will the chinese yuan ever displace the dollar?...the dollar as the benchmark.” devaluation...

OPINION 1/05/2017 @ 2:00PM 744 views

Will The Chinese Yuan Ever DisplaceThe Dollar?

Chinese 100 yuan notes in Beijing. (Credit: Fred Dufour/AFP/GettyImages)

Shanghai is China’s richest and most importantcommercial city. Interesting about it is that as of1978, a mere 15 skyscrapers dotted its largelyempty skyline. Back then China was an intenselypoor, communist (in the literal sense) country.But as of 2006, and after a few decades ofeconomic liberalization, Shanghai’s skyscrapercount had increased to 3,780. In 2017, thenumber of tall buildings surely exceeds whatseemed enormous in 2006.

Though China remains a poor country bydeveloped world standards, to visit is to seepeople who are very much in a hurry. They wantto live like we do, and they’re working incrediblyhard to get there. China is for real. For those whoclaim it’s a creation of “easy credit” (an oxymoronif there ever was one – credit is always andeverywhere difficult to attain) thanks to its centralbank and state run banks, they should thinkagain. Figure that lots of countries have centralbanks, along with politicized credit allocators, butfew can claim even a fraction of the stunninggrowth that is plainly visible to anyone luckyenough to visit the rapidly advancing country.

Eswar Prasad, a professor of trade policy atCornell University, has published an importantnew book on China’s economic rise; albeitthrough the prism of its currency: the yuan, or theRenminbi, or as Prasad references it, the RMB.Up front, it should be said that Prasad’s GainingCurrency: The Rise of the Renminbi is a very

John Tamny Forbes Staff

I cover the intersection of economics and politics.

Will The Chinese Yuan Ever Displace The Dollar? http://www.forbes.com/sites/johntamny/2017/01/05/will-the-chine...

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informative book, and it’s mostly very good.

Prasad is clearly well connected within theeconomics profession. Endorsers of his bookinclude former Fed Chairman Ben Bernanke,Harvard economist Kenneth Rogoff, and formerTreasury secretary Lawrence Summers. This ismentioned early on as a way of addressing whatwould understandably turn off perhaps more thana few potential readers. How could what’s a veryworthwhile and informative read have theendorsement of three economists who are sofrequently ridiculous?

It’s a good question. My own speculation is thatthey agreed to endorse Prasad’s book withoutactually having read it. This is assumed simplybecause Prasad’s book is decidedly not ridiculous.It’s once again very informative, and while Prasadon occasion lapses into nauseating “economistthink,” he’s quite a bit more serious than the triomentioned. Lest we forget, Bernanke is convincedthat economic growth causes inflation despitecenturies of evidence that reveal soaring growthas the greatest foe of rising prices. In Rogoff’scase, his modern war on cash has him concludingthat the best cure for recessions is rampantspending despite the tautology that entrepreneurscan’t be entrepreneurs without access to savings.As for Summers, though books could be writtenabout his silly assertions about governmentspending driving economic growth (I guess thepoliticians in Haiti missed this memo), it’s hard toforget his mind-numbingly obtuse conclusion thatJapan’s tragic 2011 earthquake would stimulateeconomic growth there thanks to the spendingrequired to rebuild all the wealth and livesdestroyed. In Summers’ defense, a poll ofcredentialed economists would reveal a nearlyunanimous and horrifyingly dim belief that all thekilling, maiming and wealth destruction that tookplace during World War II revived the globaleconomy; the U.S. economy most notably.

The economics profession of the modern day isdecidedly unserious, so much so that it took awhile to open Prasad’s book. Having recently readand reviewed the comically bad Phishing for Foolsby Nobel Laureates George Akerlof and RobertShiller, I wasn’t exactly eager to commit moreprecious time to another book widely praised byeconomists. Thankfully I dismissed my recurringnightmare that includes a read of Akerlof’s allegedinsights only to open up Gaining Currency. I’mglad I did. So will the readers of this column ifthey can get beyond the individuals who endorsedPrasad. His book is one that I’ll be referring to fora very long time.


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Prasad begins by providing the reader with abrief, but highly interesting history of China’sexperience with currencies. In a book full of funand interesting facts, the reader learns that whilethe RMB was introduced in 1949, China was thefirst country to use paper money. Interesting tosome will be why. Prasad explains that risingChinese prosperity during the Song dynasty(960-1279) made it “increasingly cumbersomeand impractical to use these heavy coins forbusiness transactions.”

