Deciphering Chinese Economics
The Wall Street Journal reported that the U.S. Treasury is about ready to label the Chinese government as a “currency manipulator” - more of a political label than anything. Basically they are officially attributing to them what we all already knew - that the Chinese intentionally keep their currency weak to fuel exports from China. [Trade deficit info.] The article said:
The shift comes as U.S. data show its trade deficit with China ballooned last year to $202 billion, more than one-quarter of the total U.S. deficit. That has added to political pressure on the administration from members of Congress, who say American jobs are being lost to the tide of inexpensive Chinese imports and the flight of manufacturing to China.
Last week, U.S. Trade Representative Rob Portman announced a task force to take up complaints about unfair Chinese trade practices. U.S. politicians allege that China deliberately keeps its currency weak to make its exports cheaper in dollar terms and U.S. imports more expensive.
The basic idea behind a ‘developing country’ wanting to have a weak currency compared to others (especially the dollar) is that a weak currency means that goods produced within that country are less expensive outside of the country–hence the trade imbalance. China keeps their currency weak, so that goods produced in China won’t cost as much to Americans, and we will continue to import Chinese goods rather than buy domestic goods. What this trade imbalance means for the exporting country is a GDP that can increase more rapidly than if it were restricted to only domestic commerce. For the importing country, they receive goods at a cheaper cost, but the trade deficit will decrease their GDP by an off-setting amount.
So why has this become an issue? The White House has been receiving increasing pressure about the perpetual trade imbalance, and the “threat” of jobs getting sent offshore. Congress has even threatened to impose a 27.5% tariff with Chinese goods. While it may seem a threat today, the market will make the correction over time on its own. China has its own incentives to appreciate its currency; including being weaned off of their dependence on exports.
Another reason to maintain our good relations with China is because of their massive holding of U.S. Treasury bonds:
In testimony to the U.S. Congress last week, new Federal Reserve Chairman Ben Bernanke sought to play down what many consider a grave risk in any trade confrontation with Beijing — that China may decide to sell its huge holdings of U.S. Treasury bills. That could force up U.S. interest rates and add to the cost of borrowing by consumers and businesses. He said U.S. capital markets are “sufficiently large and liquid that the impact of such changes would be mostly transitory and could be managed.”
China is the second biggest holder of U.S. Treasury Securities [Source]. For them to liquidate their holdings, it would decrease the demand, and therefore decrease the price, which would in turn increase interest rates. Higher interest rates means government and companies (mostly companies) are less willing to invest in new projects. Basically, although it could be managed, a liquidation of U.S. securities by a major holder would slow American economic growth.
The Chinese won’t–they can’t– keep the Yuan artificially weak forever. While they become more and more of a presence in the world economy, they will need to become independent and less reliant on imports to expand their GDP. It will be interesting to see how the Chinese government manages its currency as they make that transition.
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