Hyperinflation led to Hitler and Mao. What will China's currency manipulation lead to?

However, the flip side of keeping its currency weak for so long is that when Chinese exporters exchange back their earned dollars, the People’s Bank of China is actually overpaying yuan or long-changing (the opposite of short-changing) for those dollars. The net effect of this on the yuan after many years is exactly what happens when a company brings too much of any product to market. The value of each yuan is diminished, and therefore many more of them are required to buy anything. The net effect is not unlike what the United States will eventually face after years of monetary loosening, although Federal Reserve Chairman Bernanke can at least claim that desperate times required unprecedentedly desperate measures. Not so in China.

It should therefore not be surprising to hear recent reports about food price increases in China, which never seem to portend anything good for anywhere in the world. Not to torture a recently coined and already overused metaphor, but the tiger mom example can be instructive.

If a central bank were tiger mom, the economy would be its cub, money supply would be its food, and inflation would be the cub’s babyfat. If tiger mom provides an inadequate amount of food (money supply), the cub won’t grow. On the other hand, if tiger mom gives more food than the cub needs, the cub will first get chubby, then really fat, then hideously obese (high inflation). We can assume what the law of the jungle will do to an obese cub. But that’s precisely what China risks becoming – a chubby little cubby all stuffed with fluff. I’m all for warm and fuzzy, but that might not be the ideal goal of economic policy.

Historical dangers of inflation

Most people are aware that hyperinflation in post-World War I Germany led to disaffection among the population and the eventual rise of Adolf Hitler. Less well known is that hyperinflation in post-World War II China contributed to turning the population against the ruling Nationalists and into the arms of Mao Zedong’s guerillas, the forerunners of China’s modern leadership. The historical irony of an economic policy that stokes the fires of inflation again is as palpable as it is frightening.

For a variety of reasons, the China of the 1940s could legitimately claim to be the victim of cruel circumstance. In contrast, modern China faces a demon of its own design. Like its regional neighbors, China seems quite intent on maintaining the export-heavy model of economic development. Therefore, the self-inflicted inflation of its currency policy will very likely intensify.

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In continuing to keep the yuan weak from this point forward, China will confront multiplying patches of inflationary pressure that it will somehow need to pound down like an arcade whack-a-mole. Or China can simply stop stemming its currency’s natural rise. Articulating and elaborating upon this tradeoff might well be more effectual for US policy and lawmakers than simply decrying China’s current policy – which has gotten us nowhere.

Born in Hong Kong, Michael Justin Lee served as Financial Markets Expert-in-Residence in the US Department of Labor from 2003 to 2005. He teaches in the department of finance at the University of Maryland’s Robert H. Smith School of Business.

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