Money is a measure despite what moderneconomists worshipful of floating currency valuestell us, so while China moved to paper money outof convenience hundreds of years ago, the Songgovernment understood that money’s onlypurpose was as a ruler, or measuring rod. AsPrasad put it, the Song government resistedprivate money given its belief that “only thegovernment could ensure a reliable supply of acurrency stable enough to support economicactivity.” Wise minds can and surely will continueto debate the public versus private moneyconcept, but the good news is that Prasadfascinatingly reports that there were somecurrency dissenters inside China many centuriesago. While the Song government should becheered for understanding what neithereconomists nor politicians understand today (thatmoney is a measure which facilitates exchangeand investment, and nothing else), it’sencouraging to read that Confucian scholarsdisagreed with the notion of government-issuedmoney. Prasad writes that they felt “the marketwould compel private issuers of money tomaintain its value.” It says here the Confucianswere right. Private sector players expertly createfor us computers, Wi-Fi and navigation gadgets(GPS) that seamlessly guide us when we’re lost,and odds are they could issue money that wouldhold its value. They would because marketdiscipline enforces good behavior. While the U.S.Treasury can consistently devalue the dollar onlyfor us to keep accepting what is the world’scurrency, Visa, Amex and Walmart couldn’t soeasily devalue their currencies. Competitionwould keep them honest.

Speaking of devaluation and currency instability,Prasad very helpfully notes that the Song dynasty“was eventually weakened by monetaryinstability” only for it to give way to the Yuandynasty. Yet it too was eventually felled bydevaluation. Prasad writes that “Reckless issuanceof large quantities of paper money underminedconfidence in the currency…” Lenin, Mises,Keynes and others all understood what Prasad is


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reporting: if you want to turn society upside downon the way to tantrums in the citizenry thatinvariably force changes at the governmental top,debauch the currency. It’s so basic. People go towork in order to get what they don’t have, and themoney they earn amounts to the “tickets” (to takea word from John Stuart Mill) that they accept inreturn for their toil, and that represent theirdemand for what they don’t have. In that case, isit any wonder that citizens lose it when theirmoney is devalued? Economists generally thinkit’s low rent to talk about the price of anything ingold, but the dollar plummeted in gold terms from2001 to August of 2011, and is still quite a bitweaker than it was when the 21st century began.The latter in mind, Lenin, Mises and Keynesmight not be too surprised by Donald Trump’srecent victory, not to mention a globally frustratedelectorate. Figure that the world remains on animplicit dollar standard despite the end of BrettonWoods in 1971, so when the U.S. Treasurydevalues the greenback, it’s a global event. AsPrasad himself notes, “most countries thatmanage their currencies, especially those in Asia,tend to use their own currency’s value relative tothe dollar as the benchmark.” Devaluationwrecked the regimes of the past, and it still doesnow. The difference is that most economistsnowadays talk excitedly about the alleged goodthat comes from devaluing the money that peopleearn. Again, the profession has become ridiculousin modern times.

All of the above speaks to a needless analyticalweakness within Gaining Currency. Havingestablished the logical truth that currencydevaluation is the greatest enemy of politicalstability, Prasad then contradicts himself. At thebeginning of Chapter 2 he strangely writes that“Trying to cheapen a domestic currency’s valuerelative to that of other currencies can actuallyhelp boost exports and, therefore, offset weakdomestic demand and raise GDP growth.” It wasas though Akerlof, Bernanke, Rogoff and othertypical economists entered Prasad’s body all atonce; that or Chapter 2 was written by somemisguided teacher’s assistant in Prasad’s employ.Here the book is humming along informatively,then Prasad reverts to discredited “economistthink.” What a waste.

Addressing what is false, cheapened currenciesaren’t the path to export nirvana for the simplereason that shrinkage of the measure logicallydrives up the cost of imported inputs necessary tocreate the final good in the first place. It also can’tbe forgotten that transportation costs necessarilyrise (a dollar in 2016 buys quite a bit less fuel than


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did a buck in 2001) to reflect the debasedcurrency, as do labor costs; workers generallydon’t sit back and allow their pay to be evisceratedwithout protest. Most crucial of all is the basictruth that investment in productivityenhancements is the single best way to drive downthe price of anything, and investors are buyingfuture currency income streams when theycommit capital to investment in productivityenhancements. Yet devaluation logically makes itquite a bit less likely that investors will put capitalto work in the first place.

