China Has Us by the Ying Yangs

In the second presidential debate with President Obama, Mitt Romney thumped his chest and pledged to call China on the carpet as a "currency manipulator." His assertion is that China is using its peg of its currency, the yuan, to the dollar as a means to gain unseemly economic advantages.

First, what does all this currency talk mean? What does it mean for China to "peg" its currency to the dollar? Basically it means that China is using its economic reserves to buy and sell dollars and dollar-denominated securities to manipulate global currency prices in order to hold the value of the yuan in lockstep with the U.S. dollar. They do this to keep the value of the yuan low in order to make their exports cheaper so that foreigners will buy them.

It is true that China's currency shenanigans are causing artificial imbalances in the world's markets. What's not true is that U.S. politicians really want China to drop its peg and let the yuan rise in relative value as it naturally would. Or at the very least it's not true that these threatening politicians are being completely open about what would really happen if China dropped its peg.

Why? Because China's dropping the peg would spell economic misery for the United States, at least in the short term.

China holds its currency down in part by buying U.S. Treasuries--in other words, loaning us money. If they stopped buying our debt and loaning us money, who would we sell our bonds to? There wouldn't be enough buyers, and interest rates would have to rise to attract new buyers. Rising interest rates are exactly what our government does NOT want. They want to keep rates low in desperate hope of stimulating borrowing in order to jump start the economy. Rising interest rates would not be good for the economy in the short term.

So China knows our woofing about the peg is likely just posturing. They know they have us by the ying yangs. That's where our being the biggest debtor nation and their being the biggest lender nation has gotten us.

However, in the long run, dropping the peg would ironically be good for the U.S., because it would force us to get our economic house in order. China essentially has us strung us out on debt drugs and is profiting from our addiction. In the short term, getting off the drugs (China dropping the peg) would spell hardship for the United States. Romney either doesn't realize that or is keeping it to himself because it's not an attractive election season message.

Meanwhile, China keeps pegging the yuan, and yawning at us.