Tuesday, August 25, 2015

Donald Trump – the 1980’s man?

So I have been following Donald Trump a little and honestly, I liked the way he kicked back everyone who made fun of him as a clown, joker etc. Today, those same people in the media are just frightened of his rise and have toned down their commentary on him – and this was clearly fun and exciting to watch. Almost everyone who joked about him, not in the distant past, are now clearly shocked in the way he has gathered momentum.

And initially, I liked how Donald Trump was able to identify key issues that have affected the growth of the middle class in the US negatively – particularly, the trade deals with different countries. For example, no one can argue that the Chinese currency wasn’t a factor that affected the US manufacturing industry over the past decade (though I have a slightly different take and don’t blame China completely for every manufacturing job lost in the US – more importantly, I believe it was a direct consequence of the global free trade campaign that was kick-started by the US and other western powers to find and open new markets across the globe – a consequence which has been negative for many, but has been very positive for many many more people across the globe – including many in the US middle class).

But there is no question that trade over the past decade with a country like China, which pegged/manipulated and today manages the currency through heavy government intervention, has severely distorted the flow of capital across the globe. It has also resulted in sudden seismic changes for which the US middle class and frankly, many middle and lower-income groups across the world were not ready. All this created severe stress in the financial growth of the middle class in the US and many other western countries.

But all this said, is Donald Trump’s plan to charge a tariff on all products imported from China or for that matter from Mexico – a country which by the way has a cost advantage to manufacture products there purely from a standard of living standpoint (and probably less regulations) – the right way to go?

Mr. Trump says that he would charge 35% import tariff on all products manufactured in Mexico and shipped into the United States. As wonderful that this might seem, the simple fact is that the World Trade Organization, for which both the US and Mexico are party to, will simply rule this tariff as protectionist and probably as against the accepted rules – thereby opening the window for Mexico and other countries that trade with the US to slap countervailing duties and tariffs on all products shipped from the US – and for that matter, WTO, as far as I know, allows a broad range of options to impose countervailing duties and other protectionist measures that can seriously cripple American industries trying to capture a share of the market in these economically important nations.

It might be true that in any protectionist or trade war, China, Mexico and other such countries might stand to lose more than the US – but I don’t think we are on a war as to who would lose more, but instead on a co-operation as to how much would each make more. Mr. Trump’s policies are like taking the clock back to the past – when all seemed well and good. But that was also a time when China was still a very poor country, India was not open for business at all and the Euro currency did not exist. And so much more has since happened in the last few decades. Who would have expected that American companies can sell millions of phones, clothes, cars, heavy equipment, technology etc. to a country like India, or a country like China? Who would have expected the capitalist American middle class to more than double their investments within half a decade by investing in the communist China? Who would have expected that American shoes and German cars will be exported to Africans when all that was expected at some point in time in the past was an import of an African disease?

And who would now expect to reverse all this progress by starting a trade war through protectionist measures such as import tariffs? Not me and not the people who understand the basics of free market economics.

Obviously, there are heavy distortions in the world economy today – the capital controls and currency manipulation in China is a case in point (or) the delay in opening up of some sectors in India is a another example (or) the presence of a cartel that tries to control and manipulate the prices of oil globally..and I can go on and on. But how we address these issues is as important as these issues itself.

When Adam Smith, the great free-market Scot, repeatedly advised the British government in the 18th century that trade with the East Indies (India) would be much preferable and would in fact create more wealth to Britain than the mercantilist policies followed by the Great Britain in East Indies, the British didn’t seem to listen. Ultimately, the British did create a lot of wealth by expanding their colonization and mercantilist policies, but that came at what cost is a question that should be in everyone’s minds – especially when the same (and probably more) could have been achieved through just using the principles of free market theory and trading with all these “colonies”.

Likewise, though Mr. Trump identifies the issues in hand correctly, his solutions make one ask – “at what cost?”

