davidbau.com

Mapping Out a Trade War

What would a 21st century trade war look like?

The proper response to the Chinese devaluation of the yuan is for the U.S. to battle back and drop the dollar against the yuan. Is this possible? Famously, Soros bet against the British pound (versus the German mark), and won, in 1992, using a relatively paltry $10 billion. Is it possible to bet against the dollar/yuan rate today?

If the Chinese government insists on buying an infinite amount of U.S. Treasuries with minted yuan, perhaps the U.S. government should happily flood the global markets with Treasuries and sweep in and buy Chinese assets with the minted dollars. It seems that such a move by the U.S. would ultimately prevail, given the huge imbalances in real trade: if the whole world blew up in the end, the yuan would ultimately rise against the dollar due to fundamentals, and the U.S. government, now a large percentage owner of China, could cash in on its investments and pay off all its debt.

Is such a countermove possible? I bet it is, and that it wold cost a lot less than our trillion-dollar U.S. banking bailout. It might even be possible to do it completely within private sector banks, as a coordinated move to for private banks to aggressively purchase Chinese stocks and debt.

The trap we should not fall into is to allow U.S. consumers to spend more U.S. debt in exchange for Chinese exports. Our U.S. banks need to be soaking up ownership of undervalued Chinese assets and betting against a low yuan.

Such a bet would starve U.S. consumers of liquidity in the short run (painful!), but buy U.S. export jobs in the long run, when the yuan finally rises.

Posted by David at December 4, 2008 08:19 AM