Revaluation is the Only Choice

Alhambra: China Has No Choice

Behind everything is the same thing. Keynes was right. Inflation is one monetary evil, but its twin is far, far worse. At least with inflation things are moving, Chinese peasants are progressed up into the middle class even if it is more expensive when they get there.

Deflation, however, is when everything stops; Dante’s Hell was freezing cold. It doesn’t have to be all at once like in the early thirties, this can be a prolonged affair dragging out across more years than anyone cares to remember. The frog isn’t being slowly boiled, it is being progressively frozen. It is now almost completely frigid, too cold to be able to leap out of the icy water. Stuck here without any other options, it must conserve its energy as best it can and hope that it can somehow survive.

If given a choice, you pick the heat of high inflation over this every day of the week; until you realize it isn’t your choice. It never really was.

China does have a choice though, actually three. One is do the same and hope the experience of Japan is an anomaly, that this is not a demographic event (otherwise it might never end for people alive today) or that someone else blows up first (Japan? EU? USA?). Another choice is deflation and default. The other is yuan revaluation. The yuan is already massively devalued when looking at living expenses in China, in particular housing. The yuan exchange rate is a lie.

The history of the depression is distorted by free trade orthodoxy. It wasn't caused by trade wars. Those came in response to massive imbalances within a politically distorted gold standard. The British pound was overvalued and the U.S. dollar undervalued. It also came in response to credit and monetary growth that exceeded reserves. Serial currency devaluations were the real "war" if there was any. In the absence of coordinated devaluation of fiat currency against a standard such as gold though, then the only way devaluations will be unleashed is by one nation taking the lead.

Given social mood, there is unlikely to be international cooperation. Moreover, "the establishment" that becomes less so each day, brought us to this point. The Merkels, Obamas, Macrons, Bushes, Clintons, even Sanders aren't going to pull the plug. If there's cooperation going forward, it's likely to come from European nationalists who simultaneously parachute new national currencies from the euro.

If the post-2008 world is to significantly change course in the near term, it will involve a bullish breakout in the U.S. dollar, the yuan going through USDCNY 7.00, depreciation expectations exploding and China forced to revalue the yuan closer to where the market wants it (likely overshooting to fully extinguish depreciation pressure and ignite appreciation). Emerging markets, South Korea and Japan then devalue in turn, followed by Europe, followed by the USA. The endgame remains the same: debt repudiation by hook (deflation) or crook (inflation). But to get the latter, it will require one nation starting the devaluation fire.