In short, Prasad gets it all wrong aboutdevaluation. Needlessly. One wonders if he simplyforgot that Japan had some of its best export yearsinto the U.S. right as the yen was soaring over200% against the dollar from the 1970s throughthe 1980s. If devaluation were the driver of GDPgrowth, then Mexico, Argentina and Zimbabwewould list among the richest and most dynamiccountries in the world. In fact, devaluation isanti-growth and anti-falling prices simply becauseit’s anti-investment.

A few pages later Prasad writes that“‘intervention’ in the foreign exchange marketlimits domestic currency appreciation andtherefore improves a country’s trade balance bylimiting imports and propping up exports.”There’s so much wrong with the previousstatement. Back to reality, a rising currency wouldat least in nominal currency terms reduce the costof production and shipping, and boost the veryinvestment that would once again bring downprices. Good money is an investment lure, and byextension it’s a muscular price chopper. Not toPrasad. In his analysis, rising currencies bring onall manner of horrid outcomes, while devaluationis less than costless. But that’s simply not true.More realistically, a falling currency necessarilyreduces the investment necessary to bring downprices to begin with. As for a country’s tradebalance, there’s no such thing. What Prasad iswriting about is an accounting abstraction.Countries don’t trade; rather individuals trade.And their trade balances, as a rule. They run“trade surpluses” with their employers, and thentheir reward if they’re really productive is massive“trade deficits” with their favorite clothiers,carmakers, restaurants, hoteliers, airlines, etc.

The strange thing about Prasad’s unfortunatelurch into “economist think” is that while a stablecurrency was by his own reporting essential in theChina of 1,000 years ago, in modern times good,stable money has somehow become a liability inhis eyes. Of course, in order to defend what isabsurd and indefensible, Prasad sadly reverts to


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the silly “truth” accepted by economists thatdevaluation is good for the economy. The problemis that an economy isn’t some blob, it’s just acollection of individuals. And just as individualsare not made better off when the purchasingpower of the money they earn is diluted, neither isan economy better off. Forgotten by Prasad is thatan economy isn’t some machine that attains“balance” thanks to floating currencies; rather aneconomy is just individuals producing so that theycan get. Money in an economy properly definedremains what the Song government felt it was,what the Confucians felt it should be, and whatAdam Smith said about it: “the sole use of moneyis to circulate consumable goods.” Once this isproperly understood, or remembered, all this talkof devaluation, strength, weakness, and tradebalances quickly goes out the window. Tradealways balances, by definition. In what is still avery good book, Prasad needlessly weakens it witha persistent argument throughout that currencydevaluation is a principal driver of exports thatboost prosperity. More realistically, imports areparadoxically (at least to economists) the biggestdriver of exports. Stating the obvious, countriesthat are importing a lot are logically exporting alot.

The book is also weakened by Prasad’s occasionalreference to the “over” and “under” valued RMB.But that’s like saying the inch is sometimes toolong and sometimes too short. An inch quitesimply is, as is a foot and a minute. Fiddling withthe exchange value of money can’t change theon-the-ground reality. Money is what we need tofacilitate trade and investment. Nothing else.Prasad’s history of China’s currency situationmakes the latter quite obvious, only for theCornell professor to stray from what is basiceconomics as he talks about the RMB’s gradualevolution into a global currency.

Returning to Prasad’s early point that much ofAsia (and realistically much of the world)benchmarks its money to the dollar, he remindsreaders of what people like president-elect DonaldTrump would prefer that voters forget: that Chinaofficially pegged the RMB to the dollar in 1994.This is important when we consider the sillycommentary from Trump and others about a“weak” RMB. Sorry, but the RMB has long beenpegged to the dollar. When the latter is weak, so isthe RMB. When it’s strong, so is the RMB. Prasadalso reminds the reader (what this reader wouldgive to have members of the Trumpadministration’s protectionist wing read GainingCurrency) that from 2005 to 2014, the RMB rose25 percent against the dollar. All this runs counter


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to what we heard from Trump during hispresidential campaign. Still, Prasad and othereconomists perhaps deserve some of the blame inlight of their floating money worship, not tomention their talk of money that is “over” and“under” valued. In going to great lengths todeprive modern money of its singular purpose asa measure or concept, they hand demagogues thewords and catch-phrases that inform ridiculouseconomic commentary.

