The yuan and the U.S. trade deficit

When I hear the U.S. senate cry about how the allegedly undervalued yuan hurts the economy, I can't help myself from thinking that money would be better spent on a gigantic hamster wheel to power The Big Apple during peaks instead of having the worsts of the lunatic fringe argue over something about which they don't know anything. As the proverb states, "No attention is paid to him who is always complaining", so it is with the U.S. senate. They can blow their horns as much as they want, but no one will lend his ear. In fact, they can't be serious when they say the yuan should revalue by as much as 20% overnight by letting it float. That would spell disaster for the Chinese economy. It would not only open the floodgates and unleash huge flows of hot money onto the economy—the NYSE has by far the largest market capitalization in the world and it alone would be more than enough to completely engulf the Shanghai Stock Exchange, but many state-owned banks would go belly up as they own lots of U.S. treasuries. Moreover, singling out the exchange rate as the culprit is simply rubbish, especially since the economy was so poorly managed. Many policy mistakes were made. Reckless government spendings, unsustainable monetary policies, financial deregulations, restrictions on exports, to name a few. The main factor contributing to the U.S. current account deficit is the discrepancy between investment and savings. According to this view, domestic savings are not enough to meet the demand of capital, which is satisfied instead by offshore capital. Consequently, currency appreciation is offset by the outflow of capital hindering trade adjustment. Although this does not explain the chronic trade deficits with China, it does suggest that unless there is an increase in domestic savings the U.S. trade deficit with China would barely budge even if it were to revalue the yuan. The experience of Japan proves that currency appreciation does little to solve the problem. After the Plaza Accord, the yen exchange rate skyrocketed up to 1/145 relative to the dollar from 1/238; yet the U.S. trade deficit continued unabated. Now, there are other ways out of this. I can only think of two in the immediate present. One would be to increase wages; the other, strengthen the social safety net. I have also heard some criticisms on the interest rate, which is allegedly kept at a low rate to stifle consumer spending. Obviously, a little pat would be enough to shrug off this one. State-owned banks are heavily burdened with bad assets on their balance sheets, which threateningly creak under their weights. Raising interest rates would cause these balance sheets to buckle on their own weights. I can't wait to hear the next diatribe coming from The Congress, on Muslim extremism.

Actually, China really should let its currency move with the market. It's actually quite good for the Chinese economy. The Chinese work force's productive level is rising much faster than the current rate of appreciation, which has allowed China to run up a huge trade surplus despite the rises in currency in the past few years. China has adopted many protectionist type of policies that has helped maintaining those advantages. And as China moves up in the value ladder (and it needs to do so), a higher RMB would give it more money to spend on RnD, buying raw materials and allow it to be more competitive on high tech sectors.

As for many state-owned banks owning US treasuries, why does that even matter? US treasuries is going down in value regardless. These banks are just stupid if they keep owning them. You can't override the forces of the market. US has no way of paying back treasuries in their original purchasing power. Preventing RMB from rising will not change any of that.

As for the experience of Japan, I think that's overrated. People often forget that Germany was also forced to appreciate its currency at the same time. I had a mild recession and then started to really grow again. Even now, both Japan and Germany are running up huge trade surplus. China will continue to run up trade surplus even if its currency rises. What it needs to do is avoid making the bad gov't policies that Japan made in the past 2 decades. That's what really sunk Japan.

The value of the wages of Chinese workers must rise in line with the rising productivity. By raising the wages in RMB companies making cheap goods are driven out of the coastal areas to places further inland ( or to other countries), helping provide work for many people nearer their home, and helping raise wages in areas where wages were very low. So by raising the value of wages for about a fifth by letting the RMB appreciate and about four-fifth by letting wages raise in RMB China stimulates industrialization in an ever wider area of its country.
A contrary policy was chosen in the Netherlands in the early '80's. The wages were kept down, below the level of inflation in order to help export by Dutch industry and agriculture. The result was a slow-down in innovation and a loss in the growth of productivity. A few years later the wages of new teachers were set at two-third of the level of that of working teachers, while the requirements for teachers were lowered. The results are unfortunate.
A lot of what China exports to the US consists largely of components produced elsewhere, including the US, so the level of wages in China has little influence on the price of goods in the US, thus not leading to revival of US industry.
The US balance of payments is greatly distorted by the reckless creation of money by the US financial "industry" ( think housing bubble &c.). Now that private industry can't maintain this activity the task has been taken over by the Fed, again not leading to real growth of the US economy.
The US government might have invested in infrastructure ( there was a few years ago a backlog in maintenance of civil engineering works of $ 1600 b., which is growing fast because of the financial difficulties of the states and municipalities.),
perhaps also by building a modern railway system. But the Wallstreet banks preferred to be paid more directly and they could buy the votes in Congress so their wishes prevailed.

