U.S. government officials continue to pressure China to de-link its currency (the yuan) from the U.S. dollar. These actions are potentially destabilizing for the world economy, and are rooted in discredited economic theory.
Those who advocate floating the yuan argue that the presently fixed yuan/dollar rate keeps the former “cheap” relative to the latter. It is assumed that floating the yuan would cause it to strengthen versus the dollar, and in the process would correct a growing trade imbalance between the U.S. and China.
The above consensus is summed up by the Wall Street Journal’s Michael M. Phillips, who says a weak dollar will give “beleaguered American manufacturers a price advantage over companies elsewhere.” With China a growing trading partner of the U.S., it is thought that letting the yuan float upward will enable American manufacturers to “compete” more effectively.
All of this might sound good in theory, but in practice the thinking is full of holes. Even if currency devaluation were all that it’s cracked up to be, China’s cost advantages are such that its manufacturers would still in most cases be able to outperform U.S. manufacturers.
Economist Donald Luskin, NRO Financial columnist and chief investment strategist for Trend Macrolytics, has pointed out that the average cost per day to employ an American factory worker is $135. In China, the cost is $135 per month. In short, no yuan revaluation or dollar devaluation will alter the fact that Chinese manufacturers have enormous cost advantages over those in the U.S.
Assuming China did float the yuan, it is not a certainty that it would rise against the dollar. Economist David Ranson, president of H.C. Wainwright Economics, wrote that breaking the yuan/dollar link would deprive “the Chinese monetary system of the limited credibility it enjoys as a result of its currency peg.” Noted supply-side economist Arthur Laffer has said much the same, noting that absent its relationship with the dollar, “the yuan is not worth the paper it is printed on.”
Up or down, the direction of the yuan will not likely impact the trade deficit between the U.S. and China. If the experience with Japan (the “China” of the 1980s) is at all relevant, a rising yuan will actually bring about a larger trade deficit with the U.S. Indeed, the dollar fell substantially versus the yen in the post-Bretton Woods era (from 360/USD to 78/USD in the late 1970s), but the U.S. trade deficit with Japan still climbed.
Assuming Treasury Secretary John Snow is right, and that the yuan strengthens relative to the dollar, who wins then? There’s no evidence our trade imbalance with China will fall. There also exists in the short-term the possibility that American consumers will have to pay more for the imported goods they presently buy from China.
While China’s economy is still only as large as Italy’s, worldwide expectations are that it has the potential to grow exponentially in the coming decades. Returning to Ranson’s comment, China’s credibility, as in its ability to attract foreign investment, has a lot to do with the yuan’s tight relationship with the dollar.
A falling yuan would not just harm China, but similar to the Asian crises of ‘97 and ‘98, it would have worldwide repercussions. U.S. manufacturers claim to be hurting; would they be better off if China were struggling under a crashing yuan and theoretically even more willing to ship their goods around the world at bargain prices?
As the number-one exporter in the world, how is the U.S. helped by actions that will potentially destabilize countries that it exports to? Furthermore, didn’t the ’70s teach us the perils of a weak dollar? And how is agitating for a stronger yuan different from U.S. officials explicitly stating that they’d like to see a weaker dollar? The dollar fell against major world currencies throughout the ’70s. The result was rampant inflation and high unemployment — not prosperity.
The solution the to the yuan/dollar problem is not revaluation, but a reassessment of the value of trade. Trade is unambiguously good for the U.S. and world economy, and to the extent that Chinese manufacturers flood our markets with cheap goods, they are helping to strengthen, not weaken, our economy.
For the above to make sense, it has to be remembered that trade is decidedly not war. Just as it is with individuals, when countries exchange with each other, they exchange what they do best in return for what they do least well. As Bastiat wrote, “In war, the stronger overcomes the weaker. In business, the stronger imparts strength to the weaker.”
Maintenance of the yuan/dollar link is the best way to insure that trade between China and the United States is based on market-based strengths and weaknesses, not short-term (and illusory) currency manipulations controlled by central banks. A stable currency relationship will insure that China and the U.S. trade with each other in the most honest way possible. Countries that have vibrant trading relationships also tend to not invade each other. Don’t float the yuan.
–John Tamny is a writer in Washington, D.C. He can be contacted at firstname.lastname@example.org.