The Chinese yuan has been the subject of many debates over the last year or so. Treasury Secretary Tim Geithner and President Obama have made a conscience effort to frame the yuan as undervalued and persuade the Chinese to let it rise. The logic is that with an artificially undervalued currency, the Chinese have unfairly exported more goods, as those goods become relatively cheaper for countries abroad. The trade imbalance between China and the US has been advertised as an injustice. All of this, in turn, makes it more difficult for the manufacturing sector in America to compete with China. As the redneck citizens of South Park would say: “They took our JOBS!”
Let’s see if we can untangle this thesis. First, some background:
The Chinese pegged the yuan to the US dollar from 1997 to 2005 at 8.27 yuan per USD. The Chinese attempted to slowly let the currency rise to help curb inflationary pressures between 2005 and 2008. When the financial crisis hit, the peg was unofficially reinstituted. The Chinese central bank announced last June that they would allow greater flexibility for the yuan to appreciate against the dollar. Some believe this was partially just to get world leaders off their back, however, they do have inflation and asset bubbles to worry about with double digit growth rates.
Since lifting the fixed exchange rate in June, the Chinese yuan has appreciated. It traded at 6.59 yuan per USD as of today.
Now, it’s sort of fun to see President Obama call for “market-determined exchange rates” as being “essential to global economic vitality.” Allowing the market to determine prices is generally not something the US government has been so keen on. Does the rise in the yuan since the managed float was instituted indicate that the foreign exchange market saw the currency as undervalued? Or does it simply reflect the monetary policies of China’s central bank? The key phrase in there is “managed float.” Monetary policy is still pulling the strings here. The central bank is keeping the value of the currency within a desired band. Market valuations only offer meaningful insight when currency is freely traded without central banks intervening. And if the yuan is undervalued as US financial leaders insist, so is the dollar because of Fed policies.
To say that an undervalued yuan hurts us is like saying it’s bad for our economy to get cheap goods. Higher real incomes should be celebrated and an understanding of international trade will tell you that there’s nothing wrong with sending corn from Iowa to Asia for cars and electronics.
As for the trade imbalance, what would be weird is if every country in the world imported as much as they exported from every other country. That is, they were “balanced.” That would require manipulation. Trade deficits are not financial deficits. When America runs a global current account deficit, that means other countries are investing that deficit in American assets. We have a corresponding capital account surplus, which is a net inflow of capital into America. That doesn’t sound quite so disastrous.
To further illustrate, you don’t see state governments grandstanding about trade imbalances with other states (as fun as it would be to see a standoff between Louisiana’s sugarcane and Idaho’s potato trade imbalance). Trade is about exporting what you have comparative and absolute advantages in. Imbalances are to be expected.
FAIR WARNING: As we saw during Super Bowl XLV, Detroit is primed to up their trade game, and unfortunately, potential imbalances here and abroad: