Geithner Brings the Laughs In China

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Though the U.S. press mostly withheld mention of it last week, the international media had a big laugh over Treasury Secretary Geithner’s visit to China. Apparently more aware of the dollar’s withering condition than our chief dollar steward – a scary thought on its face – they clearly understood the audience laughter when Geithner told Chinese students that dollar-denominated “Chinese assets are very safe.”

It doesn’t take an in-over-his-head Treasury secretary to understand that when the dollar is falling, the assets that pay out those dollars are necessarily imperiled. The Chinese, and all holders of U.S. Treasuries are necessarily skeptical, and with good reason. Whereas a dollar bought 1/250th of an ounce of gold in 2001, as of this writing it only buys 1/960th. Despite this stupendous collapse in the unit of account, Geithner remarkably believes that our federal debt is a good bet.

For this alone, it’s hard to be optimistic about the dollar’s future prospects. When Treasury heads exhibit total ignorance about its value, and in Geithner’s case a sanguine countenance, this is a signal that the greenback is being ignored and that further weakness will be accepted.

Worse if that’s possible is Geithner’s stance on the very inflation that the above dollar weakness represents. As he told U.S. reporters last week, the Chinese “understand and have confidence in the Fed’s capacity to keep inflation low and stable over time.” Implicit in a statement pregnant with meaning is that Geithner shares the Fed’s absurd view that inflation is an economic growth concept that can be controlled through interest-rate machinations that supposedly fine-tune economic activity.

What this means is that true inflation, something that is always and everywhere the result of declining currency values, will be ignored in favor of central management over the economy. That economic growth of any kind has nothing to do with inflation doesn’t seem to trouble our Treasury secretary. Instead, he’ll apparently accept the dollar’s inflationary decline while allowing the Fed to make interest rate guesses that frequently end in tears. Is it any wonder that investors are growing increasingly skeptical about our private capacity to support the debt issued by Washington?

Rising Treasury rates suggest investors are growing very skeptical, and further statements by Geithner offer clues as to why. Sure enough, he mimicked his Treasury predecessors in the Bush administration with his comment that “We…welcome their commitment over time to move to a more flexible, market-determined exchange rate.”

Translated, Geithner underscored his untroubled conscience about the dollar’s decline with his statement about flexible exchange rates. What he actually meant was that China’s manipulation of the yuan doesn’t bother him so long as its value increases relative to the dollar. The Chinese currency can rise versus the dollar either through a strengthened yuan, or, and this is more likely the case, thanks to an even more debased dollar. In short, Geithner talks about sound U.S. assets out of one side of the mouth, and then out of the other he accepts further dollar decline that will necessarily make them less valuable.

More broadly for the economy, his currency stance points to a stagnant one. That’s the case because inflation invariably fosters an investment climate whereby capital moves away from the growth and wage economy, and into hard assets that by their nature can’t make us more productive. In order to expand, businesses need capital, but Geithner’s “benign neglect” of the dollar means that investors will seek safe haven from concepts whose returns will be eroded by inflation.

Concerning his view that the yuan should float against the dollar rather than be pegged to it, it’s best to conduct a thought experiment: Do individuals in California engage in more or less in the way of wealth enhancing trade with Arizonans thanks to the dollar being the lone currency in both states? If the answer is more, and that’s really the only answer, we must then ask how trade between Tucson and Torrance is any different than trade between San Francisco and Shanghai. It is not.

That the dollar is the only currency within our fifty states logically ensures more trade because a single currency greatly reduces the very currency risk that makes transacting across borders so difficult to begin with. The reality is that ever since China pegged its currency to the dollar in 1994, trade between individuals in the two countries has skyrocketed. This has of course accrued to the economic health of both countries in that workers in each have been able to specialize their labor. Absent this tight currency arrangement, it’s a near certainty that some transactions will never be, and the comparative advantage that lifts all economic boats will be compromised.

Perhaps silliest of all, Geithner made plain his desire that the Chinese “strengthen domestic demand” in order to stabilize the international financial system. He got it exactly wrong. Production itself is demand, and even if the Chinese choose to bank their monetary gains rather than spend them, the money saved will be lent out to others (including capital starved U.S. firms) who will demand what Chinese citizens presently do not. In the end entrepreneurs can’t be entrepreneurs without capital, and Geithner’s policies applied ensure that there will be less capital available for those eager to innovate.

It’s likely a testament to the world’s overall economic health that at least for now, foreigners and Americans alike can laugh at the musings of a Treasury secretary who’s so clearly not up to the job. The problem here is that the dollar remains the most important price in the world, and its decline is no laughing matter. Tim Geithner surely ignores its falling value to the detriment of the world economy, and if his indifference continues, we’ll soon enough not be laughing.

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