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Why Chinese currency manipulation is good for America

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coaster
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Why Chinese currency manipulation is good for America  Reply with quote  

The mainstream – press, business and political – wants the Chinese government to revalue their currency upward. Their main arguments are 1) the Chinese government is manipulating their currency to keep it at an artificially low level. This is true. And 2) the artificially low level of the Chinese currency makes their products artificially cheaper than they should be. This is also true. They say that the result of this is that Chinese products have an unfair competitive advantage in world marketplaces. This is also true. But there’s more to this story that isn’t being told, and why the obvious conclusion of requiring the Chinese government to revalue their currency upward to a fairer level is not the correct conclusion for either America or for China; that revaluing their currency upward will result in great pain for both countries and indeed the world; that the Chinese government mostly likely knows this and so is attempting to prevent the dire consequences; that the politicians in the U.S. either are ignorant of the consequences, or are cynically using popular but incorrect notions to further their political aims, regardless of the consequences for China and for America.

To understand this, it’s necessary for a brief review of how foreign currency exchange rates work. In the first place it should be noted that there isn’t a national currency in the world today that is actually backed by some tangible asset that has an intrinsic value. These are called “fiat” currencies. One definition of fiat is a “command that creates.” Or in other words, the government declares this is money and therefore it is. On U.S. currency it says, “This note is legal tender for all debts public and private.” So the value of one national currency with respect to any other national currency depends largely on the perception of the value of that currency, not to any intrinsic value. And to the expectation that currency will retain it’s perceived value over time. The value that currency is given depends on many factors: political and economic stability, economic and monetary policies of the government, interest rates, opportunity for gains on assets the currency can purchase; ease of doing business transactions, amount of currency in circulation, and others. If any of these factors are seen as negatives, then that currency becomes more risky to hold and to use and so its perceived value falls relative to other currencies that may be perceived to be more secure and have fewer negatives.

And so the values of currencies are generally allowed to “float.” The value of one currency in terms of another currency changes daily. For example, if the value of the dollar “falls” with respect to the Euro, then it takes more dollars to buy a Euro, and fewer Euros to buy a dollar. As an example, today $1.00 = €0.75; and €1.00 = $1.35 (approximately.) If the dollar falls then perhaps $1.00 = €0.70 and €1.00 = $1.43. Foreign exchange market forces cause the relationships between two currencies to change daily, depending on whether foreign currency holders want more of a particular currency and their buying drives the value of that currency up, or they want less of that currency and their selling drives the value of that currency down.

However, some countries “peg” the value of their currency to that of another currency. The U.S. Dollar has long been considered a “world” currency, mostly because most of the factors that influence the value of a currency are considered to be positives. The stability of the U.S. government, etc. etc. The Chinese government has been pegging the value of their currency to that of the U.S. Dollar at a fixed exchange rate. Well, if foreign exchange markets cause the values of currencies to fluctuate, how can a country peg their currency to the value of another currency? Simple – that government itself is involved in the foreign exchange markets to buy and to sell its currency and the pegged currency in order to maintain the desired exchange rate. So if the Chinese yuan is perceived to be more valuable – and it would be because of the expansion of the Chinese economy and foreign investors and businesses need yuan to purchase assets and goods in China, and so they buy yuan in exchange for their own currencies -- then the Chinese government has to sell enough yuan and buy enough dollars to keep the relative values of the dollar and the yuan at the desired “pegged” relationship.

So, for the first contention “The Chinese government is manipulating their currency to keep it at an artificially low level” – yes, of course, that’s the way the peg works. The U.S. government and the political and economic establishment isn’t asking the Chinese government to stop manipulating their currency, they’re asking them to change the fixed exchange rate by altering their buying and selling patterns so that the yuan becomes more valuable against the dollar. In other words, so it will take more dollars to buy yuan, and fewer yuan to buy dollars. What this is expected to accomplish as put forth by its proponents, and what it will actually accomplish is what we get into next. But the above relationship bears repeating: what they want is for it to take more dollars to buy yuan.