Prasad is ultimately discussing the path of theRMB to reserve currency status. It’s not quitethere yet, but it’s getting there. While the dollaraccounts for 64 percent of global reserve currencyholdings, and the euro 21 percent, the RMB wasup to 1.1% as of 2014. It’s in the conversation.Prasad writes early on that the non “marketdetermined” exchange rate of the RMB is a barrierto it becoming more of a reserve currency, but itseems he gets the story backwards. While theRMB’s peg to the dollar isn’t absolute a la 1994,it’s still pretty tight. And that’s the problem whenwe consider the dollar’s 21st-Century volatility.Money is most useful when it’s stable. Prasadintuitively knows this from his early analysis ofChina’s currency history. Assuming Chinesemonetary authorities move in the direction ofRMB-price stability (whether through a golddefinition, or more intriguingly private moneyissuance), odds are the RMB’s use as a reservecurrency will increase. One can only hope.Treasury’s oversight of the dollar has beenatrocious over the last 16 years to the logicaldetriment of the global economy. A better, morestable RMB would perhaps force Treasury to getserious.

One other weak point of the book was Prasad’sall-too-typical assertion that the U.S. economyrecovered more rapidly from the 2008 thanks tothe Fed printing “large amounts of money rapidly”alongside a U.S. government that “used fiscalpolicy aggressively.” That’s just silly. And Prasadsurely knows why. The Fed quite simply can’tincrease so-called “money supply” whereeconomic activity doesn’t already rate it. If hedoubts this, he need only ask himself how long thedollar proceeds from Fed purchases of bonds fromBaltimore, Compton, or Buffalo, NY banks wouldstay in all three locales as performing loans. Afterthat, simple logic tells us that Paul Ryan andNancy Pelosi can’t allocate precious resourcesextracted from the real economy as well asWarren Buffett, Bill Gates and Jeff Bezos can.Prasad’s already good writing would be so muchbetter if he weren’t so eager to be conventional attimes. And if he might throw statistics aside in


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favor of common sense. Simply put, neither theFed nor Congress can allocate resources moreeffectively than can the private sector. As for thisnotion that the economy will halt if Congresswon’t spend what savers will not, let’s be serious.Recessions when left alone correct quicklyprecisely because people spend less such thattheir savings morph into the very investment thatpowers the recovery. As for saving that doesn’tbecome investment, banks don’t take in depositsto stare at them lovingly; rather banks pay fordeposits only to lend them out immediately. Tosave isn’t to not consume as economists think. Intruth, when we save our consumption is shifted tosomeone else eager to consume. Getting morespecific, notions of “export-led growth” are utterlynonsensical. We’re exporting so that we canimport. Always.

Yet despite the quibbles with commentary thatPrasad is seemingly too smart to associate himselfwith, Gaining Currency is otherwise very good. Ifreaders are willing to look beyond theconventional economist-speak previouslydiscussed, they’ll come away much moreinformed. Prasad provides readers with aninteresting overview of Chinese currency history,and then offers myriad fun facts and commentaryabout the impact of S&P downgrades on U.S. andJapanese debt (it’s not what you’d expect), howChinese investors get around rapidly erodingcapital controls, why Treasuries are so attractiveto global investors (it’s not necessarily a qualitything), along with the exciting development ofChina’s “shadow” financing system.

And while Prasad is plainly an optimist aboutChina’s future, he describes as “far-fetched” thenotion that the RMB will eventually overtake thedollar as the world’s reserve currency. I hope he’swrong. One way he could be proven wrong is ifChina’s monetary authorities seek whateconomists like him strangely decry: stability ofthe unit as a measure of value. If Chinesemonetary authorities ditch the dollar in favor ofcurrency stability, watch out. What is 1.1% reservepenetration will quickly soar. The problem is thatPrasad and his esteemed colleagues recoil at thevery RMB stability that would give the dollarserious competition, all the while serving as amassive investment lure into China.

Of course, all of the above helps explain why avery good and informative book isn’t great. Simplyput, the wise thinking that informed Prasad’sexplanation of early Chinese currency history(when stability as a measure of value was crucial)went out the window when he set out to tackle thepresent. This doesn’t mean Gaining Currency


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This article is available online at: 2017 Forbes.com LLC™ All Rights Reserved

wasn’t highly informative despite Prasad’soccasional migration into the absurd, but it doesmean the book wasn’t as excellent as it could havebeen. Readers should read Gaining Currency withan eye on learning a lot, but with eyes wide opento how much better it could have been had Prasadignored the economists in favor of common senseabout why the Chinese first introduced money tobegin with.

John Tamny is Political Economy editor atForbes, editor of RealClearMarkets, a senioreconomic adviser to Toreador Research &Trading, and a senior fellow in economics atReason Foundation. He’s the author of the 2016book Who Needs the Fed? (Encounter), alongwith Popular Economics (Regnery, 2015).

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will the chinese yuan ever displace the dollar?...the dollar as the benchmark.” devaluation...

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