Is Revaluation of the Yuan the Only Answer?

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Global Trade, Macroeconomics

An interesting article in the New York Times is worth reviewing because the topic is a hot issue on Capitol Hill yet the debate is far too often argued as if there is only one answer without discussion of any other solutions.

I talk of course of currency manipulation in general and the Chinese authorities control of the Yuan or Renminbi in particular.

As this graph courtesy of msn money shows, the Yuan has been fixed with just one period of gradual appreciation over the last decade. Consequently as the dollar has weakened, China has remained competitive in the US market and the two countries balance of trade deficit has widened. Congress has resisted repeated calls for action to force the Chinese to allow the currency to float to a more “normal level opinions vary on where that point would be but most agree if the controls were removed the exchange rate would be significantly higher than it is.

The question the NY Times raises is whether allowing the yuan to float would actually have any impact on the trade deficit. Common sense (and most of the arguments) says of course it would but history suggests otherwise. The paper takes the example of Japan in the early 1970’s. Germany and Japan were going through rapid export led growth building up significant trade deficits with the US. The Yen was fixed at 360 to the dollar during August 1971. Following imposition of import tariffs and banning exports to Japan of certain foodstuffs the Japanese (and nine other countries) removed currency controls. Within a month the Yen was at 315, but rather than shrink the trade deficit continued to grow. At the end of 1970 it stood at $1.2 billion; by the end of 1972, with the yen at 302 to the dollar, it was $4.1 billion.

By 2006 the yen stood at 119 to the dollar ” more than three times as expensive as in 1971 ” and yet the deficit hit an all-time high of $90 billion. The Japanese just became more efficient and continued to compete; arguably China could do the same. Much of China’s early advantage has been built on cheap labor and lax labor laws, greater mechanization while requiring capital would readily increase efficiency as it did in Japan.

Without delving any further into the likely results of a revaluation the report offers two solutions, which in the opinion of the author offers a better long-term solution to reducing the trade imbalance. The first is to boost US exports, if necessary with government help although in what form is not explained. Our view is if exports were that easy to boost the US would be doing it. The reality is exports are a function of long term trends such as the product mix manufactured by a country, wage rates and productivity Germany for example is a major exporter but slewed heavily towards manufacturing particularly automobiles, machinery, metals, and chemical goods. It has taken Germany the best part of 50 years to reach that position of pre-eminence in those sectors. It isn’t a tap that can be turned on with government subsidy.

The second solution is to encourage the Chinese it recycle all those dollars amassed selling goods to US consumers by setting up manufacturing operations in the US. This idea has more merit. To get around import tariffs, the Japanese invested heavily in manufacturing in the US in the 80’s and 90’s. While some domestic manufacturers may argue with the report’s author that, “This was a boon for the American economy it certainly did spur innovation and regeneration among domestic producers and in the process Japan invested almost $260 billion, supporting more than 600,000 US jobs. The US enjoys better cars, better white goods and generally better manufacturing working practices as a result of Japanese investment.

One problem the authors did not address however is that in dealing with Chinese businesses we are invariably dealing with the Chinese state. There are some industries and some technologies that we may not want to openly invite a country like China to invest in too readily. The same fears were raised in the 80’s about Japan as are voiced today about China but Japan shared our views on human rights, democracy, freedom of speech, intellectual property rights and so on whereas today, China remains diametrically opposed from us on so many of these issues. However, the country is, in its own way moving gradually in the right direction, greater cooperation and mutual investment would hasten that process providing that it was not a one way street.

–Stuart Burns

Comment (1)

  1. AverageOne says:

    Oh, the Chinese think open markets are good, huh? Well, they should. Because we have allowed them to hock their schlock over here with minimal tariffs, they have grown fat. What is good for the goose is good for the gander. They have had enough catch-up time. Until they open their markets to us in a genuine manner, and/or stop pegging the yuan, there is no good reason we should not fire a warning shot across their bow, and levy some tariffs on a few types of goods they export to our shores. The alternative is economic suicide.

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