|Here is another, more recent one:|
When the Fed devalues the dollar by printing ever more, it devalues the Chinese yuan as well as the yuan is pegged to it. What happens if China snaps the peg? Most people will reflexively say "Oh China wants to export to the US and wants to keep their currency cheap"
What if China allows the yuan to appreciate to say 2 yuan to the dollar? And what if China demands payment in yuan for exports?
First, a lot of the stuff exported by China, even low tech stuff like swabs, doesn't seem to be made elsewhere or not in the quantities needed, so the world has to pay whatever price the exchange rate dictates, in the short to medium term.
Second, as articulated by President Xi, aided by demographic reasons, labor is increasingly expensive in China, and China wants to move away from cheap exports to higher value exports. So China may not care, in the long term, if they eventually lose the "Walmart quality" product manufacturing.
The effect of the yuan decoupling would be explosive inflation in the US, coupled with global demand for yuan to pay for Chinese exports. The dollar would buy little as we make nothing much in the US except planes, soybeans, oil and software. The yuan will be the only currency that buys whatever China makes, which is pretty much everything else.
The Fed will faced with two choices, 1) print more currency and watch the dollar collapse even further 2) tighten monetary policy by selling treasuries and watch treasury prices fall and yields rise.
Effect of 1 would be even more inflation and effect of 2 will be soaring interest rates. The Fed, will find out, like a cat climbing a tree, its easier to go in one direction than retrace its steps. It far more difficult to tighten monetary policy than ease it.
The dollar right now has value until China decides it has. When China depegs the yuan, the US would have hit its credit limit and printing more IOUs in the form of dollars will be worthless.
When the yuan soars, in nominal terms, the Chinese economy will be several times the size of the US, as it probably already is, in real PPP terms. China will be the biggest economy in the world and we will have a new reserve currency called the yuan and the decline of the US into a second rate economy will complete with Powell acting as the facilitator.
Note: For the consequences of depegging to the hit the US, China doesn't even have to let the yuan appreciate to 2 yuan to the dollar. Just even 5 yuan to the dollar would pretty much result in soaring inflation. And if China wanted, they can crush the dollar even further by selling treasuries (raising interest rates, unless the Fed buys them by printing even more dollars) and selling the dollars received for the treasuries to buy yuan, weakening the dollar and strengthening the yuan.
The US is like the "big gun navy" of World War II, unable to comprehend a paradigm shift to air power had happened. A paradigm shift by China from "weak currency" to "strong currency" would crush the US economy in a flash.
and the article:
Lessons From History: 1929