The Budget Debate

There has been a general societal movement towards greater savings in the post-financial crisis period. Households and firms are saving more than they used to due to the weakened economy. Government has been faced with the choice of stimulating economic growth or confronting the budget deficit. To date, it has tried to spur the economy through low interest rates and increased spending. However, now, the big issue has become the budget deficit. Legislation to cut spending on both the local and national stage has been met with scrutiny and protests. The alternative to cutting spending would be to increase revenues through revised taxation. Republicans and Democrats disagree on this issue fundamentally, which has spurred the debate. Both sides have preached rhetoric attacking the American people’s fears about the job market. The problem with these two issues, cutting the budget deficit and creating jobs, is that may conflict with one another. Cutting spending directly addresses budgetary issues, but may hinder a recovering economy. Attempting to stimulate the economy and increase tax revenue through tax code revision might not address either issue. Cutting spending seems like the best way to tackle the budget deficit, but it is important to keep in mind what is being cut such that economic recovery is not negatively affected.

To understand why the GOP is so concerned with the budget deficit, it is important to understand the underlying economics. While it may seem counterintuitive to say it could have a negative impact on output, government spending can be bad when the government is increasing the national debt. First, increased government spending through increases in output and money demand increases the overall domestic interest rate, which can have a negative impact on consumption, investment, and net exports. Secondly, increasing the national debt through the deficit increases the size of interest payments on that debt. Recently, we have seen countries like Greece and Ireland seek bailouts because of the amount of debt they faced due to mounting debts. The GOP seeks to avoid that sort of situation by reducing government spending. It might be more important to decide what to cut rather than to unleash an all out assault on spending.

Wisconsin has come under the public eye both because of their attempts to pass legislation to cut spending as well as the heated reaction the legislation has received from unions. The key part of the legislation, which Republicans are having trouble passing because the Democrats have boycotted the vote, seeks to increase cost sharing of healthcare and pensions between government and government employees. These savings to government from increasing cost sharing would potentially save 5,500 state jobs and 5,000 local jobs. Private companies have already employed this type of cost sharing plan, so it makes sense for government to do this as well, particularly in Wisconsin where public employees enjoy higher salaries than their private counterparts. Why should government both provide better salaries and full benefits when private employers are not facing the same costs? It is not an efficient use of government funds to provide more than what the market dictates. While the pending issue is the limitation of collective bargaining, the spending cuts in this bill are in line with how government should target spending cuts. Government should try to make its spending more efficient while not hurting jobs.

The Wisconsin legislation gives us insight on the debate between Republicans and Democrats on the national level. After the House passed a $61 billion cut in government spending, Republican House Speaker, John Boehner, said, “we will not stop here in our efforts to cut spending, not when we’re broke and Washington’s spending binge is making it harder to create jobs.” In response, House democratic leader, Nancy Pelosi, disagrees “the Republican spending bill destroys jobs and their reaction is, ‘so be it.’” The key here is to understand what spending is being cut. In Wisconsin, they want to make spending cuts through cost sharing, taking measures similar to private enterprise and saving government jobs. The concern from Democrats is that spending cuts will slash program funding instituted to create jobs. Whoever is right in this regard is dependent on what the spending cuts actually intend to cut. The Democrats seem more intent on tackling the jobs issue than the budget problem.

The Democrats do not seem to have a definitive response to the budget issue, but certain actions that the Democrats are preaching could both help stimulate the economy and indirectly address the budget issue. In his State of the Union speech, Obama preached the need to revise corporate tax code, particularly in closing loopholes. The US corporate tax rate of 35 percent is amongst the highest in the world, but some companies pay much less than that. Obama hopes to simplify the code to lowering the rate, but making sure all companies pay the same rate. He believes this can be done without increasing the deficit. While it might not stimulate investment from these companies, it would resolve a key issue concerning these companies.

Many companies are currently cash rich, but are choosing to issue debt. Much of this money is overseas, so to bring this cash over, these corporations would be subject to the corporate tax. Since interest rates are low, companies are issuing cheap debt rather than bringing over foreign earnings. Companies would rather use foreign earnings to invest in lower yielding foreign assets, borrow money, or even not invest in a potentially profitable project in the US with foreign earnings all because of the tax rate. This is hurting investment in the US and taking away jobs. Whether a lower corporate tax rate would stimulate corporations to bring their foreign earnings into the US remains to be seen, but it is clear that the current corporate rate is discouraging companies from bringing over foreign earnings. This could have significant implications on tax revenues.

