Last Tuesday’s Treasury Department report on the Chinese yuan made some conclusions about the currency that could be charitably described as “stage one.” Thomas Sowell coined the latter phrase, and it refers to thinking that does not look past the most basic assumptions about the impact of public policy.
While the report did not specifically designate China as a country “which manipulates the rate of exchange,” it was fairly explicit in saying China’s failure to revalue the yuan upward, or, failure to “float” its currency, would potentially lead to the above designation. Future reports could precisely state that China manipulates the yuan to gain “unfair competitive advantage in international trade.” The Treasury Department’s assertions are facile, and for the department’s ability to destabilize the world economy, potentially very dangerous.
Stage-one thinking about the yuan says that if it rises versus the dollar, Chinese exports to the U.S. will become more expensive and U.S. exports to China less so. The unseen second stage that’s apparently being ignored by Treasury is that material imports are the major cost-factor for Chinese goods. If the yuan strengthens, China’s material costs will drop. Wages are a smaller component of the cost of Chinese goods, but a stronger yuan will give Chinese workers a real rise in income, and could potentially lead to lower nominal wages as they adjust to the revalued unit of account.
Returning to stage one, Chinese exports to the U.S. rose to over $210 billion in 2004 alone. If all works out as planned and Chinese goods become more expensive, Treasury will explicitly force price-hikes on the great mass of American consumers. That in itself should be bothersome, but it gets worse once the stage-two implications of such an act are considered.
While Treasury Secretary John Snow and senators Schumer and Graham are the public faces behind this attempt to make Chinese goods more expensive, it’s easy to assume that a small number of industry groups are forcing their pleas. Stage-two thinking makes clear what they’re not seeing: To the extent that consumers are forced to pay more for Chinese imports, it can only be concluded that they’ll have less money to purchase other products, including those made in the U.S. Has Snow or anyone in Congress bothered to consider the impact of more-expensive imports on the industries that lack political clout?
Some might say that any harm brought on less politically connected U.S. business sectors will be made up for by companies allegedly made more competitive by attempts to weaken China. But these people will have not thought through to stage three: China does import U.S. goods — over $34 billion in 2004. A weakened China will necessarily import less.
Snow has stated on a regular basis that currencies should be “set in open markets.” What he fails to see is that no currency, not even the U.S. dollar, is set by markets in the way he assumes. The late Robert Bartley said as much in a 2003 Wall Street Journal column: “each central bank has a monopoly on the currency it issues, and uses this monopoly to dictate the price. . . .” That markets respond to the central bank monopoly does not mean free markets set currency prices in any sense at all.
Worse, Snow’s unwillingness to move beyond stage one presumably makes it hard for him to see the track record of floating currencies. Bartley said floating currencies represent “an absence of policy,” and with good reason. Was the U.S. better off in the 1970s after the dollar was allowed to float? While the Greenspan Fed should be credited for its use of a dollar price rule in the first half of the 1990s, were South Korea, Thailand, and Malaysia (to name a few countries) better off when a rising dollar helped force them off their dollar-pegs towards the end of the decade?
Decidedly not. In fact, amidst the Asian economic crisis the major fear was that China would follow the lead of the aforementioned countries and make a bad situation worse. Short-term thinking plagues the present attempt to remove the yuan from its dollar peg, and seemingly none of it is asking what happens if the yuan implodes once “freed” from the credibility brought to it by the U.S. dollar.
We have a good sense of all the negatives that would result from a more expensive yuan, or even a floating yuan. The unknown is what will result if China’s currency goes into freefall. But it’s probably safe to say that anything that destabilizes the economy of the world’s most populous nation would be pretty disastrous, with the damage reaching well beyond China. Since John Snow apparently hasn’t thought to this stage, it can only be hoped that more seasoned money experts clue him in to the dangerous game he’s playing with the world economy.
–John Tamny is a writer in Washington, D.C. He can be contacted at firstname.lastname@example.org.