China Vs. U.S.: Clashing Monetary Paradigms


March 23, 2010

(This originally appeared in the Huffington Post on March 23, 2010.)

http://www.huffingtonpost.com/nathan-lewis/whats-the-chinese-word-fo_b_502534.html

It seems that some people were confused by my last post on China's currency. Maybe I was trying to fit too many topics into one item. (See What's the Chinese Word for Baloney?)

The broader principle here is that there are two basic approaches to monetary policy. One is the "hard money" approach, and the other is the "soft money" approach.

The hard money advocates want the most stable, predictable currency possible. When the currency is stable, it is easier to do business, and business thrives. In practice, they usually opt for some simple rule, which is typically either a peg to a major international currency, a basket of major international currencies, or a peg to gold.

Up to the introduction of floating currencies in 1971, the major international currencies were also pegged to gold, so "hard money" meant a gold standard, and nothing else.

From the standpoint of the hard money advocates, any sort of currency deviation produces problems. This should be obvious to anyone engaged in international trade, who has to deal with unpredictable floating currencies. From a domestic standpoint as well, how could any economic problem be meaningfully solved just by jiggering the unit of account? (See A Brief History of the Dollar)

During the Bretton Woods period, 1944-1970, hard money principles were in force worldwide. Exchange rates didn't fluctuate. The Japanese yen, German mark, French franc, British pound, and most of the minor currencies as well (including the Chinese yuan), all had fixed exchange rates that didn't change for decades at a stretch. The dollar was pegged to gold at $35/oz., so in effect all major currencies in the world were pegged to gold.

The soft money advocates try to fix this or that economic problem with currency manipulation. Whether to address a recession and unemployment, or for export competitiveness, or for some perceived "trade imbalance," their solution always involves some sort of monetary manipulation.

From the standpoint of the soft money advocates, a stable, fixed currency is an anathema. Obviously, if the currency is stable and predictable, then it can't be manipulated to fit the soft money advocates' short-term objectives. The soft money advocates want floating currencies, managed by a "policy board."

You have no idea how old these ideas are. Plato was a soft-money guy, but his student Aristotle was a hard-money advocate. No kidding.

We can also see here that soft money is plainly a "statist" solution, enacted by a central government bureaucracy. Hard money is a "capitalist" or "libertarian" solution, in which the government simply ensures that the currency is as stable as possible, and lets businesses act freely within that framework. That is why the United States, which upon its inception in 1789 was by far the most "libertarian" major government on the face of the earth, also mandated a strict gold standard in the Constitution.

From this description, we can easily see that China has a hard money policy - a dollar peg dating from 1995 - and the United States has a soft money policy.

Thus, it is completely absurd to accuse China of "currency manipulation." China has a policy of no currency manipulation - a hard dollar peg. The U.S. has a policy of continuous currency manipulation. China's hard-money policy is coming into conflict
with the U.S. government's soft-money ambitions.

Like any soft-money advocate down through the centuries, the U.S. government wants to achieve certain policy goals by way of currency manipulation. It's the same litany: to lessen the domestic effects of recession, to generate a trade advantage versus China, and to resolve some perceived "current account imbalance."

We can also see, by way of this recent conflict, how the U.S.'s academic establishment has devoted itself completely to soft-money principles.

Unfortunately, you can't create wealth by jiggering the currency. People have tried to do this for hundreds of years, with no success. The hard-money advocates are right - the best foundation for long-term prosperity is a stable currency.

Just look at the situation today. Which country is on the path to long-term prosperity? China or the U.S.? Which government tries to solve its problems with currency manipulation, and which government instead tries to address the real underlying issues?

Isn't it obvious?

Thus it was in past generations as well. The United States used to be the world's greatest champion of hard money principles, until the money manipulators became ascendant around 1971. During that great stretch on the gold standard, from 1789 to 1971, the U.S. became the world's most successful industrial power, and had the wealthiest middle class in all of history.

How has the U.S. middle class done since 1970? You might look at the work of Elizabeth Warren, elsewhere on the Huffington Post. The summary: the U.S. middle class has gotten kicked in the guts. (See Elizabeth Warren: America Without a Middle Class)

At some point in the future, people will get fed up with the currency manipulators' big promises and disappointing results. Their interest may again turn to the hard money principles that have always built wealth through the centuries.

I say "people." This does not necessarily mean people in the U.S. It could be people in China.