The financial crisis and the recession have caused a notable decline in tax revenues. Tax revenues are down nearly $400 billion since 2007, and corporate tax income is down $175 billion over the same period. This is not due a change in the tax code because President Obama has maintained the tax status quo, recently extending the Bush tax cuts. The big difference, however, is that the unemployment rate has risen significantly, meaning less people have jobs, and therefore, there is less income to be taxed. They also had less money to consume, hurting companies’ revenues and their incomes that they could be taxed upon. If simplifying the corporate tax code can spur investment in the US and create jobs, it would help reverse this trend. Unfortunately, there is no definitive effect from taking such measures. Changing the tax code does not mean that companies will invest, thus creating jobs and increasing tax revenues. It does not tackle the deficit problem head on like cutting spending.

Both Republicans and Democrats will debate this issue because they think they know what is best for the country. While the budget deficit is of significant concern, it is further complicated by the recession and the need to create new jobs. Cutting spending is complicated because it can save jobs by making government spending more efficient, but it can also cut programs that would create new jobs. However, it guarantees to tackle the issue head on. Hoping that spending and changing the corporate tax rate will stimulate job growth and tax revenues is not a certainty. In deciding a compromise, Democrats and Republicans must decide what measures will have the most positive impact on the economy.

The Grammys Fashion

Normally, I don't fuck with fashion, but watching The Grammys last night has set me off.

Look at the above picture. When did it become fashionable to look weird? When was it acceptable to come out looking like an alien dinosaur baby freak? When was it okay to wear christmas decorations as a dress? And what the hell is Nicky Minaj wearing?

Are we in a time where it's more important to make a statement than exhibit class, style, and sexiness? I remember back in my day, Jennifer Lopez wore this dress and it was sexy.

Is that the most clean conservative dress ever? No. The colors are kind of garish, but the style was risque. She was pushing standards and flaunting what her mama gave her. That was the main purpose of award show fashion. To find new ways to flaunt your body. Instead, it's about drawing attention to yourself wearing these outrageous costumes.

I mean let's be truthful, it's working. People are talking about these artists today. Though, it's not for what it should be: their music. They're not talking about how beautiful some of them are, but rather how crazy they must have been to wear what they did.

But what do I know about fashion? May be I'm just old school. May be I'm just that old man who doesn't appreciate these things. I just think these women are drawing attention to themselves like attention whores rather than for their music. That's what The Grammys are supposed to be celebrating right?

My One Problem with The Godfather

The Godfather is perhaps the all time greatest movie. It's perfect on almost every scale. It has everything you would want from a great movie: a great cast, great acting, great soundtrack, great story, violence, sex, I could go on and on.

My one problem with the movie is Lucy Mancini. She's not hot. Sonny is supposed to cheat on his wife with Lucy? Are we really supposed to believe that? This has been my one qualm with the movie. The casting of Lucy was not done well.

The Future of Coal

Recently, Alpha Natural Resources (ANR) acquired Massey Energy Co. (MEE) in a deal that has significant implications in the coal market. This capped an interesting week in the world of coal which saw Rio Tinto’s offer to take over Riversdale backed, Mobil-Exxon predicting natural gas to overtake coal by 2020, and Chevron getting out of coal all together. These news events signal a mixed outlook on the future of coal with some companies looking at alternative resources whereas others are looking to strengthen their position in the coal market. Looking at all these events, it is possible to get an outlook for the future of the coal market.

The Massey Acquisition
Regardless of what the future is, coal is a significant resource today, since it has many uses. Coal has various grades which contribute to its different uses. It is a significant source of electricity; 40 percent of the world’s electricity production comes from coal. The world’s two biggest economies, China and the United States, both consume a large portion of coal for electricity. There is a strong demand for the resource. Coal is also used in the blast furnace for smelting iron, another important mineral commodity to industrialized nations. Furthermore, since coal can be liquefied into gasoline or diesel, it is seen as a backstop technology to limit price escalation in the oil market.

