Bernanke’s high stakes poker game at the G-20

By Guest Contributor
November 9, 2010

By Peter Navarro
The opinions expressed are his own.

Ben Bernanke is about to play the biggest poker hand in global monetary policy history: The Federal Reserve chairman is trying to force China to fold on its fixed dollar-yuan currency peg. This is high-stakes poker.

Although Bernanke will not be sitting at the table to play his quantitative easing card when all the members of the G-20, including China, meet this week in South Korea. Every G-20 country is suffering from an already grossly under-valued yuan pegged to a dollar now falling rapidly under the weight of Bernanke’s QE2. In fact, breaking the highly corrosive dollar-yuan peg is the most important step the G-20 can take for both robust global economic recovery and financial market stability.

Regrettably, China continues to believe — mistakenly — that the costs of a stronger yuan in terms of reduced export-led growth outweigh three major benefits: increased purchasing power to spur domestic-driven growth, significantly lower costs for raw materials and energy, and a dramatic reduction in speculative hot flows rapidly pushing up inflation.

Of course, the biggest victim of the peg is the U.S which can never eliminate its huge trade deficit with China through currency adjustments. The resultant chronic trade imbalance shaves almost 1% from America’s annual GDP growth rate and costs almost 1 million jobs a year.

Europe, with the notable exception of Germany, suffers a similar problem because of a euro overvalued relative to the yuan. Moreover, as the dollar-yuan pair declines under the weight of QE2, the risk of recession in Europe rises.
For its part, Germany largely avoids the peg’s damage through robust exports to China. In addition, Germany’s higher savings rate coupled with vaunted cost efficiencies have allowed it to gain at the expense of other more free-spending countries of the euro zone. Politically, this spells trouble because Germany’s separation from the euro zone pack makes it the one country most likely to align with China.

In sharp contrast, Japan has been brought to its knees by China’s fixed peg. Every time the U.S. dollar declines in value and pulls the yuan down with it, Japan (as well as fellow G-20 members South Korea and India) lose more jobs and growth to China. As a further injury, China has aggressively pushed up the yen up through massive interventions in the Japanese market.

The commodity-rich G-20 members — Australia, Canada, Russia, Brazil, Indonesia, Mexico, and South Africa — suffer quite a different fate. All are now fighting speculative hot flows, rapidly rising currencies, and the loss of export advantage. The reason: As the dollar-yuan pair falls and commodity prices rise, global speculators are capitalizing on a new, emerging “carry trade” by borrowing at near zero interest rates from the U.S. and then investing abroad in commodities.

This long laundry list of G-20 victims brings us back to the perilous poker game the U.S. Federal Reserve is playing. In fact, the refusal of China to allow its currency to strengthen coupled with the failure of President Barack Obama and Treasury Secretary Timothy Geithner to negotiate Chinese currency reform has forced Bernanke to make his own play. The question, of course, at this G-20 meeting is whether China will get the message.

Perhaps the biggest obstacle to G-20 success is the mixed message that American policymakers are sending. While Bernanke is clearly signaling the yuan must float, Geithner has decided to tilt at a particularly peculiar windmill: Rather than demand a free market floating of the yuan, Geithner wants trade surplus limits. Such limits are, however, not only economically impractical, which is why most G-20 members have rejected them. Geithner’s own gambit is political suicide because it pushes the Germans right into the Chinese camp.

If Bernanke’s gamble fails and the G-20 reaches no rapprochement on the Chinese currency question, the eventual cost may not just be a global currency war. It will likely be a bout of hyperinflation, the likes of which the U.S., and the world, hasn’t seen in almost a century.

Peter Navarro, a business professor at the University of California-Irvine, is co-author of “Seeds of Destruction.”

4 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Something that took me a long time to figure out is how currency traders make money. Keynes made a small fortune day-trading in currencies.

The key, I realized, is simple: the whole thing revolves around trying to figure out relative rates of inflation, which is to say money creation, which is to say the acquisition of private wealth by either governments or central banks.

China’s export driven economy benefits an elite, at the cost of daily hardships for ordinary Chinese. It’s really not different in principle or practice than our own Robber Baron era–at least as it is portrayed in the myths of the era–with the difference that the Chinese have far, far fewer rights as workers or citizens than Americans did in our worst and darkest times. This is, ironically, because of Chinese Communism, which purported to help workers.

No serious person ever believed that silly notion though. Self evidently, academics are not serious people.

What effect giving over half a trillion in unearned money to the Wall Street banking cartel will have, will depend entirely on what they do with it. People look at inflation in the abstract, but concretely, investment professionals at some HUGE banks are getting checks in the mail. They can spend it on any little thing their hearts desire.

They could in fact use it to take advantage of the artificially low exchange rate of the currency I prefer to call the “Mao” to buy up large segments of Chinese industry. Devalued currencies work both ways: they foster exports, but they also make all domestic companies cheaper to buy. The devaluation of our currency will only happen AFTER Wall Street finishes their “Wheel of Fortune” style buying spree.

I wrote a series of pieces on how our system works, and how it should work. You can read it here: http://www.goodnessmovement.com/Page14.h tml

Posted by barrycooper | Report as abusive

Rather than demand a free market floating of the yuan – This comment shows why people in the world of academia should not be writing postings for people in the real world. – Demand? – Oh Yes, China is really going to give a hoot about what we DEMAND!

Posted by DeerHunter | Report as abusive

[...] Federal Reserve Chairman is trying to force China to fold on its fixed dollar-yuan currency peg. The Great Debate This entry was posted in Global News and tagged Bernanke’s, Game, High, Poker, Stakes. Bookmark [...]

There’s an old saying, “You can’t win them all”. Old Witless Bernanke is proving the truth of the converse of this saying (i.e. “You can lose them all”). Wouldn’t it be nice if he could win just one? Do you think he’s going to win this one? Yeah, sure! Ha, ha, ha.

But it’s not true that when Witless loses, everybody loses. With QE-1, his Wall Street banking buddies “made out like Flynn” (Earl Flynn was a famous 1940s era movie star and lady’s man).

Posted by gAnton | Report as abusive

By linking the currency the Chinese have linked the US and Chinese economy. What better than to have no currency risks with your major customer. If the US devalues then its currency will also devalue vs the rest of the world giving it competitive advantage.

When the Fed pumps money into the economy, it is in effect pumping money into the combined Chinese US economy. Guess where all the money will end up. In low cost/ high return China ofcourse.

So you have inflation in China and deflation in USA. If the Chinese dont give in on exchange rate and they just tighten then there could be a hard landing in China. Thats after a hard landing happens in other developing economies and US enters another recession. Hopefully sense will prevail before then.

Posted by shivers1 | Report as abusive