26 October 2009 Posted on BlackState 26 October 2009
Back in the 1970s and 1980s, one of the dominant theories for economic development in the Third World centered around currency devaluation or depreciation. When a country devalues its currency vis-à-vis another currency or currencies, its exports become less expensive to other countries, while imports from other countries become more expensive to its population. In effect, a currency devaluation is simultaneously an import tariff and an export subsidy. As a tariff, it raises prices on imports; as a subsidy, it lowers the costs of exports. We understand all of this using the language of exchange rate.
Assume, for example, that the US dollar ($ or USD) currently has an exchange rate of $1 to the euro (€). In other words, for €1, you need $1; it’s a one-to-one exchange rate. Your $100 is €100 in the EU countries that use the euro. If the $ depreciates or devalues vis-à-vis the €, then it means that it takes more dollars to buy a €. Thus, the exchange rate might change to $1.50 per €. Your $100 becomes about €67. If you had U.S. dollars and been to Europe recently, you quickly noticed the impact of the exchange rate between the $ and the €. Everything was very expensive for you in Europe. I bet that you’re now thinking twice or three times before buying anything from these EU countries. That is the same logic countries use when they manipulate their currencies to make them less expensive vis-à-vis other currencies. This has been China’s practice for years. How does this type of currency manipulation give China an advantage over the U.S. with respect to trade?
The value of a currency is determined by market forces based on the strength of the country’s economy. Countries that trade with each other want a system in which each currency is allowed to float in the open market. In other words, the value of the currency ought not to be controlled by the government or any other authority. China has not allowed its currency, the renminbi or yuan (CNY), to float. In 1994, China fixed (or pegged) the exchange rate (or value) of its currency to the U.S. dollar. In 2005, after considerable pressure from Mr. Henry Paulson, then Secretary of the Treasury, China moved its peg from the U.S. dollar to a basket of foreign currencies. The change resulted in a brief and meager 2 percent appreciation of the renminbi against the dollar. The fixed exchange rate (6.8 CNY per $1 or 1 CNY = 0.146 USD) is good for China because it creates stability for Chinese manufacturers/exporters, and it helps to control inflation. More important, however, is that it helps to keep Chinese exports cheap, which gives China a significant advantage in international trade. Let’s look at an example.
Assume that Thomas Smith is an American and owns a business that makes television sets in North Carolina, U.S. Likewise, Lun Hsiu, a Chinese, owns a business in Guandong, China that makes television sets. Both businesses have the same number of employees and use similar components to build a television set. The fact that the value of the Chinese reminbi is artificially set to the dollar or other currencies means that Smith’s costs to buy needed components and paying employees would be much higher than those of Hsiu. Of course, there are other reasons. So, in order for Smith to make a profit, say, he sets the price of his television at $600. If he sold it at that price, he would make, say, $30 profit. Hsiu, on the other hand, can afford to set her price at $475 and still make the same profit margin as that of Smith. A consumer (Chinese or American) who is in the marketplace looking for a television set is more likely to buy the Chinese one because it’s cheaper. For an American, who can get almost 7 CNY for every 1USD, a Chinese product will always be cheaper than one made in the U.S. On the other hand, for a Chinese who needs to cough up almost 7 CNY to equal 1USD, a U.S. made product is likely to be way too expensive for her. She, too, is more likely to buy a Chinese made product for much less. Multiply this basic scenario by hundreds of millions, you begin to understand why the U.S. continues to have such a huge trade deficit with China.
Given the strength of the Chinese economy, if China were to let its currency float in the open market, it would appreciate against the dollar, thereby making American made products and services comparably competitive to those made in China. This would in turn help to create jobs in the U.S. and would also help reduce the huge gap in the U.S. trade deficit, not just with China, but also with the world at large. Unfortunately, U.S. politicians have been reluctant to stand up to China on this issue. The Clinton administration did not do anything about it. The Bush administration tried for a short time, and then gave up. The Obama administration is using double talk. In January of this year, it issued some strong statements warning China that it will need to change its exchange rate policy. However, in recent weeks, it seems this administration is backtracking. One of the reasons for this reluctance has been because some economists and pundits continue to argue, with no evidence, that pressuring China on the currency issue could have adverse consequences for the U.S. This claim has no basis. China would suffer as much as the U.S., if not more, if it decided to push U.S. legitimate concerns to a trade war.
Against these economists and pundits, I am urging the Obama administration and the U.S. Congress to take strong measures against China. I am proposing a tax on Chinese made products entering the U.S. to offset the advantage that the Chinese government has given to its manufacturers by manipulating the value of China’s currency. Using the example of television that I have offered here, the U.S. government would impose a $125 tariff on Ms. Hsiu’s television at Best Buy or other retail stores in the U.S. so that the price can equal to that of the U.S. made television set. I would call it a currency-parity tariff. It would be in effect until China liberalizes its exchange rate. By imposing this tariff, a consumer who is looking to buy a television set would base her decision on other factors such as quality, style, and national preference instead of price, as both items would cost the same.
Some would say that my proposal is protectionism. My answer is: currency manipulation is protectionism, as I have explained in the first paragraph. Some would ask whether I am promoting a weak dollar. My answer is: not necessarily; I am promoting currency parity based on market forces. A more equal USD-CNY exchange rate would make U.S. goods and services more attractive to citizens and businesses of other countries, including China. This would mean increased demand for U.S. goods and services. Increased demand would mean increased production to supply the demand. Increased production would mean hiring people—job creation in the U.S. However, in this case, it means that the dollar would depreciate against the renminbi compared to where it currently stands. A weaker dollar would also make the U.S. an attractive place to vacation, which would increase revenues from visitors in stores in major tourist states, especially New York, California, Florida, Washington, DC, and others. Businesses would also be booming in airports across the United States. What’s not to want!
If we, Americans, are serious about restoring U.S. manufacturing capability and trade parity with China and/or the world, we need to be serious on this issue. We need press our government to stand up to China and demand a fair exchange rate policy.
Figaro Joseph is a PhD candidate at the Josef Korbel School of International Studies at the University of Denver. He can be reached at firstname.lastname@example.org
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