The acquisition of Massey by Alpha Natural Resouces brings America’s third and fourth largest coal producers together. Under the terms of the agreement, Massey stockholders will receive 1.025 shares of ANR stock and $10 for each stock of Massey Common. This represents a 21% premium on Massey’s share price, but the deal should see ANR, with its 5 billion tons in reserves, become the US’s second largest coal producer, leapfrogging Arch Coal, and the third largest producer of coal in the world. The cash and stock deal is valued at $7.1 billion and should help ANR become a significant player in the metallurgical coal market.

Because metallurgical coal is a factor of production for industrial, manufacturing, and steel industries, the deal should put Alpha Natural Resources in a strong position. With emerging markets, like India, China, and Brazil, the demand for steel and other goods should be high. This should help sustain the demand for coal. ANR is putting themselves in a strategically solid position.

Riversdale Takeover
Rio Tinto is one of the world’s largest mining and resources companies, so an attempt to acquire a coal mining company should not be a huge surprise. The large majority of Rio’s coal operations are geared towards thermal coal. With its bauxite refinement and iron ore production, it makes sense for Rio to acquire a company whose resources can contribute directly towards another subsidiary’s factor of production. Perhaps more significant, however, is that magnitude of the resources they are acquiring.

Not only is Rio making an attempt to shift much of its coal holdings from thermal to coking, but they are also adding greatly to their potential production. As of 2008, Rio only produced 153,111 tonnes of coal. The Riversdale acquisition could substantially increase the production numbers, so not only is Rio getting more coking coal resources, but they are increasing their stake in coal mining. This, however, is by no means a done deal.

Just like Rio, there are two steelmakers, who are substantial holdings of Riversdale, with interests in coking coal. India’s Tata Steel owns 24.2 percent and Brazil’s CSN owns 16.29 percent. While the board representative from Tata backed the offer, Riversdale has made it clear that this does not mean that Tata Steel will sell it share of Riversdale. Obtaining Riversdale would be a strategic coup by Rio, both finding a resource to help itself and taking away a resource from a competitor.

Mobil-Exxon Prediction and Chevron’s Exit
Exxon-Mobil has made a bold call by suggesting that natural gas consumption will overtake coal by 2020. To put that in perspective, the International Energy Agency does not see that happening until 2035. As preposterous as it sounds, there is a method to Mobil-Exxon’s madness as trends in the market suggest that they may just be right.

Cheap prices have not discouraged exploration and production companies from raising supply, but the key to gas’s role in the future will be dependent on demand. The thought is that natural gas will make its leap in the power generation market. This sector accounts for 34 percent of US gas demand. While coal dominates this category, tightening environmental regulations could push power companies towards natural gas because it is a much more efficient source of energy. The shift away from coal seems to already taking hold.

Chevron Corp announced that it will be leaving the coal industry, stating that clean coal technology is too far away. This relates directly to Mobil-Exxon’s prediction that companies will look for cleaner energy sources. Clean coal technologies are technological developments aimed at reducing the environmental impact of goal energy generation. Since coal is one of the leading causes of climate change, there has been an initiative in the industry to find ways to limit the environmental impact. Although Chevron only produced 10 million tons of coal last year, it is significant that the energy giant is leaving the industry.

The Future of Coal
The coal market as a whole will be sustained so long as there is a demand from steel, manufacturing, and other industrial industries. However, coal as a source for electricity production might have a less certain future. With growing regulatory burdens, the demand for clean coal technology is at an all time high. How viable is clean coal technology? How long will it take for these technologies to develop? How much more efficient will these technologies be?

These lingering uncertainties must be sorted out in the near future for coal to survive as a source for electricity production. If these technologies do not make substantial reductions in the environmental impact or take too long to develop, these companies will look at alternative sources that are more efficient and less harmful the environment. This will have a spiral effect on the price and supply of coal because as demand goes elsewhere, prices will drop making the extraction of coal reserves uneconomic. A price drop would have a precipituous effect, not just on these coal companies, but the many miners who would lose their jobs.