^Appreciation of the Yuan has been happening since 2006, in which it has risen to around 20% in value, which has occurred gradually as the government has allowed controlled valuation of currency.



Also what you said about manufacturing has been happening for a while too as part of a great CCP policy to help increase development inland, supporting eliminating poverty through development and allowing commercial enterprises to flurish in the coastal regions, part of the purpose of the three gorges dam was to allow that to happen via providing both cheap electricity and a means for large cargo ships to go inland and support commerce there as well.

There was a good article I read on this one time, I believe it was called "the dollar crisis in detail".. basically US petrodollar hegemony has enabled America to act as an empire that colonizes the rest of the world (since dollar is the global reserve currency) and the Feds printing all those trillions in bailout and stimulus has gone overseas to China and caused them inflation, basically eroding away the life savings of the Chinese to prop up the American nonnegotiable way of living standards.. So even if Chinese is not stop pegging the currency, Federal Reserve by printing monies and the quantitative easings is indirectly doing the same effect.

^Pretty much, that goes for the rest of the world to, which makes QE the financial equavilent of starting WWIII, so that's why its more likely the world will rally around China to decouple from the dollar and reintroduce gold.

Have some people forgotten that if the China currency rised against the US dollar, then China would lose about 300 billion dollars in the US Treasury just by the change in currency alone?

^All the more reason the Chinese government should continue their current policy of buying gold, maintaining a large Forex reserve and slowly raising the value of the yuan.

And honestly, with Obama's QE policies the US dollar is going to destroy the global economy as is, so decoupling from the US dollar becomes all the more vital.

I think China has a real problem on its hand with this situation.

The underlying issue is of course hot money, namely preventing it from moving in and out unsanitised and causing massive property and stock market bubbles. The main policy for control to date has been the exchange rate which is being kept to a rate of appreciation against the dollar to about 3% pa. This represents the bid-offer spread of the currency trade markets and means, taken together with a raft of other cooling measures and restrictions, that major short term currency gains are impossible to achieve.

On the other hand, the dollar is being weakened by the growing static cost of debt, rising debenture interest rates and of course Q.E. This is dragging the yuan down with it and introducing overstated inflation into the Chinese economy.

Its a quandry. Does China keep to its tie and swallow the unpleasant consequences? Does China cut the tie and float free but again deal with the very unpleasant hot money consequences?
Is what we are seeing a major league game of Chicken between the two powers?

Interestingly of course which ever way you go, hot money remains the core problem as funds usually at home in the US Property, Stock and Currency markets look for any other secure home such as commodities and leading emerging markets.

My suspicion is that for Beijing, maintaining a competitive exchange rate will trump everything unless the current conditions deteriorate markedly. My suspicion of Seoul fanning tensions on the peninsular to scare off hot money and weaken its own exchange rate remains as strong as ever.

China does have a problem, and I also think there is a sort-of game of chicken. This is why they are using administrative means to keep prices down. My hunch is that they will allow some inflation plus some appreciation (3%) and hope that that is enough. On the brighter side, most of Chinese inflation today is actually food prices, which may well go down again. Their "core" inflation (taking out fuel and food prices) is not so bad.

The problem with allowing the currency to rise is not just fueling hot money inflows. Since most export contracts are still signed in dollars, a rising currency gives rise to much uncertainty, and hedging against this is too costly for the slim profit margins many exporters operate under.

There is another side to this game of chicken however: Inflation in India, Brazil, Indonesia and many other countries is higher than in China, so in reality, the US is playing a game of chicken against most emerging markets. This policy (quantitative easing) may force many emerging economies to moderate their growth to contain inflation. It may force some others to crash too. To my knowledge, this is the first worldwide recession in which many 'weaker', less developed economies have taken less of a hit than the 'advanced' economies, and have recovered quicker. Is American policy trying to reverse this? If this whole thing is aimed at China, it is very silly policy, because everybody else hurts worse than China.

And there's yet another side: American quantitative easing complicates matters for some of the most important allies the country has: Japan, Germany, South Korea, for example. This last fact, in my view, is why the tone in US-China relations has softened some of late.