Now that that’s clear let’s look first at the “why” and then at the consequences. Why does the Chinese government want to peg the yuan at an artificially low rate? The contention is that doing so makes Chinese produced goods cheaper and gives them a competitive advantage in the world marketplace. Of course that’s true. Anytime anything can be sold for less it gives it a competitive advantage. Is gaining a competitive advantage for their products the Chinese government’s only concern? I think it’s a concern, but it’s a lesser concern than something else that’s of more important to the Chinese government. That’s the consequences of allowing the Chinese currency to seek its own level.

Consider the great migration of Chinese workers from backward country regions to the modern cities in search of work. There they can find work and earn wages unimaginable back on the farm. The Chinese economy has been expanding rapidly and indeed needs to continue expanding rapidly to accommodate this great worker migration. There is unrest and even violent uprising in the poor regions of the country that aren’t participating in the great economic growth. What would happen if the Chinese yuan were allowed to appreciate? Remember that if the yuan appreciates, it takes more of whatever other currency is used to purchase Chinese products and assets. And it’s a basic rule of economics that increased prices reduce demand. When the Chinese-produced goods cost more in other currencies, the rest of the world will buy less of them. If demand is reduced, the Chinese economy slows down. If the Chinese economy slows down, there are no jobs for these workers that come to the cities looking for work. China had a one baby per family policy in effect for many years, and male children were desired above female children, so China today has a huge male/female imbalance. These young males are migrating to the cities looking for work and hoping to get rich. What will they do if they find there are no jobs for them? Go back to the farm? I think not. Can you imagine the civil unrest that would result? The turmoil might even be severe enough to damage the current Chinese government and the basic structure of the Chinese society. I cannot imagine any government knowingly acceding to something that might result in its downfall. Not to mention the pain, anguish, and perhaps bloody unrest of the population.

The Chinese government needs to keep the economy growing in order to avoid open rebellion, and to keep the economy growing they need to peg the yuan to the dollar at an artificially low rate. It’s not the competitive advantage they’re most concerned with, it’s their very survival.

Now, let’s look at the “why” from the U.S. viewpoint. As the mainstream would have us believe, it’s in our advantage to get the Chinese to allow their currency to appreciate and seek its own level to eliminate the competitive advantage of their products in the marketplace. Why they’re maintaining this position is obvious: it’s good public relations, it’s good political advantage, it sounds pro-American. But it cynically ignores reality.

Let’s look at the consequences to America if China allows the yuan to appreciate. Have you been to the store lately? Everything is made in China. They say the artificially low yuan gives China a competitive advantage. Competitive against what? Nothing is manufactured here anymore. It’s all manufactured in China. We don’t even have the capability to manufacture many things any more. They say that allowing the yuan to appreciate would make American products more competitive and preserve American jobs. What American products? They’re all made in China.

America is no longer a producing country. America is a consuming country. America’s contribution to the world economy is no longer manufacture, it’s ideas and services. America’s inventive ideas, its research and development, become products that are produced elsewhere in lower-cost countries such as China. Even if the competitive playing field were leveled so that it was fair competition, we no longer have anything to compete with in the way of actual production. And what’s “fair” anyway?

And as far as jobs go, we’re currently at four and a half percent unemployment, which is considered by economists to be full employment. Lower-wage entry-level jobs go begging because there’s no one (except perhaps illegal immigrants) who wants to do them. Allowing the yuan to appreciate would not improve the employment picture in this country. It would not bring back the lost production.

