Can you explain the dispute over Chinese currency valuation?

July 12, 2007 3:49 PM

Can you explain the dispute over Chinese currency valuation?

I've read lots of articles about this, but most seem to cover it fairly superficially. I'm interested in learning about it in more detail than the popular press normally provides, but don't have much of an economics background (I'm a scientist). Can anyone with a good understanding of these issues explain the dispute and implications of the desired policy alterations on both sides of the issue? Thanks.

posted by underdetermined to law & government (9 comments total)

Previously on AskMe: 1 2 3 4
posted by falconred at 3:59 PM on July 12, 2007 [1 favorite]

Fortune:

Beijing's burgeoning foreign-cash pile is a consequence of its effort to boost exports by fixing the value of its currency, the yuan, to the U.S. dollar. To keep the yuan from appreciating too quickly, the central bank buys up dollars brought to China by foreign investors and Chinese exporters. Then the bank issues bonds to mop up the yuan it has paid for those dollars, thus warding off inflation.

Reading this paragrah was the first time I felt I had at least an elementary understanding of this issue. Hopefully, Fortune isn't just making it up because I sure wouldn't know the difference.
posted by stuart_s at 7:21 PM on July 12, 2007

In simplest terms, the Chinese government does not allow the global market of currency traders determine the exchange rate between the dollar and the rmb. The government has a monopoly on currency exchange to enforce this.

If global currency traders could set the value, the rmb would be worth a lot more and the dollar a lot less. There are many reasons for this, but the bottom line is that the market knows what the value should be, and the Chinese government isn't letting it go there. As Stuart said, they are doing this to boost their exports and grow their economy.
posted by alms at 7:43 PM on July 12, 2007

Western politicians want the yuan to float because they want the Chinese to export less to the west and buy more from the west.

Whether this would actually occur, no one knows. I tend to doubt it.

The Chinese government has other means to discourage consumption, and no other way to employ the capital and labor devoted to the export manufacturing sector. In the west, capital has long since fled low value manufacturing, and there's no ready supply of low-wage, long-hour labor.

My guess is that the big winners would be Mexico and Eastern Europe -- the low(er)-wage annexes to the west which would suddenly find themselves competitive with China.
posted by MattD at 7:58 PM on July 12, 2007

From what I retained in Business class when I wasn't asleep...

Imports and Exports either contract or expand the economy, which in turn determines the value of a certain currency. If country A sold a lot of things to country B, then country A becomes richer. Subsequently, country A's currency will be in higher demand, since people want to invest in this growing economy. Higher demand for the currency drives the currency value up. This means that someone from country B who previously invested in country A at a lower price now has to spend more B-currency to buy the same amount of A-stuff. Kind of make sense so far?

This operates under the assumption that the government allows the currency to fluctuate depending on the global economy. It's got a fairly stabilising effect, since if the currency grows too low, people buying the cheap labour and products will drive it up, but if it gets too high, then less people will be willing to pay the exorbitant price.

The Chinese government is suppressing the Yuan, so that it continually trades at about 7 or 8 RMB to the dollar. This means that labour and products will continually be cheap, leading to more countries buying from China, which essentially is an increase in Chinese exports. Exports inflate the economy since it's foreign money being injected, which has partially helped the rapid growth of the Chinese economy.

If the Yuan were to fluctuate with Supply and Demand, then the RMB would be much higher, and western economies like the US and Europe would have more of a fighting chance in terms of manufacturing things like clothes or toys or everyday household items, which would help stunt the exponential economic growth China's currently going through.

disclaimer: high school student with one year of business and one independent politics class research assignment on China. not much detail, just loose theory
posted by Phire at 8:48 PM on July 12, 2007

Various countries have diplomatically requested China to stop buying so much counterweight currency (it's usually dollars) so that the yuan would begin to float up. China, as previously mentioned, doesn't want to do this. They buy things, instead. Foreign bonds. American foreign debt is in very large measure owed to China.

If China were to stop, overnight, buying dollars, the US government would lose a huge source of bond investment, the yuan would start trending up like crazy, the dollar would start coming down, and things would get pretty fucking crazy for a while.

In real terms, the Chinese government has a lot of money. The US government wants the dollar to go down in value so that American exports are more competitive. The Chinese government wants to keep the yuan where it is so they continue getting all this foreign investment.

So, when you sum it up, China basically invests all of its foreign investment capital, and surplus domestic capital, in the US. It makes American capital artificially expensive and Chinese capital artificially cheap. Though arguments are occasionally made that it isn't "artificial", since it's a market just like anything else, the central problem is that, since China doesn't necessarily need to do this sort of thing, they're just messing with the market for their own gain. This is (in my opinion) entirely correct, and I think that this is due to the fact that China's playing the long game. The longer they can keep this up, the quicker they can grow their economy, and solidify their position as the economic powerhouse of America.

Especially with this new investment operation. (As mentioned in the above-linked Fortune article.)

This sounds ridiculous and alarmist - feel free to dismiss it, if you like - but the massive debt of America, both in public and private sectors, is in my calculation making it very easy and very possible for more and more foreign investors to pick up American investments. In fact, this is basically what the White House has said at various times that they would like to encourage. I don't have any links handy, but "exports" doesn't just mean goods. You can export the ownership of your corporations. Sometimes people forget in the age of multinationals that one's nation does still affect one's currency, and the fluctuations of value between various currencies affects how easy it is for international businesses to start picking off the profitable segments of your economy.

