The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Fear of Peasants

05/23/2018

When I went to China a few years ago, my strongest impression was just how frightened the central government is — afraid of their own people.  That makes the tightest controls on freedom necessary.  After all, with a minimal middle-class, China could have a billion poor people take to the streets — how scary is that visual image?

Three years ago, they started the Asian Infrastructure Investment Bank (AIIB).  Because that overlapped the World Bank and Asian Development Bank (ADB), the purpose was not obvious.  Today, the AIIB only has loans outstanding of about $4 billion, compared to $139 billion for ADB and $185 billion for the World Bank (globally, not just Asia).  Digging deeper, AIIB has $19 billion of paid-in capital and a capital base of $95 billion.  Yet, total loans are only $4 billion?  Why isn’t AIIB making significant loans?  They raised a huge amount of capital and then chose to do nothing with it.

It was not so long ago that China had aspirations of their currency challenging the dollar as the dominant world currency.  The huge AIIB could lend only yuan, thus making the yuan more prestigious.   However, that also increased demand for yuan, which in turn caused the yuan to be become more valuable.  That appreciation in their currency naturally caused import prices to rise and exports to fall — a potential disaster for a government afraid of its own people.

As President Trump negotiates the new trade paradigm, I hope he will play on the Chinese fear of Chinese people.  After all, the U.S. could begin buying the yuan to push up the exchange rate, causing problems for the Chinese.

The difference between a trade war and a currency war is similar to the difference between a recession and a financial crisis.  A trade war and a recession send signals they are on the horizon.  A currency war and a financial crisis happen relatively quickly and do more damage.

I hope the president will let the Chinese that know we are aware of their soft underbelly but nothing more.

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