization and wealth creation, the expansion of the division of labor to China’s millions of able-bodied workers has similarly enriched us. For those who doubt this, try to imagine how much smaller our economy would be if every state in the Union had a different floating currency. Much as trade would decrease in an impoverishing way if a New Jersey currency were to float versus a New York currency, so will we weaken ourselves if the value of the yuan starts to gyrate relative to the dollar.
And when we consider market returns, it’s then that we see that Geithner is truly playing with fire when he jawbones China. Indeed, contrary to the broad assumption that Federal Reserve activity is the main driver of the dollar’s value due to its control over “money supply”, the real truth is that Treasury secretaries hold more sway.
When Carter Treasury Secretary Michael Blumenthal expressed unhappiness with the allegedly weak Japanese yen (history always repeats itself) in June of 1977, the dollar proceeded to collapse. The Reagan Treasury talked up the dollar in the early ‘80s, but Secretary James A. Baker used the 1985 Plaza Accord to bring the dollar down, and markets complied. Baker’s indifference to the falling dollar in October of 1987 is thought by many to have sparked the ’87 crash.
Moving to the Clinton years, tariff threats on Japanese luxury autos combined with Secretary Lloyd Bentsen’s acceptance of a weak dollar brought it down during Clinton’s first term, but the dollar’s value jumped during his second term owing to the basic truth that during Robert Rubin’s tenure at Treasury, not once did a responsible official there ever express unhappiness with the yen’s value versus the greenback.
It’s well-known now, but all three of Bush’s Treasury secretaries revealed their weak-dollar stance in suggesting that "markets" should set the value of the dollar concept, and investors once again complied with a collapsing unit of account. This is important when we consider equity performance. Carter and Bush were weak dollar presidents, and equity performance was dismal under both. Reagan and Clinton were mostly strong dollar presidents, and stocks soared under both.
So in assessing Geithner, his intimate involvement in the disaster that has been TARP should have disqualified him for Treasury out of the gate. That he’s now shown his true colors with regard to a weak dollar makes his confirmation even more of a mistake given the impressive correlation between falling currency values and poor economic performance. What’s unknown at this point is whether Barack Obama will countenance the very currency policy that sank George W. Bush’s presidency. Indeed, if history is any kind of indicator, Obama’s embrace of Geithner foretells a future in which the numerous agents of “change” in this country will have very long faces.