NEW YORK (TheStreet) -- During the past year, the U.S. dollar has appreciated more than 18%, and last week, China surprised investors and traders by allowing its currency to depreciate almost 3% against the dollar, thoroughly roiling equity markets.
The People's Bank of China had typically pegged the value of the yuan to the dollar. Last August, it took 6.15 yuan to purchase $1, and last Tuesday, it took 6.21 yuan. Thus, by pegging to the dollar, China's currency was appreciating almost as fast as the dollar was.
It showed up in China's exports. July's exports were 8.3% lower than a year earlier, and they fell a whopping 4.9% between June and July, and so one can't really blame the Chinese for allowing their currency to depreciate against the dollar and put their exports back into price contention.
In addition, China has wanted its currency to be accepted internationally. After all, it has the second-largest economy in the world, and it soon will be the largest. One step in that process was to have the yuan placed as a reserve currency by International Monetary Fund. But earlier this month, China was rebuffed by the IMF, which indicated that the country's wasn't allowing market forces to set the currency's value.
So the nearly 3% depreciation last week accomplished two things: It made China's exports more competitive, and it catered to the desires of the IMF.
The reality here is that the world is still in a deflationary mode, and currency wars have erupted as economies fight for the limited demand for industrial exports.
What is really strange, however, is that over the past year the U.S. has refused to defend its export market share, as the U.S. government has taken no official policy position on the value of its currency.
In effect, the rapid 18% rise in the dollar's value has left the U.S. business sector -- and more specifically, the industrial sector -- to bear much of the brunt of the worldwide adjustment to slow global economic growth. Because of the rising value of the dollar, American industrial companies have lost a huge percentage of the export pie.
Under these conditions, the thought of the Federal Reserve actually raising interest rates appears to be, for lack of a better term, insane. The Bank of Canada raised interest rates three times in the post-recession period, only to unwind two of those this year as the country's export-oriented economy has ground to a near standstill in a stagnant world.
If the Fed's oncoming rate hike is truly data dependent, as Chair Janet Yellen has insisted, then there should be no rate hike in September, as the labor market seems to be the only area of real strength. Yet, even with the apparently strong labor market, wages aren't rising.
It could be that the rising value of the dollar has put downward pressure on wages, especially in export-oriented industries such as manufacturing. All other things being equal, the export sales will go to the country with the weaker currency. The only way for the industries in the country with the stronger currency to compete is to lower their prices, which squeezes profit margins.
As a result, either the jobs migrate to the countries with the weaker currencies, or if the exporters in the country with the strong currency lower prices to compete, they squeeze their margins and keep a lid on wages.
Going back to the Fed's data dependency, the central bank's preferred inflation gauge, the personal consumption expenditure price index, hasn't been rising and is sitting at a year-over-year growth rate of 1.3%, which is far below the Fed's state objective of 2%.
Furthermore, incoming data still show at least a 2% gap between potential and real gross domestic product, and U.S. fiscal policy has been tightening dramatically, as the deficit/GDP ratio has fallen to about 4.5% this year (it's projected to fall further) from almost 13% in 2009 and more than 9% as recently as 2012.
Finally, the increase in the value of the dollar itself, according to Wall Street economist David Rosenberg, is equivalent to 200 basis point (2 percentage points) rise in interest rates. So, significant monetary tightening has already occurred.
In conclusion, if the Fed is truly data dependent, it won't raise rates in September. But Fed officials have been talking about a hike since the taper tantrum of 2012, and they have hinted that the rate increase would occur in the second half of this year.
Unfortunately, an increase in rates will further strengthen the dollar and place an even greater burden on U.S. industrial exporters. It is a good thing that the industrial economy represents only 12%-13% of GDP.
So, while the service economy may continue to expand enough to keep U.S. economic growth between 2% and 3%, the industrial portion of the economy will continue in its current funk, at best, and could possibly fall into recession.