All of these news events, in a way, suggest this trend away from coal as a source of electricity production. Both of the takeover/mergers seem to be motivated by a desire to further a stake in the coking coal industry that is tied with the steel, manufacturing, and industrial industries. The moves would help the companies strengthen their position in those markets. Exxon-Mobil's shunning of the coal industry and Chevron's departure from the coal industry is an indicator of what the future of the industry might hold.

Update: Egypt

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Tracy Morgan Is Ridiculous

The title of the post and the video speaks for itself. Whenever Tracy Morgan appears on anything, it's must watch television.

Protests in Photos

Big Picture Protests in the Middle East:

This is Worth Watching

Al Jazeera English: Live Stream - Watch Now - Al Jazeera English

Roundball Rock

The original Roundball Rock:

We Awarded The World Cup To This Country?

Really FIFA? Really IOC?

You may have heard how critical I was of the decision when it was made in early December. One of the criticisms of the Russian bid was safety concerns. Russia is hosting two important world events in the next 8 years. How has this happened?

When you have events like this:

But Monday's bombing, which killed 35 people and wounded more than 150, highlighted the persistence of terror attacks in the Russian heartland. Terrorists have struck the capital twice in the past 10 months, breaking a relative lull in attacks there that had lasted for several years.

You're going to put the world's people in the line of fire? I'm not saying that there will be a terrorist attack or a suicide bombing during the games, I hope there isn't one. But why take the risk?

These games are a time where we take a break from the rivalries and the fighting to contest them on the fields, the tracks, the swimming pools. The games are a time of peace. It is up to the host nation to maintain the peace. We've seen the consequences of a lack of peace in the past, in Munich 1972. Who is to say something similar cannot happen in a country where these kinds of events occur regularly?

Oh, that's right...money in your pocket is what's important. Corruption in sport is the worst. I hate it. It's absolutely ridiculous that Russia got the 2018 World Cup when safety was the number one issue and Qatar got the 2022 World Cup which they may move to winter because of weather concerns. It's particularly ridiculous when they beat the likes of England:

Events like these really annoy me because they show a lack of attention. These type of things need to be prevented, not just in Russia, but through out the world. I know that you can just as easily walk into a US airport. May be there should be further securities to prevent these measures. Airport are high capita areas and easy targets as a result. I know flying is a hassle, but what's the cost of a human life?

Women as Referees

Those were the comments by Richard Keys and Andy Gray during the Wolves-Liverpool match. These comments have caused an uproar and Sky Sports subsequently been dropped from Sky's coverage of Monday Night Football. I'm honest enough to admit that when I first heard the comments I chuckled, but then I thought about it more. Female referees are often chastised more openly than male referees because there are so few of them. This means that when they make an error, the reaction is amplified. Everyone knows the names of the female referees because there are so few of them. Fact is though that every referee makes mistakes.

I think the NBA is a good example of this. There is one female referee and her name is Violet Palmer. I will not comment on her credentials as a referee, but if you call her a bad referee, I can name you at least 10 male referees who are just as bad. Going back to football, there was a couple instances in the last two Arsenal games where the male linesman made the wrong call on offsides. The player that the ball was played to was onsides, while another wasn't. The correct call was to play on, but the referee waved his flag for offsides. Where is his criticism?

Fact is that men's sport still has a men's club mentality. There's a certain masculinity that's expected from all aspects and when a female tries to get into the men's club, it's received poorly. This does not make it right, but it's a reality of societal issues in sport. Will this change in the future? I think it's too soon to say. Sky made the right call in dropping Gray and Keys though.

Cajas: Reform At Last

Following concerns surrounding the financial system, Spain has decided to inject its banks with billions of dollars. The lingering problems with the financial problem have been attributed to the cajas, saving banks, which have struggled in the eye of the financial crisis and the collapse of the housing bubble. Spain attempted to rescue these banks last year, but the attempt to recapitalize and restructure these banks was thwarted by a lack of widespread reform and a desire by the banks to maintain the status quo. A year later, Spain has found itself under scrutiny for its increasing debt issues as well as its struggling economy. This time, Spain has responded with a more proactive plan. Injecting cash into the financial sector to recapitalize these banks has been well received, but the new reform measures have been the key to the positive response since they address the underlying issues which plagued last year’s rescue attempt.

