Yuan Manipulation: The Wrong Course
By Kudlow Money Politic$
The Chinese Communists partially capitulated to U.S. Congressional China-bashing protectionists and to U.S. Treasury monetarists in search of an impossible quick fix that somehow would narrow the bilateral Sino-American trade gap and provide more jobs for American manufacturers.
It is a poor deal, replete with bad thinking that very well could damage the economies of both nations. The People’s Bank of China announced a small currency revaluation whereby the yuan would rise to 8.11 dollars from 8.28 dollars. Henceforth, the daily trading price of the yuan against the U.S. dollar will now float within a trading band of plus or minus 0.3 percent.
Additionally, the value of the yuan will be referenced to an as yet undisclosed market basket of currencies. This last point could mean a stable yuan value in relation to the currency basket, but the potential pitfalls of this so-called managed floating exchange rate regime are sizable.
Remember when the U.S. dollar was taken off the Bretton Woods gold-dollar exchange system in the early 1970s. This led to over a decade of hyperinflation and high unemployment. Remember also when Argentina was forced by American pressure to terminate its dollar-based currency board system in the mid-1990s that ended an era of rapid Argentine economic recovery.
It’s hard to understand the charge of currency manipulation aimed at China when for over ten years they stabilized their shaky currency with a disciplined link to the dollar. During that period China growth soared and inflation collapsed. In fact, it appears that it was the U.S. dollar that was heavily manipulated with a near 50 percent appreciation between 1994 and 2001, and then a near 30 percent depreciation between 2001 and 2004.
Looking for currency confidence to attract foreign investment inflows to rebuild their economy, it was the Chinese who maintained stable dollar value even while the greenback embarked on a Coney Island-like roller coaster. As for the monetarists at the Treasury who insist that floating exchange rates are necessary for free market economic reform, they forget our nation’s own history where for the better part of 200 years the free market American economy became the most powerful in the world with dollar stability linked to gold.
The same was true for Britain from the early 19th century to the early 20th century. Today in Europe the idea was to link the original twelve nations of the European Union in a free trade zone anchored by a stable euro currency value. In the United States we have always had a free trade zone among the individual states linked by a fixed exchange rate common currency whether or not New York runs trade deficits with Mississippi or surpluses with South Carolina.
Senators Smoot Schumer and Hawley Graham are willing to risk a potentially depression-causing trade war with China with a 27.5 percent tariff on Chinese imports, the biggest tariff proposal since the early 1930s. Apart from the obvious threat of Chinese retaliation that could stop commerce and growth dead in their tracks in both countries, a recent study from the Asian Development Bank reports that a 10 percent or 20 percent yuan revaluation against the dollar would slow the Chinese economy and provide a boost to rival Asian exporters.
But neither scenario would tackle the problems Washington has targeted, namely the ballooning U.S. current account deficit and China’s significant contribution to it. Of course, no one ever mentions that U.S. exports to China have more than doubled since 2000 as Beijing has liberalized its trading rules during its move into the World Trade Organization.
Another interesting point if that over half of all Chinese exports to the U.S. are goods and services produced by American multi-national companies that operate large production facilities in China. These exports to the U.S., even though they are produced by American companies operating in China, are counted as part of the trade deficit, just like products from home-grown Chinese companies.
A number of perverse consequences could also stem from China’s currency shift. For example, if the yuan is pegged to a currency basket, but the greenback continues to rise this year as it has already by 10 percent on the strength of its investment-led recovery, then the China currency could actually depreciate relative to the dollar rather than appreciate.
Then again, if China exceeds to the 20 percent or more revaluation demands of the Congress and Treasury, U.S. inflation and interest rates (including mortgage rates) might rise significantly with great damage to capital investment and housing. Up to now, Wal-Mart and Target shoppers have been quite happy to purchase quality Chinese goods at low prices. But a 20 percent price hike in Chinese goods will damage consumer spending and erode household living standards.
On the China side, a major revaluation would slow their entire economy including their purchases of American technology, machinery, commodities, and capital goods thereby damaging our economy as well. Then, too, what goes up can come down. Creating China currency instability could just as easily lead to a large fall in the yuan’s value as Chinese savers switch to gold, dollars, or Japanese yen and foreign investment inflows consequently dry up.
Indeed, the whole economic history of currency instability, whether in the name of floating exchange rates or the false hope of manufacturing protectionism is a sorry tale. That is why the new manipulation of the Chinese yuan puts U.S.-China monetary relations on the wrong course. |
