Getting to a Special State of Ugly

There are certain phrases – like “trust me” or “I got this” – that should immediately provoke one’s suspicion.  When your slippery contractor tells you, “trust me, your kitchen renovation will be done before Christmas,” you should be wary.  There’s no way it’ll be done until late spring.

Or when your incompetent client says, “I won’t be needing your services at this time, I got this.”  You should expect a panicked phone call at 5pm on Friday.  “This is way more than I can handle,” your client will say, “take care of it.”

On Monday, when the sky was falling, and there was much weeping and gnashing of teeth, the Chinese yuan weakened to above 7 per dollar for the first time in over a decade.  This prompted U.S. Treasury Secretary Steven Mnuchin to waft out a suspicious phrase of his own.  He called China a “currency manipulator.”

Mnuchin’s logic, as far as we can tell, is that China manipulated their currency because their central bank didn’t adequately intervene in foreign exchange markets to prop up the yuan.  Conversely, direct intervention into markets, to maintain a centrally planned price that’s acceptable to Mnuchin, is not currency manipulation.  Go figure!

On Tuesday, to restore confidence in the yuan, and refute accusations of being a malevolent currency manipulator, the People’s Bank of China (PBOC) announced a plan to price fix the yuan.  Specifically, the PBOC will sell 30 billion yuan ($4.2 billion) of offshore bills in Hong Kong on August 14.  This move is designed to drain liquidity offshore, thus strengthening the yuan against the dollar.

Why bother?

Cooperative Currency Debasement

The world, circa 2019, is a fabricated reality.  Debt, piled upon debt, piled upon debt, ad infinitum, has erected a financial order that’s at perilous odds with the underlying economy.  Central bankers attempt to manipulate fake money and fake foreign exchange rates to keep the debt pile from cascading down.

The primary tactic central bankers use to haphazardly keep this sucker from going down, a la George W. Bush, is currency debasement.  Central bankers inflate their currencies to keep asset prices and corporate operations, which are dependent on cheap credit, above water.  Without perpetual currency debasement, the debt structure will break down…and assets and businesses will be liquidated for pennies on the dollar.

Such a liquidation is exactly what’s needed to return asset prices and businesses to a form and function that’s inline with the economy.  However, getting from here to there would be incredibly disruptive.  Many businesses would shutter their doors indefinitely.  Unemployment would go through the roof.

But more important to the central planners, debt deflation and liquidation would overturn the wealth and power structure of today’s elites.  Many of today’s wealthy and powerful would be reduced to paupers.  That’s why they’re so determined to prevent it.

Nonetheless, the dirty deed of currency debasement is a delicate endeavor.  The major central banks of the world must practice it in a loosely coordinated and cooperative manner.  They must hold hands and debase their currencies together, maintaining relative stability.

Getting to a Special State of Ugly

The point is all central banks manipulate their currencies in an attempt to preserve a certain realm of acceptability.  But, above all, they must supply liquidity to credit markets, via currency debasement, to levitate asset prices, and forestall the great liquidation.  Ultimately, these efforts are doomed.

For one, they ignore the fact that foreign exchange markets are made by more than just central bankers.  They’re requisite for international trade.  They’re used by large investment funds to hedge against an abrupt devaluation.  They’re also used by speculators to exploit perceived price differentials, which are often the result of central bank intervention in the first place.

Throw in a currency war and escalating trade war, and the fabricated reality becomes increasingly difficult to maintain.  Sooner or later it’ll be impossible to keep this sucker from going down.  Before then, things will have to get to a special state of ugly.

For example, yesterday [Thursday], via Twitter, President Trump bellowed for greater currency manipulation:

“As your President, one would think that I would be thrilled with our very strong dollar.  I am not!  The Fed’s high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers like Caterpillar, Boeing,…John Deere, our car companies, & others, to compete on a level playing field.

“With substantial Fed Cuts (there is no inflation) and no quantitative tightening, the dollar will make it possible for our companies to win against any competition.  We have the greatest companies…in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve.  They have called it wrong at every step of the way, and we are still winning.  Can you imagine what would happen if they actually called it right?”

Indeed, we can imagine many things.  We imagine that when the Fed gives Trump what he wants – substantial rate cuts – the results will be remarkably different than he imagines.

Rather than invigorating American businesses, it will sink them under a red sea of debt.  After that, this sucker’s going down.


MN Gordon
for Economic Prism

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