But that’s not yet the entire consequences. What happens if China allows the yuan to appreciate? Recall from earlier that would mean it takes more dollars to buy yuan. Now that everything is produced in China, the costs of production and the final products are denominated in yuan. So to purchase a product, it’s going to take more dollars. More dollars means that everything produced in China is going to be more expensive. This is what they’re missing. What they’re proposing is really going to hurt American consumers, and it’s also going to hurt American workers. More expensive Chinese-produced products, along with higher food prices, higher medical costs, higher gasoline prices, higher everything, is going to cause tremendous inflation. This inflation is going to seriously dampen the consumption of the American consumer, slowing down the economy, and hurting America as well as China. A slower economy will result in higher unemployment, so what they so cynically propose as a plan to help the American worker is actually going to hurt.

So what to make of this? The America economy is on a roll. Unemployment is low. People are able to buy cheap goods produced in China. They’re happy to be able to buy cheap goods. What’s wrong with this? What’s the problem here? If the Chinese government wants to spend their yuan to buy dollars so that American consumers can have cheap Chinese goods, why not allow the Chinese government to continue subsidizing American consumption? What’s good for China – i.e. keeping the yuan low – is also good for America. Low prices mean more disposable income which means more consumption which means a better economy which means more people have jobs which means more people have money to spend. And it’s not only money spent, it’s money saved. When the products they want to buy are cheaply priced, there is more money that can be saved and invested.

Let the status quo stand. The Chinese government is smarter than the American politicians and mainstream who think that the current state of affairs is “unfair.” Unfair to whom? Wouldn’t it be more unfair if the Chinese government caved to these proposals, and it caused massive unrest and economic turmoil in China and a depression and massive inflation in the U.S.? If the Chinese government is happy spending their money to subsidize Chinese products for sale at cheap prices in America, products that have no American produce competition anyway, let’s allow them to continue to do it and get off their case. Let the Chinese spend their yuan; we’ll laugh all the way to the bank.

~Tim~
Post Sun May 27, 2007 10:04 pm
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2006buckeye
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You brought up a ton of good points. I don't fully understand how the Chinese keep their currency pegged, but doesn't it partly have to do with them buying US treasuries? Have we felt (or will we feel) any impact from such activity?
Post Mon Jun 04, 2007 12:20 am
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coaster
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Yes, you're right. Buying US Treasuries takes dollars. So they have to sell yuan in exchange for dollars to buy Treasuries. This is another benefit for the US that I didn't mention because it's kind of a sidebar to the currency manipulation. But they have to do something with all the dollars they're buying, as well as the dollars manufacturers have received for producing goods for US markets that they exchange with the central bank for Chinese currency. Something the Chinese do with all the dollars in their central banks is funding our government debt.

Of course the risk is that they decide to sell their Treasuries. But why should they? They're getting a decent yield; probably the best yield for the least risk of anything they could put their dollars in.

Currently Great Britain is the single largest holder of US Treasuries and related government debt securities.

~Tim~
Post Mon Jun 04, 2007 2:31 am
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carly_hk2000
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This can help the economy of the US and other countries which buy china export
since all the bills are calculated in Yuan, if the Chinese currency manipulation started, this is good for the manufacturing industry in the US and other countries. It is no doubt that the wage of china is much lower that these countries and china can produce goods with a lower cost and offer them a lower price. These countries will buy more good from China, but this hits the manufacturing industry of those countries. The manipulation of chinese currency will lead to the increase in price of her export and the quantity demanded of the export may fall. People in the US and other countries may tend to buy goods from local. Therefore, the manipulation of chinese currency is good for the US and other countries.
However, to someone like me who lives in Hong Kong, this is definitely not a good thing
Post Wed Feb 27, 2008 4:12 pm
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Anol12a
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Thanks Nice sharing .
Post Thu May 03, 2012 1:01 pm
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Sime
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Wow coaster you really pulled all the strings with that post!

Not all countries can afford... a lavish monarchy.
Post Thu May 03, 2012 3:19 pm
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coaster
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Ummm, Simon, that's five years old. Wink

~Tim~
Post Thu May 03, 2012 3:27 pm
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Sime
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Ah well. Can't read everything I guess. Laughing

Not all countries can afford... a lavish monarchy.
Post Sun May 06, 2012 5:16 pm
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