Wednesday, December 20, 2006

The Great China Exchange Rate Obsession

. Wednesday, December 20, 2006

I am puzzled that so many smart people--in and out of government--seem convinced that revaluing the yuan against the dollar will narrow the U.S. current account deficit.

It won't. The current account deficit is the difference between savings and investment. The U.S. saves substantially less than it invests, and as a result it has a current account deficit equal to the difference (good discussions can be found here and here). A currency realignment will narrow the current account imbalance only if it raises U.S. savings or reduces investment in the U.S.. There is very little reason to believe that revaluing the yuan will have either effect.

Because I am disinclined to believe that smart people fail to understand this, I am compelled to look elsewhere to explain the obsession with China's exchange rate. The most obvious alternative candidate is old fashioned trade politics.

Schumer-Grahamism (wherein we impose a 30 percent tariff on Chinese goods) and yuan revaluation are substitute policies not because both will correct the current account imbalance (for neither can). They are substitutes because both benefit American traded goods producers. A 30 percent tariff and a 30 percent yuan revaluation each raises the dollar price of Chinese goods sold in the American market. This makes it easier for American producers to sell their higher-priced products to Americans. Recognizing these potential gains, American traded goods producers pressure Congress. Congress pressures the Bush administration to get serious about the "China problem". Given that Graham is from South Carolina (think textiles and Roger Milliken) while Schumer is from New York (think financial services) joint action makes perfect political sense. Revalue the yuan to benefit American manufacturers; liberalize China's financial market to the benefit of American financial service firms.

While yuan revaluation (or Schumer-Grahamism) benefits some producers, it makes the rest of us poorer. American paychecks will
buy less--fewer holiday gifts (China produces many of the electronics and toys we will purchase this holiday season), fewer clothes and shoes for the kids (China produces much of the low-cost apparel and footwear we buy), and so on. And as much Chinese production dominates the low-price end of the spectrum (off-brand electronics and apparel sold in the major discount retailers at very low prices) both measures hit the poor the hardest. Yuan revaluation thus transfers income from the poor to large American companies.

I am puzzled that no one else has noticed the perversity (hypocrisy?) of this aspect of the "new populism". With one hand the new populists offer a 20 percent bump in the federal minimum wage to the benefit of a very small segment of the American workforce. With the other they strive to impose a 30 percent income reduction on all of us.


The Great China Exchange Rate Obsession
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