Without any changes made, America may end up hollowed out - a shell, with a government, a citizenry, some rudimentary public services, and every profitable corporation a foreign subsidiary of some European, Chinese, Canadian, Japanese, Indian, whatever multinational. It sounds ridiculous, but what happens when the USD is 0.25 EUR? Why shouldn't some bored emir in Dubai pick up a few pharmaceutical corporations, or HSBC buy Wells Fargo and Bank of America?

It's obviously more complex than the above, and no one has any idea what will truly happen. The base facts: yuan's undervalued, dollar's overvalued, China likes it that way, and though over time as their economy gets up to speed they're going to bring them back to real values, they're the ones with the money, so it's up to them as to whether it goes smoothly or not.

I think the investment program is a signal that there are strong chances it'll go well for them. I don't know what this means for the US, besides my worst-case scenario above. Luckily, I'm not American, so I don't have to worry about it too much.
posted by blacklite at 8:50 PM on July 12, 2007

Good question. I've often wondered this as well. So if China owns so much American dollar and could send our economy in to a serious shock if it ever decided to dump its holdings, isn't that a pretty powerful economic weapon they could use against the U.S.? like the equivilant to an economic nuke? Granted that would kill their exports, but would a war like event make it worth it to drop the economic nuke?
posted by jlowen at 9:21 PM on July 12, 2007

As for the fear that American multi-nationals could be cheaply bought by foreigners, two things:
1) so what? Countries like Australia have vastly fewer multi-nationals, but we still levy taxes on Phizer or Microsoft activities here.
2) too late! My retirement fund already holds investments in US multi-nationals, and I have held Dow and Nasdaq stocks directly. So when I say dance monkey boy, you better hop. Er. I mean, the ownership matters little, as the multi-nationals are run to benefit the shareholders, and as long as the US is the most attractive headquarters, they will continue to be based there. The HQ location delivers few real benefits to the host country though, as it is trivial to have operations and profits delivered in the countries where the tax regime etc. is most favourable. That said, US multi-nationals still have lots of American share holders, so much of the profit ends up back in the US to be taxed etc. by the feds.

Back to China, in many ways the huge economic investment in the US is today's equivalent of cold war MAD. Yes, the Chinese could break the US economy, but only at the expense of their own. I'm hoping this is the thing that will stop the two powers going toe to toe at some point in the next 25 years.
Finally, remember this is trade, so it isn't negative. Yes, China has these bulky investments, but the US has cheap cameras. You wouldn't swap your greenbacks for the Chinese gear unless you thought you were getting a good deal, and the Chinese wouldn't do the deal either unless they felt they were getting a fair price. So both parties magically are better off after the trade, which incidentally, is why many argue globalisation is good for rich and poor alike, as maximising trade maximises the number of times the magic value creation happens.

Whether the Chinese are making a good long term deal, by holding US debt, and whether the Americans are making a good long term deal by buying Chinese consumables, only time will tell. But it is important to realise it isn't some dark governmental conspiracy. Every time you swap a greenback for a camera you are pushing the process along. If your personal view, like some of the isolationist commentators, is that allowing others to have your money is bad, you must forgo the trade.
Then you won't have cameras.
By keeping the RMB low, the Chinese have chosen to get fewer greenbacks for each trade, but make it upon volume, just like Walmart or McDonalds. Since their competitive advantage at the moment is cheap labour to produce lots of volume, this is pretty sensible. Conversely, US Pharmaceutical companies, for example, have pretty much chosen the opposite, as their ability to make many different types of drugs is limited, as each medicine is a huge investment of smarts, but they can then charge top dollar, even if it means less are sold in poor nations. With the US educated populace and IP laws, this looks pretty smart too.

What would be dumb would be trying to fight the free action of the markets by adding tariffs, for example. This just puts a drag on the trade process, reducing the number of magic value creation steps. Better to help the suddenly unemployed US textile workers to up their skills through training, rather than try and hold everyone back through more taxes.

Thats the theory anyway. It can be a lot harder at a micro level when you are the t-shirt maker in Nebraska.
posted by bystander at 5:28 AM on July 13, 2007 [1 favorite]

What would be dumb would be trying to fight the free action of the markets by adding tariffs, for example. This just puts a drag on the trade process, reducing the number of magic value creation steps. Better to help the suddenly unemployed US textile workers to up their skills through training, rather than try and hold everyone back through more taxes.

I think you're exactly right. But widespread skills training is really something you need an active and participatory government for, and the current administration seems too busy pumping money into Iraq to bother with any sort of major new program like that. Hence the massive bifurcation these days of the people who are riding the technology/services/financial wave to general success, and all the people who can't afford and haven't been able to afford the training (in both time and money) to break themselves out of the industries that are getting fucked by the new order of things.

Globalization is great but it takes a steady hand at the wheel to ride out the changes it causes, and I think it's far too laissez-faire right now in the US to transition smoothly. But probably the average metafilter reader can keep themselves .... I'm in a coffee shop and a girl just walked in with pink hair, a black baby tee, and white football shoulder pads on top of that. ... huh. Anyway. I think the average metafilter reader can probably keep their head above water by staying skilled. It's just not going to be good for people who have been e.g. working in car factories for the past 20 years.
posted by blacklite at 9:16 PM on July 13, 2007