The Spanish financial system is being monitored with a watchful eye by other European countries. Greece and Ireland have already accepted bailouts from the European central bank, so the worry is that, with its growing debts and struggling financial sector, Spain will be the next country to need a bailout. The deficits have hurt investor confidence in Spain, making debt hard to finance. Spain is already estimated to borrow €125 billion this year “just to finance its deficit and roll over maturing debt.” This new infusion of cash financed through debt poses risks and adds stress to an already taxed economy. However, it is a necessary move because the cajas are an important part of Spain’s financial and economic well-being.

The cajas are integral to the interests of Spain because of the large role they play in driving Spain’s economy. The cajas account for €1.3 trillion in assets, which accounts for 42%% of the total bank assets in Spain. The problems with the cajas are two fold. First, they have had trouble raising capital because there is lack of investor confidence. Second, the lack of regulation combined with the complex structures and histories of these banks are part of why these banks are in such dire situations. For example, because of the lack of regulation in lending practices, these banks, like many others around the world, funded a housing boom that went bust, crippled by “bad loans and heavy losses.” The housing spiral has played a huge role in depleting the banks’ funds.

Mortgage or other real estate loans account for nearly half of the cajas assets, therefore the burst of the housing bubble had a considerable effect on these institutions. As the defaults in the housing market began, the cajas were forced to foreclose on the assets and attempt to sell them to recoup the funds. The new influx of real estate for sale further plummeted housing prices, making the underlying assets worth less than the value of the loans. The result was a housing spiral that has seen the cajas suffer great losses. The easy response to fix the depleted capital at these banks is to provide them with more funds. It is not enough just to hand these banks some money; reform measures are necessary to prevent another financial crisis from happening in the future and to satisfy investors.

The idea to inject new funds into these banks is not a new one; Spain injected €11 billion into these banks last year through the Fund for Orderly Bank Restructuring (FORB). While the government had said that that amount put into the fund could rise to €99 billion, the country did not make more money available. A requirement of that rescue attempt was forcing the mergers amongst different cajas, reducing their number from 45 to 17. However, the mergers resulted in “confusing, unwieldy structures” which “scared off investors.” What is more is that they did little to provide transparency in these banks. The politicians who control the cajas used the FORB to create “virtual mergers,” allowing “the banks to keep their own brands, governing bodies and local retail operations while combining treasury and risk-management functions.” This is symptomatic of the political and social issues that go with forcing reform on these banks.
Part of the problem with the cajas is intrinsic with their history and their roots. These banks have “close ties to provincial governments,” which can be traced to the cajas rurales. These rural banks were affiliated with syndicalist, co-operative movements and the Catholic church. While they were absorbed by the savings banks, their ties to political and social interests remained. Because of this, the cajas “face pressure to back projects that may not be profitable.” For example, Bancaja and Caja Granada invested in a theme park, Terra Mitica, in Benidorm, which “went bankrupt in 2004” and” has struggled since reopening in 2006.” Additionally, another bank, CajaSur, which is operated by the Roman Catholic church in Cordoba, mysteriously refused to merge with Unicaja. It exemplified an instance where “politics often trumps rationality” in Spain. As a result, the Bank of Spain had to seize control of it. For Spain to make a real impact on these banks, widespread reform is necessary to usurp these special interests.

The overriding sentiment for reform seems to be that the cajas need to become more “centralized” and “transparent entites,” but in a country with Spain’s history, it might be difficult challenge to overcome. The Franco regime was extremely divisive, and though Spain has done much to repair these division, cultural and lingual values still prevail. For instance, the idea of centralized banks may not resonate well with Basques or Catalans, who were marginalized by the strong, centralized, Madrid-based government of Franco. In instituting this new reform, the hope here would be that the country is far enough removed to accept a decision that affects the health of the overall economy. A strong Spanish economy is beneficial for everyone and reforming the cajas would go a long way in repairing financial uncertainty. These political and social differences which have affected the effectiveness of past attempts to reform the cajas serve as evidence why the new reform has been positively received.

