Now that we have a general layout in our minds of how all
of the mechanics are fitting together, what I want to do in
this video is discuss a little bit about why the different
actors would do what they are.
How they could benefit or get hurt from this cycle.
And really, why it's so hard to unwind each of the actors,
why it's so hard for them to unwind
themselves from the scenario.
Where I finished off this last video, I talked about more
cash being in American pockets because of essentially, debt
being cheaper, government can spend more money, lower taxes.
And I said that's more money to buy Chinese products, but
it's in general more money just for Americans to spend on
each other.
They might buy each other's houses or buy
each other's services.
So in a lot of ways, it does stimulate the economy.
For any Keynesians out there, the more you spend, that will
stimulate the economy, lower taxes.
For more conservatives, that also can
stimulate the economy.
And in general, debt being cheaper, lowers interest
rates, all of these things stimulate the economy.
Now, normally when you're stimulating the economy like
this, and you have all of these factors, you have the
risk of higher inflation.
But remember, inflation, or at least price inflation, is just
the price of all of your goods.
But notice, we're buying more and more cheaper goods, and
interest rates are low.
So to some degree this whole cycle also keeps-- I guess you
could say, the surface growth that the average American
consumer experiences looks very positive and inflation
stays slow, so we can also say money to buy
each other's services.
Now with that said, let's think about why the different
actors want to do this.
So let's think about it from the Chinese perspective.
So if you are China and you're starting off, you are a real
Communist country maybe 30 years ago.
And then you start to have market-based reforms and you
really want to enter the developing world.
But you don't have the industrial base in the late
'70s or early '80s to to really compete with the
Germanys, and the Americas, and the Japans-- and when I
say Americas, I mean United States-- on their terms.
So one advantage of export-led growth is when you're just
beginning to develop, you have a less-developed society, you
have less of an industrial base.
So when you have export-led led growth, you can actually
build, you actually will encourage investment in
factories that can go and produce things for the
developed world.
And by keeping your currency low-- by artificially keeping
your currency low-- and let me be clear.
With just standard free trade, labor costs are going to be
cheaper in a place like China or India that has a lower
standard of living.
So there would be just straight-up free trade with no
manipulation of currency.
You would have things that would move offshore,
manufacturing and services that move offshore.
But if you super charge it, if you make it even cheaper to
manufacture, to do business in China, it'll just accelerate
the investment in production in China.
So this export-led growth-- let me put it this way.
Artificially suppressed currency-- and this also
happened with Japan after World War II-- artificial
suppressed currency, and to some degree we wanted that,
because we want to Japan to become intertwined with the
United States.
We wanted it to be successful.
We saw what happened to Germany after World War I,
where it was so economically unsuccessful that it was very
easy for a character like Hitler to come to power.
So we learned our lesson.
We said, you know, it's never good for another country to
not have an economic recovery.
So we actually, to some degree, many people think,
encouraged it in Japan.
But anyway, you artificially suppress a currency, it makes
your exports cheaper, and which then encourages more
investment in production at home.
And in this case, when I'm talking about home, I'm
talking about China or Japan.
And more production at home means more investment at home.
More investment.
If you're producing more in China, you're going to have to
build more factories.
And this means literally more jobs and, to a large degree,
capital for the Chinese people.
More jobs and capital.
And as you become more efficient and as you go down
that development curve, you'll become more and more
competitive over a whole series of industries.
And the idea is, once your people get developed enough,
you will have enough capital at home.
You will have enough of a consumer base at home that
some of this extra capacity can then be turned back to
your own people.
That you can then use these goods to sell to your own
people to increase their standard of living.
So at first, you are building washing machines and
refrigerators for the United States and Europe.
And because you're building those washing machines, those
are jobs for Chinese and eventually, once they have
enough money, once there's a critical mass of a
middle-class Chinese, that same capacity could be used to
sell washing machines and refrigerators to the Chinese,
and it would raise their standard of living.
So it builds a manufacturing base and a home market.
Let me put it that way.
So from China's point of view, it looks unambiguously good.
It builds manufacturing base, and a domestic consumer
market-- which just means people in China, once they
have jobs and they have capital, will be able to buy
the goods themselves-- and domestic consumer market.
Now where is the negative here?
You could imagine, if you are the developed country that is
buying these goods, they would be cheap to begin with, but
now they're even more artificially cheap.
