Chinese Currency: The Market Forces Fairness
China and the United States have a trade deficit. Ok, big deal. That happens all of the time throughout the world. A problem exists, however, when the country in question has experienced economic growth of 7 to 10 percent since 1994 and its currency has increased in value by 0%. This issue has been extremely politicized, but it still has very basic principles behind it.
The Chinese are doing what is best for the Chinese. That is, they are artificially depressing export prices and pulling trade from other nations in the world. This is not all bad news for the US. In fact, many US economists say that a revaluation is actually not in the interest of the US. They argue that this would cause a large drag on the global economy, depress US currency on the global market, and cause an economic crisis. On the other side, many in the US, particularly organized labor, are pushing for either revaluation or floating (allowing market determination of exchange-rates) of Chinese currency. It is ironic that an organization (AFL-CIO) that pushes policies that would have similar effects for their members at home is the one fighting this, but nationalism provides no shortage of irony. They argue that the current situation provides China with unfair competitive advantage as it makes their goods relatively cheaper than other nations goods. There have been claims that Chinese currency is under-valued by as much as forty percent. In the past, particularly in the Japanese case, removing a currency-peg has the undesirable consequences of deflation and struggling domestic industry.
This is where things get sticky. The Chinese will most certainly experience deflation nearly instantly as prices for raw-materials (the factor of production that China does NOT have a surplus of) will fall and prices will tumble. Foreign investment will slow and the resulting low-price pressure on Chinese companies will be disastrous. Their feeble banking system, which already has a glut of unpaid loans, may even collapse. And to top it off, the thing of which deflation is made, bankruptcies, will skyrocket as foreign demand for goods slows and businesses, laden by overcapacity, begin to collapse. The outcomes for the US, on the other hand, are less certain. Some believe that this, coupled with the real-estate market and the over-abundance of credit, will cause deflation here at home as well. Others say that the increase in price level will produce an inflationary shock, albeit a mild one, and the US will gain competitiveness and jobs. While this picture is surely a bit too rosy, it is plausible. It is also possible that because many companies use Chinese made inputs to boost competitiveness the US job market and overall industrial economy may be hurt. The policy of China financing public debt by investing their glut of US currency in US T-bills would then slow and the US government, and economy, would be in big trouble.
So we should do nothing?
NO! This is the biggest mistake of all, we have to act. The reason is that the currency peg cannot last forever. The pressure on the Chinese financial system from such a glut of reserves is already causing stress. Eventually, if nothing is done, the system will fail and China will suffer a major recession. This will have disastrous effects on the entire world. The fact is, a currency peg that does not at least attempt to find equilibrium will cause market distortions that will be painful to correct. We have to look long-term, and in the long-term, the market will force corrections, and it will not be as gradual about them as the world governments could be. The end issue is that, this is going to be painful for China no matter when they do it and probably for the US as well. If the distortions are not gradually eliminated now, the pain that will be caused when the eventually do end will only be intensified.
The Natural Fairness of the Market
The market, when properly regulated, demands fairness. It attributes no importance to nationality, race, or sex. Labor is cheaper in China, therefore the market naturally begins an arbitrage process to balance out the imbalance. Labor prices fall in those nations with high labor prices (thus the Union resistance to globalization) and begin to increase, aggregately, in those with lower cost. However, the market always punishes cheaters. The Chinese currency peg is unfair to the poorest nations in the world. It hurts un-skilled labor demand in every poor country in the world. The US, by dumping capital into the Chinese economy, has not been losing that much, because we reap part of the benefits of the lower prices. In the end, China and the US will lose. Nationalist policies cannot survive in a global-market. These policies, unless limited to temporary relief for short-term emergencies, will backfire. The incredible complexity of the market can be summed up in a phrase that everyone knows. "You can't get something for nothing." When nations try to get an unfair advantage from the global market, they inevitably pay the price.
The Chinese are doing what is best for the Chinese. That is, they are artificially depressing export prices and pulling trade from other nations in the world. This is not all bad news for the US. In fact, many US economists say that a revaluation is actually not in the interest of the US. They argue that this would cause a large drag on the global economy, depress US currency on the global market, and cause an economic crisis. On the other side, many in the US, particularly organized labor, are pushing for either revaluation or floating (allowing market determination of exchange-rates) of Chinese currency. It is ironic that an organization (AFL-CIO) that pushes policies that would have similar effects for their members at home is the one fighting this, but nationalism provides no shortage of irony. They argue that the current situation provides China with unfair competitive advantage as it makes their goods relatively cheaper than other nations goods. There have been claims that Chinese currency is under-valued by as much as forty percent. In the past, particularly in the Japanese case, removing a currency-peg has the undesirable consequences of deflation and struggling domestic industry.
This is where things get sticky. The Chinese will most certainly experience deflation nearly instantly as prices for raw-materials (the factor of production that China does NOT have a surplus of) will fall and prices will tumble. Foreign investment will slow and the resulting low-price pressure on Chinese companies will be disastrous. Their feeble banking system, which already has a glut of unpaid loans, may even collapse. And to top it off, the thing of which deflation is made, bankruptcies, will skyrocket as foreign demand for goods slows and businesses, laden by overcapacity, begin to collapse. The outcomes for the US, on the other hand, are less certain. Some believe that this, coupled with the real-estate market and the over-abundance of credit, will cause deflation here at home as well. Others say that the increase in price level will produce an inflationary shock, albeit a mild one, and the US will gain competitiveness and jobs. While this picture is surely a bit too rosy, it is plausible. It is also possible that because many companies use Chinese made inputs to boost competitiveness the US job market and overall industrial economy may be hurt. The policy of China financing public debt by investing their glut of US currency in US T-bills would then slow and the US government, and economy, would be in big trouble.
So we should do nothing?
NO! This is the biggest mistake of all, we have to act. The reason is that the currency peg cannot last forever. The pressure on the Chinese financial system from such a glut of reserves is already causing stress. Eventually, if nothing is done, the system will fail and China will suffer a major recession. This will have disastrous effects on the entire world. The fact is, a currency peg that does not at least attempt to find equilibrium will cause market distortions that will be painful to correct. We have to look long-term, and in the long-term, the market will force corrections, and it will not be as gradual about them as the world governments could be. The end issue is that, this is going to be painful for China no matter when they do it and probably for the US as well. If the distortions are not gradually eliminated now, the pain that will be caused when the eventually do end will only be intensified.
The Natural Fairness of the Market
The market, when properly regulated, demands fairness. It attributes no importance to nationality, race, or sex. Labor is cheaper in China, therefore the market naturally begins an arbitrage process to balance out the imbalance. Labor prices fall in those nations with high labor prices (thus the Union resistance to globalization) and begin to increase, aggregately, in those with lower cost. However, the market always punishes cheaters. The Chinese currency peg is unfair to the poorest nations in the world. It hurts un-skilled labor demand in every poor country in the world. The US, by dumping capital into the Chinese economy, has not been losing that much, because we reap part of the benefits of the lower prices. In the end, China and the US will lose. Nationalist policies cannot survive in a global-market. These policies, unless limited to temporary relief for short-term emergencies, will backfire. The incredible complexity of the market can be summed up in a phrase that everyone knows. "You can't get something for nothing." When nations try to get an unfair advantage from the global market, they inevitably pay the price.
posted by SpacemanSpiff at 11/18/2005
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