The new plan has shown investors how Spain has learned from previous misgivings and how the country is going to take a more proactive approach towards fixing the caja problem. Last year’s rescue attempt was focused on providing capital for the banks by holding them to lax restrictions. However, the banks took advantage of this through “virtual mergers,” providing access to the capital, but not making the desired changes. This time, Spain is not only providing capital, but also forcing “them to be more open about their lending practices.” By “simplifying their complex structures” and “making them more like traditional banks,” Spain is taking significant steps to usurping the “influence” of “local politicians, union members, clients,” and “Catholic priests” who were “reluctant to relinquish their influence” in the past. With all of these changes, it is easy to see why investors have reacted positively to the announcement.

Under the new plan, the cajas will no longer be complex, enigmatic institutions, but rather more like other banks in Spain. Spain wants to “transform” the cajas into “centralized, transparent entities” that “resemble traditional banks by placing all of their assets into a central holding company and streamlining management.” it is easy to see why the country wants the cajas to be more like traditional banks because Spain’s traditional banks, like Santander and BBVA, are strong. The plan already seems to be shaping the cajas. Cajastur, which merged with three other lenders, has said that it would be “pooling 100% of its assets.” However, the government is going to wait to see the “results of detailed disclosures” before giving an “ultimatum” to the cajas. This should allow the government to assess how bad the situation really is and allow the banks to restructure themselves before necessitating government intervention.

Improving the health of the Spanish economy should be a strong first step towards addressing concerns about Spain’s debt problems. Once these banks are recapitalized and restructured, they can get back to providing loans, stimulating economic growth, and creating new jobs. It should eventually ease the stress on the government, increasing the number of people contributing taxes and reducing the strain of social welfare programs. Spain has been plagued with issues relating to investor confidence because of the cajas for some time; resolving the caja problem should go a long way to addressing these issues.

How Does a Chant at Yost Begin?

So Friday night, I walk into Yost and go to my seat. There's a group of kids, not sure what age they were, but they definitely weren't regulars. This one kid was obsessed with Carl Hagelin. Through out the night, he would yell "give it to Carl" or "Carl's my boy," you know general fanboy fodder. They were just being obnoxious before the game, and I gave them a look. One of the kids asked me "you want in on this." Now I thought they were just drinking or something, but I wouldn't have been surprised if it was something else.

Anyway, these kids were just awful. They were sitting in the student section but had no interest in chanting with the student section. After a while, it sounded like they got bored with Carl, and started chanting "Beat that ass." It was really awkward for us regulars. We all just gave each other looks and rolled our eyes. It was annoying but partially funny.

Well, after one of the goals, one of the kids threw that ball on the ice. Kid tried to take and blow my vuvuzela too, which I snatched before he even took it (this is where I had had enough of this fucktard). The Alaska goalie was hilarious though.

So last night (YES THE THREAD TITLE HAD A POINT), whenever Michigan got into a skirmish, we broke out into chants of "Beat that ass." It was more a hilarious recall to an awkward yet entertaining night. I'm just glad I didn't get into a fight with that kid.

Browntown

Would you buy this?

Yuan Appreciation!

On Wednesday, Chinese President Hu Jintao will meet with President Obama to discuss the relationship between China and the United States, focusing particularly on issues of trade. This has been a hotly contested issue for sometimes now as the US has pressured China to appreciate their currency, claiming that China has held the exchange rate artificially low so that Chinese businesses can enjoy a trade advantage over their US counterparts. In an interview with the Wall Street Journal, Jintao has fired back at the US saying that “the monetary policy of the Untied States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable level.” He also suggested that China will consider making the yuan a global currency, while conceding that it “will be a fairly long process.” This is the setting for what should be an intense bilateral discussion between the leaders of the two biggest economies in the world.

The yuan has tremendous potential as a global currency because of China’s continuing emergence as a global economy. Currently, less than 1% of China’s $2.3 trillion imports are done in yuan. According the the Wall Street Journal article “New Move to Make Yuan a Global Currency,” “some analysts have predicted that it will be only a few years before 20% to 30%” of the imports “will be conducted in yuan rather than dollars.” This suggests that there is already a demand for direct yuan exchange in foreign exchange markets.

Trade between the United States and China constitutes a large portion of the United States’ goods deficit and China’s surplus. Of the United States’ $51 billion monthly goods deficit, $26 billion is attributable to China. The trade between the two countries means that both countries have a stake in each other, present and future. The US has helped China build its economy by buying their goods, and as a result of this capital outflow and wealth, China has accumulated US financial assets.

