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It’s all about the yuan, baby. Is its manipulation hurting us?

February 10, 2011

For the better part of the last decade, a debate on China’s currency manipulation has been raging among economists in the United States. Much of this debate has been pretty one-sided, with the conclusion being that China’s currency manipulation hurts U.S. commerce and that something must be done about it. This is not the whole story, though. Some people disagree with this assessment, claiming that in the long run, depreciation of the yuan hurts the Chinese more than it does us. The latter argument is mostly made by Austrian economists and some other more free market economists.

In this case, it can be hard to peg a specific view to one economic theory or another. Keynesians are traditionally in favor of currency manipulation in as much as it helps dig a country out of recession. Modern Keynesians such as Paul Krugman, however, take umbrage with how the Chinese peg the yuan to the dollar, claiming it costs the U.S. in jobs and exports.

How does this manipulation work?

The Chinese manipulate their currency by not allowing supply and demand in the world market to determine the yuan’s value. Instead, China buys and sells their currency in the market in order to peg the yuan’s value to the dollar.

Why it is bad and must be stopped (the Krugman argument)

Krugman, the Keynesian he is, concedes that China’s currency manipulation was not always a bad thing. In a 2009 op-ed for the New York Times he wrote:

There’s nothing necessarily wrong with such a policy, especially in a still poor country whose financial system might all too easily be destabilized by volatile flows of hot money. In fact, the system served China well during the Asian financial crisis of the late 1990s.

The problem, he claims, is that the Chinese continue this policy even during recession. By pegging the yuan to the dollar, the Chinese have devalued their currency by virtue of the fact that the U.S. dollar has declined in value, as well. This creates a trade surplus, which according to Krugman (and many policymakers), siphons jobs from the rest of the world. Krugman claims in the same op-ed:

The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.

China’s currency should be getting stronger. Compared to how the yuan would stack up against the dollar were it floated, it takes more yuan to buy a dollar. This makes American goods more expensive in China, meaning we import more from them than they do from us.

China’s large trade surplus is the reason Krugman find’s China’s currency manipulation to be unforgivable. The United States, on the other hand, has a large trade deficit with China, so it is O.K. for us to manipulate our currency to get our economy back on track.

Why it’s potentially good for us and bad for them (the Austrian argument)

Instead of focusing on trade deficits and surpluses from country to country, Austrian economists take a more microeconomic view. Taking aim directly at Krugman, Jonathan Catalan at the Mises Institute claims:

For the individual Chinese entrepreneur, the undervalued yuan has brought disaster. China’s central bank is not subsidizing the Chinese exporter but the American importer.

Austrian economists claim that instead of looking at the fact that China buys fewer goods from us because it takes more yuan for each dollar, we should be looking at the fact it takes fewer dollars to buy more yuan. We have a trade deficit because it benefits consumers to buy goods for less money overseas.  Catalan claims “Krugman fails to realize that the Chinese are selling their goods at a loss.” To free market economists, we have a trade deficit because we are getting smoking-hot deals from China.

Comparison to the Japanese yen

Free marketers also like to draw comparisons to the Japanese Yen in the 1980s. The U.S. had a large trade deficit with Japan when they pushed the country to appreciate its currency, which they did. However, this did not decrease the trade deficit. According to the New York Times:

The trade deficit with Japan actually widened to $108 billion in 1987, from $94 billion in 1985. The rising yen wasn’t enough to halt the growth of companies like Sony and Toyota. They had too many advantages, including lower labor costs.

The Japanese soon thereafter went into a decade-long economic slump, but this policy did nothing to help the U.S.

The final word

The world cannot avoid inflation forever. For this, I will give the final word to the esteemed Economist magazine:

…a real appreciation in China will sooner or later feed into American inflation, in one of two ways. First, it can be achieved via a controlled nominal appreciation of the yuan. Second, in the absence of such an appreciation it will come via inflation in China, since—as Paul Krugman bluntly  puts it—inflation is merely “the market’s way of undoing currency manipulation”.

No matter what China does, sooner or later something will have to give.

One Comment leave one →
  1. CurtisTip permalink
    April 8, 2017 4:04 am


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