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Yuan Capital and the Dollar Peg

January 5, 2016

Yuan Capital and the Dollar Peg

by Lushfun

China is about to be presented with a choice. Three choices actually, devalue the currency, reinvent the financial system, or keep the status quo. The problem with consecutive growth is that all the mal-investment that is hidden aggregates and the incentive to keep it from unraveling from a government perspective goes up exponentially. Social pressure to keep adjustments (layoffs, and re-deployment of capital) into productive assets and or industry presents a problem nobody wants to solve and the three actors; government, labor, and capital fundamentally invested in keeping that industry from contracting.

 

Capital destruction will likely accelerate and occur on a massive scale precisely at the time when perceived transition outlets are mapped out. You cannot buy capital and this is precisely what the governments with massive reserves of cash think they can achieve by deploying it into thousands of projects that will have some perceived notion of payback in the future. Scale is the problem and real transitions happen with capital dynamics that make old employment of capital if not obsolete, than at least drastically reduce the rates of return it can gather. Coal electricity generation plants vis a vis Natural gas electricity generation plants influence returns not just for the plant but the entire supply chain that accommodates each choice, one can view how things worked out for the former vis a vis the later. There are exceptions to capital destruction, but they are risky and generally are fundamentally driven by a lot of waste no private actor is willing to take on, mainly technological research and implementation or at least pathway to design and implement ability.

What gains when capital is destroyed? new ideas, new inventions, new supply chains attached to new inventions or services, new technologies, new prerogatives, new ways of thought, perhaps other things that do not come to mind. Capital destruction brings fracture to solidity of society under the purview of better horizons. Dreams shatter and reality of competition sets in, horizontal within social groups, vertical amongst social groups, external against other states, internal against rationalization of resources and their availability, etc.

Yuan is entering a period where it begins to expand the monetary base it has in order to prevent the clearance shock inside the financial system due to aggregate mal-investment. Doing so would devalue the currency tremendously, especially internally. If this is done it will create a dynamic of systemic mistrust for decades from outside actors. This will prevent any external capital formation since all whom would invest for the long haul will make sure they have an extraction mechanism to make sure they recoup their purchasing power and capital, irrespective of internal policy goals. Waves of capital washing in and washing out will further pressure steady devaluation until the point of no return. Real solution to all of this would have been year-in and year-out bankruptcy and cleansing of non-productive companies from a capital point of view. It would create tremendous pain and dislocation but it would create a dynamic where trust is earned internally for the financials system. This could have been coupled with policies that foster internal capital deployment and credits to those displaced in those industries to transition to something else. Problems of-course would revolve around success vis a vis of these potential movements and social strains.

Mistaking the devaluation of the currency internally while simultaneously expanding the use of it externally for ‘capital’ base expansion will cost dearly. This tsunami of purchasing power transfer is predicated on expectations that Ricardian gains from trade vis a vis use of currency for trade and/or via production in it will not lead to negative capital consumption. The utter stupidity of government planners will become apparent when surplus capital is exported via production, speculation on various exchanges, and depreciation in non-productive investments that will not be counter-cyclical as they have hoped to be. In the end we will witness the greatest capital destruction to that date with trillions of current dollars being nullified in the span of perhaps a few years. Control over distribution of Ricardian exchange gains is given over to external actors in the hope that those actors will not re-distribute not just gains and capital out while backing the sterilized expansion of currency in, without going overboard. As with all things reliance on things going perfectly generally ends with everything that could go wrong doing so.

Be well dear reader.

Okudzhava song “While the Earth is still turning” below

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