Tuesday, August 11, 2015

Devaluation of the Renminbi

On April 9th of this year, I wrote in this blog that the Chinese stock markets were going crazy by reaching new peaks every day and that it was better to get out of Chinese stocks. In the months that followed, the stock markets in China took a hit and lost more than 50% of its value – in fact, the declining trend was put to a pause only because of the aggressive interference by the Chinese government (there are still thousands of companies whose trading is yet to resume after the Chinese regulators halted them).

Today, the Chinese government shocked (or should I say annoyed) the global financial markets by devaluing its currency, Renminbi, by 1.9% against the US dollar and other major currencies. I was not shocked. This move by the Chinese made a lot of people in the US and other parts of the world who trade with China angry complaining that this devaluation was giving an unfair advantage to Chinese exports. It did not make me angry, though I felt a little sense of “missed opportunity”.

The Chinese authorities set a reference rate every day for the renminbi against the US dollar and other major currencies – and allow the currency to trade within a band of 2% from that reference rate (plus or minus 2%). In currency markets, they call this as “managed float” of a currency. It has to be noted that the band was much less than 2% years ago and over the course of the years, China has increased the trading band to 2% with the reference rate as the mid-point.

I, as most people, would like to see the renminbi to freely float. And I, as most people, would like to see the renminbi appreciate in value rather than depreciate in value (given China’s account surpluses, it is only natural to expect the renminbi to appreciate over the long run to a more stable and fair value). But all that said, today’s devaluation of the renminbi has caused over reaction in the markets and among policy makers, people and politicians.

In the recent past, I have advocated for a stronger renminbi through interference in the markets – a.k.a currency manipulation. The reason for that is that I am counting on China in the years and decades to come to create a global engine of consumer-driven growth. And in many respects, it is time for China to start taking up that role – given their account surpluses, forex reserves, state investments plateauing and their massive population. But what I am talking about is a significant re-structuring of the economy that would initially slow down the growth by a significant margin before picking up steam. And that requires enormous political will in a communist nation. Today’s action made it clear that the government is not ready yet to go through that tough road of re-structuring. Fine, that’s ok, but I am atleast expecting that they would take the smooth road of re-structuring – which they seem to be. In other words, if I have to wait for the renminbi to depreciate first before it starts appreciating, then I am ready to do that – provided there won’t be any artificial hindrance to its appreciation when the time comes.

Other than that, all the hue and cry about today’s action by the Chinese monetary authorities to devalue the renminbi is not warranted, in my opinion. Everyone demands China to float their currency freely (and I do too, though I am okay with a managed float during extreme volatility) and if China had indeed freely floated their currency, we would have seen the renminbi to depreciate far more in value this year than the 1.9% that the authorities devalued there. The Chinese economy has been doing terribly this year, there has been an exodus of foreign money from stock markets – and all this should have dented the renminbi to a significant extent (well above the 1.9% devalued today) even if it were left to market forces. Instead the renminbi stayed stronger than the market would have priced it because the renminbi tracked the strengthening US dollar throughout this year.

One significant change that the Chinese authorities did today is to start taking the previous day’s final value of the renminbi into their calculation rather than the previous day’s reference rate to set the next day’s reference rate. This is akin to dancing with the markets in the direction the markets take the currency’s value. In my mind, this is a significant and a positive change in the way the “managed-float” of the renminbi is carried out on a daily basis. If China had followed this methodology from the start of this year, we would have seen the renminbi depreciate by 1.9% (or even more) by now – albeit that would have been a gradual depreciation rather than today’s sudden devaluation.

What is important for the US and other trading partners of China is not to complain about their actions today, but rather to welcome it and make sure that China follows the same methodology even during times when the market forces pull the currency in the opposite direction (when the renminbi is supposed to appreciate). And the US and other trading countries should also put pressure on China to gradually increase the trading band to 3% or more instead of the 2% that they currently have (and make sure that China actually allows the value of its currency to reach the upper and lower limits of the band if the supply and demand requires it to).The pressure could also be put to eliminate other forms of capital control that China currently has in place. 

And by the way, on a different issue, as long as China maintains a trading band for its currency on a daily basis, the renminbi should NOT be added to the basket of reserve currency list by the International Monetary Fund.