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Wednesday, February 28, 2007

The Market "Correction"

Inasmuch as I have publicly predicted that the trade deficits (and relations with China in general) are no big deal, I should probably comment on yesterday's large movements.

Contrary to what my critics (who roost around the mises.org blog) may think, what happened yesterday has little relevance to my ongoing critique of people like Paul Craig Roberts and Peter Schiff. In particular, each of my 3 predictions (no recession in '07, oil under $50 by Christmas, and dollar stronger against euro by year's end) could still come true.

But there's more than that. What exactly happened yesterday? Well, the conventional story (and I have no reason to doubt it) says that the Chinese stock market tanked because on Sunday, the Chinese gov't said it would crack down on stock "speculation" and might impose capital gains taxes on their unconscionable profits. So is this cause-and-effect--namely, gov't threatens to tax and regulate, and this lowers asset values--due to trade deficits? If American households had a 3% savings rate, would the Chinese stock market have shrugged off the threats?

Now as far as the link to European and US stock markets, even here the conventional story doesn't vindicate Schiff (or embarrass me). Here the story is that foreigners don't own much of the Chinese stock market per se, but even so foreign investors are fearful that if the Chinese economy slows, then the market for many exporters will shrivel up.

OK, so let's think that through. Assuming the analysis is correct, that means we are vulnerable to a Chinese slowdown because we export things to them. So, when PCR and Schiff complain that we need to export more stuff to the Chinese to reduce the trade deficit...

One last inconsistency: The same people who worry about the dollar being grossly overvalued against the yuan are also worried about the Chinese gov't printing massive amounts of new money. Don't those two worries offset each other?

In conclusion, let me fully admit that I was stunned by what happened yesterday, and it initially made me doubt my articles on international trade etc. But after calming down, I still stand by my arguments on all this. It is entirely possible, of course, that I will be proven wrong, but I still think much of this hysteria is internally contradictory. I am trying to lure these alarmists into making concrete predictions, so that if and when nothing happens for the next 5 years, they will be clearly wrong.

16 comments:

  1. "The same people who worry about the dollar being grossly overvalued against the yuan are also worried about the Chinese gov't printing massive amounts of new money. Don't those two worries offset each other?"

    Well, no, this is the very condition necessary for there to be an over-valuation: there is too much of currency A in circulation vis-a-vis currency B given the exchange rate, but there is a peg in place keeping A too high relative to B. So, given the peg holds, if China prints more Yuan, the over-valuation will be even worse.

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  2. http://www.theonion.com/content/news_briefs/u_s_dollar_drops_against

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  3. Anonymous1:22 PM

    Emerging asset markets in general did very well in 06, 05. They seem to topping out short term along with many of the BRIC related trades. The excuse was cap gain tax/greespan, but there has been money going into those markets for a while now. They were bound to correct.

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  4. Anonymous5:20 PM

    This is Bob posting...

    Gene proves he should stick to philosophy. If there is too much of currency A in circulation vis-a-vis B, then printing more of currency B will alleviate the problem, not make it worse.

    To put it in other words, the dollar won't be as overvalued when the Chinese print yuan faster than the Fed prints dollars.

    To put it even another way: People are mad that the Chinese won't let the yuan appreciate against the dollar, as it would in a completely free market. So, by them printing more yuan, that reduces the forces propelling the yuan to appreciate against the dollar.

    What say you, Gene?

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  5. You are correct -- I misread the direction of the over-valuation, and was correct per my mis-reading, but wrong given the actual situation.

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