From an economics perspective, it should be understood that both countries can benefit from a yuan as a global currency, one that is subject to appreciation and convertible for direct trade with other countries. The appreciation of the yuan relative to the dollar can help the US industry and trade in a number of ways. However, it can also help China by reducing its exposure to the US, reducing its transaction costs in trade and making foreign resources less expensive. The decision to make the yuan a global currency should have mutually beneficial consequences.

The US has been clamoring for the Chinese government to appreciate their currency for sometime. Because the yuan has been pegged at a fixed rate, China has enjoyed advantageous trade with several countries, but in particular the United States. We know from our stock and flow model that countries neither want to face a trade deficit (because of the marginal cost of debt) nor accumulate foreign financial assets forever (because of the risk of default). Eventually, the demand for a flow of foreign goods and services must shift, leading to an appreciating yuan. An stronger yuan should help the US trade deficit by making its goods cheaper and China’s goods more expensive.

Devaluing currency often is depicted in a negative light because it is usually caused by inflation. Traditionally, inflation has been the primary cause of a depreciating dollar. Additionally, a strong dollar is important for buying foreign foods and for travel. However, it has been detrimental to domestic industry and labor. First, depreciating the dollar relative to the yuan is not a result of inflation but rather a consequence of the market forces; there is a demand to conduct trade directly in yuan rather than in dollars. Second, a strong dollar has hurt the US by making domestic goods less attractive to foreign countries, influencing the balance of trade. It has also made it more attractive to invest in cheaper foreign labor by outsourcing, since domestic labor has been relatively more expensive. As other currencies appreciate relative to the dollar, companies from those other countries will be more attracted to hiring US labor. Having the dollar depreciate relative to other currencies can have a positive impact on the balance of trade and labor without the worry of inflation.

China has been accumulating US financial assets through the influx of dollars from the imbalance in trade. The combination of accumulating US assets as well as the growth in the US budget deficit has made China increasingly exposed to the US default risk. While US bonds have always had the reputation of being a safe asset to hold, the recent financial crisis has reinforced the important of diversification. China has been concerned that the US will “inflate away its debt” “by printing money.” By making the yuan a global currency and relying less on the dollar as a medium of exchange, China will accumulate less dollars which will not necessitate the purchase of US financial assets. Instead, China will be trading in their own currency and accumulating other foreign currencies and financial assets. This will increase their portfolio’s diversification and help stronger relationships with foreign countries. It will make the countries interdependent on China just as the US has been. Diversification will make China less susceptible to fluctuations in the United States, enabling for a more stable economic environment.

Another advantage of opening the yuan to global trade is reducing transaction costs. By using the dollar as a medium of exchange, China is paying a spread, the difference between the price to buy or sell, of the dollar exchange rate. Essentially, for every transaction that China is conducting in dollars, China is paying a tax. They are paying more and getting less than what they would if they had direct exchange through the yuan. While it may only be a small fraction of the transaction, with the magnitude of trade that China is involved in, its sum adds up. If it makes the yuan a global currency, it can trade directly with other countries rather than using the dollar as an intermediary medium of exchange.

As a developing country, China has become a huge player in the commodities industry. Commodities are very much the life blood of industry and commodity production is integral to industrialization. The mark of an industrialized nation is consuming 300 kilogram per capita of steel. Currently, China is producing 426 kilograms per capita. To produce steel, you need coke, which is a product of coal. Additionally, 68.7% of China’s electricity comes from coal. While China is the leading producer of coal, it imports nearly 3 million tons of coal from the United States. This is only one example of China growing demand for resources, but a stronger yuan would make these resources, these factors of production, cheaper.

The bilateral meetings Wednesday should serve as an opportunity to discuss the possibility of opening up the yuan to the world. As Juntao said, it will be a “long process.” As the world’s two largest economies, China and the United States are the leaders of the global economy. For both sides, it is important for them to come to a resolution that is mutually beneficial. A war of words between two countries so interdependent on each other is not a viable solution. Appreciating the yuan can go a long way to better the relationship by helping trade and industry in the US and making trade less costly and risky for the Chinese.