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What’s All This China Currency Business About?

Yesterday, in a rare occurrence of bi-partisanship, U.S. House of Representatives passed legislation that would allow U.S. companies to petition for tariffs on imported goods from China.  This legislation is a response to China’s currency manipulation.  But how effective would tariffs be?

A cheaper currency relative to other currencies - in this case the Yuan vs. Dollar - makes prices of imports to U.S. cheaper relative to other goods made domestically or from other countries (with more higher valued currencies).  But it also makes exports to that cheaper currency country more expensive to their citizens than domestically made goods - in these case U.S. exports to China are more money to Chinese citizens.  It’s all about foreign currency exchange rates. 

China hasn’t been a fair trading partner to U.S for quite some time.  It has manipulated the value of its currrency relative to the dollar.  This makes its imports cheap to U.S. consumers and makes U.S. exports more expensive for it’s citizens.  This manipulation has resulted in job losses in the U.S. 

Why does China do it?  Consider this - China recently passed a huge population milestone: 1 BILLION working-aged people.  That is a lot of people to keep employed.  Plus China is run by a totalitarian regime and if the ruling class wants to stay in power it must keep 1 billion people relatively happy with jobs.  The ruling class does what it can as a means of its survival.  That means keeping its export (to U.S.) driven economy humming along at any means necessary including currency manipulation.

How does China manipulate its currency?  By buying more and more U.S. dollars.  That’s right China uses the U.S. dollars it gets from exports to U.S. and invests it in U.S. dollars (USD) mostly through U.S. Treasury Securities.  It purchases a ton of U.S Treasuries to keep the value of Yuan much lower than USD.  Really, China, if it wants to continue manipulating its currency relative to USD, needs U.S. Treasuries a lot more than we need them to do so.

Interesting side note, when China accumulates USD from exports to US, as Marshall Auerback points out, it has three options: 1) invest USD in Treasury securities (a fancy Certificate of Deposit at Fed); 2) purchase real assets in USD such as real estate or companies; or 3) buy other currencies in the foreign currency market with USD.  If it does No. 3 that will weaken USD but that will improve our exports to other countries thus lowering our trade deficit and current account deficit.

Problems with tariffs:

* Most products made in China are made for U.S. based multi-national corporations (MNCs).  If the price of imported goods from China becomes too costly because of tariffs these MNCs can easily move production to another country to exploit labor and resources.

* Current economic system in U.S., relies heavily on cheap imported goods from China in order to ameliorate stagnate wage growth for Working Class Americans.  Increasing cost of goods from China via tariffs without a corresponding increase wages for Working Class Americans could be very painful. 

Our first mistake was thinking that a totalitarian regime would be a good trading partner but MNCs wanted lower and lower costs to achieve higher profit margins so politicians in DC went along.  Now, we are involved in a very serious game of chicken.  China should change its manipulative economic model, if for the very least for its own people, but can the ruling class afford to do so?  U.S., while correct in pressuring China to drop its model, must work on changing its own economic model to encourage income/wage growth for Working Class Americans. 

Who knows how this game of chicken will end?  Sadly, I don’t have much confidence that it ends well for Working Class Americans. Stay tuned.

Good luck.