Will China Crash The US Dollar?

Will China revalue the Renminbi? The question has merit for those of us in the West in light of the massive Asian (read, Chines & Japanese) support for the US dollar.

It works like this: China needs an undervalued currecny. This, coupled with its low cost of labor (though that too has begun to change), has enabled it to take over manufacturing and create a pseudo-capitalist economy for itself.

Other Asian countries must compete, and have therefore done their level best to devalue their own currencies in response, in a kind of race to the bottom. The devaluations are particularly important against the US Dollar of course, as that is the currency of choice of the vaunted US consumer.

'Then what do you mean to be, my boy,
When you grow to be a man?'..
..'I want to be a Consumer
And live in a useful way;
For that's the thing that's needed most,
I've heard the Economists say.
There are too many people working
And too many things are made.
I want to be a Consumer, Sir,
And help to further Trade.'
--Patrick Barrington, Punch, April 1934

It's not that the Asian countries want to devalue vs each other; rather, it's that with China, the 800-pound gorilla, keeping its currency artificially low vs the US Dollar, they have no choice but to follow.

They genuinely fear their own currencies' appreciation, so they buy US debt/dollars, with China and Japan leading the way. Without the buying, which is massive, the US dollar would plunge, with all the good and bad that this would entail.

How long can this go on, people ask? Won't China one day let the Renminbi float and revalue? Haven't they already agreed to do so by 2007? And on the day they do, won't they no longer have a need to buy US dollars, leaving the American currency without its support? Surely the dollar will dive down by 20-40 percent almost overnight. The panic! The disaster!

But I wouldn't count on it happening this way, which would ultimately hurt China as much as it does the US. Yes, the Ameribuck is overvalued by traditional measures, but I suspect its decline will be somewhat less dramatic than thought. The reason is that a rebalancing of the relative worth of each currency need not take place through a specific revaluation - it can also be achieved by Chinese inflation.

Inflation is the legislator's friend worldwide: the tax that need never be seen; the policy that need never be announced. It's the butcher, the baker and the candlestick-maker who are held to blame, not the government. Governments fight inflation on our behalf!

Louis Vincent Gave states it clearly:

...right now, it appears that this is the course that Chinese authorities have decided to embark upon.

More importantly, it is hard to see what will make them change the course; by taking care of the overvaluation through inflation, the process is gradual, painless and face-saving. All aspects that a revaluation of the RMB does not offer!

Expect to see a very gradual decline of the Renminbi, probably followed by an equally gradual decline in Chinese (and hence Japanese) purchases of US debt. Yes, the US dollar will decline, but it will likely be smooth and steady, as much as these things can be, to everyone's benefit.

(hat tip: JohnMauldin at InvestorsInsight dot com)