[T.S.R:15911] The Fallacy Of Competitive Devaluation

The Fallacy Of Competitive Devaluation Andrew Tignanelli    It is amazing how politicians can be so narrow-minded. The first narrow-minded move is the Federal Reserve keeping interest rates low to boost the economy. There has never been any assurance that low interest rates boost an economy (Japan has proved this). In addition, low interest rates are a disaster for savers and income-oriented investors. So while narrow-minded politicians cheer a monetary policy that benefits commercial banks and wire house investment trading, they are punishing the rest of us.   The second narrow-minded move is President Obama, Treasury Secretary Timothy Geithner and Congress getting tough with China to allow the yuan to float against the U.S. dollar. The foolish belief is that if the yuan appreciates against the dollar, then U.S. manufacturers will have a better competitive advantage with the Chinese. This is only partially true, but even if it were perfectly true it comes with the possibility of dire consequences.   If a devalued currency were perfectly correlated with trade increase, then Zambia would be the world's sole trading nation. The fact is that currency is only part of the equation.   Other factors include the education of each nation, trade laws, the people's perspective of each nation's goods, the cost of legislation, the cost of transportation, work ethics, the supply of labor, etc.   Let's consider the dire consequences of pushing for yuan convertibility with the U.S. dollar. The U.S. dollar is the world reserve currency, making it an amazing economic benefit to our nation. A world reserve currency is the currency that international partners use to trade between partners. This creates an advantage to minimize inflationary forces in the U.S.   If Brazil's currency loses value to the dollar, then the cost of all goods bought on the international markets are more expensive. If you are the world reserve currency, then you have to lose value to all major currencies of the world to push prices up in the U.S.   With that simple understanding of the world reserve currency, it's also important to understand what makes a country's currency the reserve currency. It is not by vote, but by practical application. The U.S. dollar is in abundance, which allows for all nations to deal freely in it.   Only the Chinese yuan has the potential to be a plentiful enough currency to push aside the dollar as the world reserve currency. The yuan will one day be the reserve currency if it becomes convertible, as President Obama and Secretary Geithner are crying for. If it does occur, Americans are going to have a difficult time doing business globally in U.S. dollars.   Think about it this way: If the dollar devalues against the yuan, and we buy most of our goods from China, those goods will potentially become more expensive. Which do you think is more important, buying your goods for the best price possible, or giving U.S. manufacturers a potential competitive advantage against China? The U.S. does not allow each state to have its own currency because of the detriment of freely floating currency values. It is a tremendous blessing to America that China has spent the time, effort and finances to keep the yuan static vs. the dollar.   So unless you want to pay higher prices on goods imported from China, and potentially see higher inflationary forces, then tell people like President Obama, Secretary Geithner, Reps. Tim Ryan, D-Ohio, and Tim Murphy, R-Pa., as well as Sen. Harry Reid to learn basic economic principles before making brash remarks to China about freely traded yuan.   There is a positive to all of this political rankling from both America and China that investors can benefit from. There is no doubt that the yuan is undervalued to the dollar due to the currency peg the Chinese are maintaining. This aberration of the true value of the currency will not last forever. A conservative way to take advantage of this is by investing in Chinese bonds and notes that currently yield a higher rate of return than American bonds and notes.   An added benefit is that you may get a big appreciation in the value of the currency if the Chinese allow their currency to float freely in the markets. I use the Aberdeen Asia Bond Fund to take advantage of some of this possibility, since the fund is not purely Chinese bonds. A slightly more growth-oriented way to play this is through Chinese stocks; two options are the Morgan Stanley China A Share Fund and Matthews China Dividend Fund. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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