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Trade

Is Chinese Currency Manipulation a Bad Thing?

One of the most striking features of the last two Presidential Debates was the rather strident, bipartisan China-bashing. While it’s relatively easy (and quite popular) to bash the Yellow Man for his purported economic misdeeds, I think the topic requires thoughtful consideration and a little more attention than either candidate appears to be giving it.

Currency manipulation came up a lot in the debate. Apparently, the Chinese are deliberately under-valuing their currency (shocking, I know). First, I think it’s useful to gain a basic understanding of how the Chinese yuan operates. For the last 20 years or so (the exact date eludes me), the Chinese government has maintained what is known as a “peg” on the US Dollar. So, as the dollar appreciates in value (becomes “stronger”), so does the yuan. As the dollar depreciates (“weakens”), the yuan also depreciates. This ensures a fixed exchange rate between the yuan and the dollar and theoretically eliminates some of the currency risk between the US and China. So, if an American wants to invest in China (or a Chinese in America), he can be reasonably sure that the value of his currency holdings won’t change over time and, in theory, this makes it easier to conduct business in both countries. This is in contrast to something like the Euro, which maintains a floating exchange rate. So, the value of the Euro via the Dollar changes daily. The Chinese government sets the value of the peg (currently set at about 6.3 yuan to the Dollar) and actively trades in the currency markets to maintain that value. Every now and then the government may opt to change the spot of the peg (they are currently allowing for some appreciation), but this is the only time you see any real change in the value of the yuan. Pegs are nothing new and nothing unique to Communist governments. The US Dollar was pegged to gold until Nixon severed the peg in the 1970’s. So, that’s how the yuan works.

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The yuan is generally believed to be valued at about 20% less than what it would be were the government to allow the value to float. This is the heart of the currency manipulation concerns. So, what does this mean? All else being equal, something priced in yuan whould be cheaper than something priced in dollars. But of course, everything else isn’t equal. People like to claim that China’s economic competitiveness is due largely to its intervention in the currency markets. However, there are other domestic factors that make China a hot-bed for manufacturing and industrial growth. One of the largest is labor costs. A recent report by the Bureau of Labor Statistics indicates that when compared to the United States, labor costs in China are 97% lower. In other words, if an employer pays an American $10/hour to do a job (make iPhones or something), he can pay a Chinese worker $0.30/hour to do the same job. Clearly, the employer is going to produce his goods in China. With such extreme differences in labor costs, a little currency manipulation isn’t going to change the equation much. There are other factors that make China a desirable place for businesses to set up shop (i.e. its rather lax attitude towards regulation and enforcement among others), but I think labor costs are key. With such low labor costs, even if the yuan traded at a “fair” valuation, China would still be the cheaper place to do business.

This then raises the question, what is the effect of the manipulation of the yuan on the average consumer? The answer is that the consumer gets a discount every time he walks into Wal-Mart, courtesy of the People’s Republic. So, on the consumer side, he can buy more things (things made in China, that is) for less money. Not too much to complain about there. Labor, of course, will complain about Chinese price advantages driving jobs overseas, but the fact of the matter is that those jobs were probably headed overseas anyway. Technically, I suppose this is a form of government welfare, with the PRC indirectly subsidizing American purchases of Chinese products. Conservatives generally take issue with any form of government subsidy, but is it really my place to complain if a foreign government wants to give me a subsidy? Really, instead of getting all over China for undervaluing their currency, we should be thanking them.

It looks impressive until you realize she’s only holding about $150.

Let’s also not pass over the sheer hypocrisy of the China-bashers. When the Chairman of the Federal Reserve is promising to pump $85 billion per month into the money supply indefinitely (thereby devaluing the dollar), it’s a little brazen for the federal government to get its nose out of joint over China’s effectively doing the same thing. Indeed, while the yuan has appreciated about 24% against the dollar since 2005, the Federal Reserve has spent the last four years printing off as many dollars as they can. The peg will help mitigate some of the effect of this unprecedented currency-printing on trade between the US and China, but for other American trading partners (Europe, for instance), the FED is effectively slashing the value of the dollar.

So, Chinese manipulation of the yuan isn’t quite so bad as people make it out to be. In all likelihood, it works out to be a kind of economic “stimulus” (if I may dare to use the word). It makes Chinese products a little bit cheaper, which allows consumers and businesses to buy more goods for less money. While there are some legitimate concerns about job losses, such concerns are overblown in light of China’s sharply lower labor costs and the FED’s Quantitative Easing program (look up Competitive Devaluation). There are some areas of legitimate concern in Sino-American relations. Threatening China with a trade war over its currency manipulation is a little ridiculous.