Well you lose your manufacturing base.
So if you look at it from the U.S. point of view, you lose
the manufacturing base.
And it's very clear that this has been happening, whether
you want to point to Japan or in general, we've been losing
our manufacturing base to other countries.
And some people view this as a good thing.
Some people say, hey, we are further down
the development curve.
We shouldn't focus on manufacturing, since
manufacturing always tends to go to whoever can do it for
the cheapest price.
We should focus on knowledge things, whether it's
pharmaceutical industry or the IT industry.
So there's maybe an argument there.
But the other reason why this is maybe compelling to the
United States is its lower costs.
So this looks like a negative, and it is really a negative on
some level, but the one I guess you could call it a
superficial positive is lower cost for American consumers.
So if you're not one of the people who lost their jobs at
the manufacturing plant, and your the great majority of the
rest of Americans, it seems like a good thing.
Things are cheaper for you, it's cheaper to buy clothes
for your kids.
It's cheaper to buy a car.
It's cheaper to buy a refrigerator.
It's cheaper to buy an air conditioner.
Now the problem is, when and how does this end?
Because this whole cycle that we create, it might
sound good for China.
In theory it sounds good.
You suppress you currency, your goods are cheap, more
production at home, more investment at home, more
capital and jobs eventually, point that capital, point that
investment back at your own home market and now you are a
developed country.
Seems to make a lot of sense, but it's
easier said than done.
In particular, it's not a trivial thing to make that
whole market be as consumptive or as consumer-driven as maybe
some of these developed markets abroad.
The other problem is this whole time,
remember what's happening.
You're just accumulating this mass of, in this case, U.S.
dollars and you're using it to go essentially lend to
Americans, to lend to the government, and it essentially
gets lent to the American people.
And the minute that you stop doing it,
think about what happens.
The minute that you stop, let's not even talk about
unwinding this, let's say the minute that you stop buying
dollars, your currency will inflate and the holdings--
these trillions of dollars of assets-- will drop in value,
because the minute you stop buying dollars, the currency
markets will allow the yuan to appreciate, the dollar to drop
and so stopping buying leads to drop in value.
And that's just if they stop buying.
If they actually ever tried to unwind this situation, as they
start selling these, that would drop the value of
whether you want to call it the dollar or the U.S.
Treasuries even more, and so everything else they're
holding would drop in even more value.
So the whole time, in order to keep their currency propped
up, they've been buying these assets, they've been buying
these dollars.
But the very act of unwinding it will-- I won't say make it
worthless-- but it will make the value of their holdings go
down dramatically.
So you have a very hard situation for the Chinesese.
It's a hard situation to even get out of.
And it's just as hard for the U.S. because if you think
about it, a lot of people in the U.S. would look at this
and they'd say, hey, this is horrible.
This is why our manufacturing base has gone away and it is
partially true.
And so they'd say hey, let the currencies just
do what they will.
No more artificial distortions, no more
manipulation by government.
Let the currencies be freely trading.
But what would happen then to the United States?
The minute that China stops doing this, stops artificially
supporting their currency, or even worse, the minute they
start unwinding all of these dollars that they've
accumulated, what's going to happen?
They're going to start selling U.S. Treasuries, there's going
to be lower demand for U.S. Treasuries because they're not
even buying it, they might be selling it.
Interest rates are going to go up, long-term interest would
go up in the United States.
Now when long-term interest rates go up, that means that
borrowing is harder, that people will want more interest
to lend you money, that credit card rates will go up and in
general, the entire United States economy will go down.
Why are we in this recession right now?
Because it is harder to borrow.
We were so dependent on cheap debt, and when that debt got a
little less cheap, everything kind of ground to a halt.
That would be even worse if the Chinese stopped buying our
debt and allowed interest rates to go up.
So we are kind of locked in this very perverse cycle,
where although it looks like the Chinese are unambiguously
I guess, benefiting from this, they are accumulating these
assets and the minute that they try to stop accumulating
those assets, the value of those assets
are going to go down.
And even though the United States looks like it's getting
their manufacturing base depleted-- and that is true,
it is getting its manufacturing base depleted
because of this-- it is keeping interest rates low.
And if you're a politician, you like that.
It makes the overall environment look
superficially positive.
I'll leave you there and let you think about this whole
situation for a little bit.
In the next video, I'll try to do a little bit of analogy to
think about where all of this might go.