16 November 2010

Will A Stronger Yuan Not Benefit The U.S.?

Not everyone agrees that China's huge current account surplus with the U.S. this year supports the contention that China has been manipulating its currency, destroying jobs or limiting growth in the U.S.

China's trade surplus is due to its investing in the U.S.

China's trade surplus has led to its huge accumulation of foreign reserves, much of which it invests in U.S. government and other securities and commercial assets in the U.S.  These investments did not lead to China's trade surplus; instead, they resulted from it.

By investing its current account surplus in the U.S., China provides capital to American companies.  Does the U.S. prefer China to invest its current account surplus in Iran instead?

Americans have not been saving enough and American companies have not been investing enough, and China's investments in the U.S. have helped meet this savings deficit.  But the U.S. (or almost any other country, for that matter) would prefer to stand on its two feet, rather than having to rely on a Chinese crutch, especially if its current predicament is viewed as having stemmed at least partly from a very undervalued yuan.

The U.S. wants to increase its exports to, and lower its trade deficit with, China.  This will drive the U.S. economy, and in turn reduce its dependence on investments from China.

Getting the Chinese to make the yuan more expensive against the U.S. dollar will not make Chinese exports more expensive to American consumers.  This is because the cost of production (in yuan) will fall as the supply of yuan falls when the government engineers a yuan appreciation.

While the cost of imports (in yuan) will fall as the yuan appreciates, the cost of domestic production inputs (such as the wages of Chinese workers) will not fall unless there is a severe and prolonged recession or deflation in China.  A 20 per cent appreciation of the yuan will not result in a 20 per cent reduction in the domestic cost of production in China.

Revaluing the yuan will not solve the U.S.'s problems

The current cheap yuan contributes to, and exacerbates, the problems faced by the U.S.  If the Chinese government does not believe this, it would not have expressed concerns about the adverse impact of an appreciation of the yuan to a more realistic level on the Chinese economy.  It knows how a stronger yuan can hurt China.

The yuan may or may not be "manipulated", but the yuan exchange rate is clearly determined and guided by the Chinese government, rather than free market forces.

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