The Fix Is In: China’s Currency Manipulation (Part 2 of 2)

In Part One , we set up some oversimplified and hypothetical examples to show how China manipulates the exchange rate of its currency, the Chinese Yuan (or “CNY”).   1<- – – Click this little footnote.

To recap, China doesn’t want the Yuan to appreciate because the US and other trade partners wouldn’t be able to afford as many Chinese goods.  So China prevents the Yuan from strengthening against the Dollar by printing new Yuan and holding the Dollars rather than letting the Dollars-to-Yuan exchange take place.  Said differently… China is manipulating the system and keeping its currency from appreciating.

Be careful what you wish for.

This has become a very politicized issue.  During the last US Presidential election, Mitt Romney made this an important part of his campaign by promising to formally label China a “currency manipulator.”  While a senator, President Obama also took the position that China was not playing fairly.2  We are likely to see this issue come up again once the 2016 election cycle heats up.3

In the meantime, this “currency manipulation” issue will keep coming up as Congress continues to take issue with trade imbalances and politicizes the issue because it makes for good press to bash China.  Like when Michigan Senator Debbie Stabenow says the following:

“I want to export our products, not our jobs. Our business and workers lose when other countries cheat…”

Ok.  Heavy sigh.  That just rings of patriotism and many of you reading might even be nodding your heads.4

But if you are reading this on a computer, an iPhone, or basically anything other than paper5 then please just realize that agreeing with that statement has repercussions.

Repercussions like the fact that the laptop or iPhone you are reading on would cost you a lot more if we formally name China a “currency manipulator” and try to force the Yuan to appreciate against the Dollar.

I’m not arguing that the current system is awesome and should be left alone.  Far from it.  It has cost the US a lot of GDP and jobs – and of course I think that is a terrible thing.  But US consumers have also benefited in the form of minimal inflation and lower prices for just about everything we import.6

I have personally benefited from this because I’m typing this post on an amazing new Macbook Pro.  A computer that cost less to buy today than a new computer did in 1990.  And yet this Mac has more processing power than the computers used by NASA to put a man on the moon.7  So all consumers in the US have benefited from this screwed up currency relationship with China.  But it is not just the cheap iPhones.

In addition to inexpensive imports, all those Dollars flowing back from China to the US into our government bonds have helped to keep our interest rates so low.  So it has been a double edged sword.  But you won’t hear about that part because thanking the Chinese for cheap goods or low interest rates doesn’t make for good press.

So please just pause to think for a second the next time you read hard hitting political statements about China “cheating.”  Because unless8 you are willing to pay 50% more for that iPhone, iShirt, iTV, or basically iNything else that you own,9 just realize that what you are wishing for does have consequences.  And even if a revaluing of the Yuan is a good thing – it will take time to correct this issue.

That which cannot continue shall not

So.  If we have established that China is manipulating its currency and that this is also the worst kept secret in economics, then what comes next?

Let’s think about the global economy over last thirty years.  China, much of Asia, and the other developing and emerging economies made “the stuff.”  And the US and The West bought that stuff.  Our economies boomed and our lives improved – on just about every possible metric there is.10  We all have benefited.

But the current system will soon come to an end.  That system was the fuel for the rise of China.  But that is old news.  China isn’t rising; it has risen.  And in the process China has lifted hundreds of millions of people from poverty, it’s economy is now the second largest in the world, and incomes are going up.  And now it wants to reset the game again.

China no longer wants to make the world’s stuff.  China wants to buy the world’s stuff.

Over the long run, it will be to the advantage of both the US and China for this trade imbalance to correct.  Sure, if the Yuan were to rise by 30% against the Dollar, we in the US would be able to afford a lot less “stuff” since we don’t really manufacture the goods we consume.11  But on the flip side, if the Yuan rose against the Dollar then the Chinese would be able to afford more US goods.  This would be great news to US exporters and at least some of the manufacturing jobs lost over the past few decades would likely return as Chinese consumers purchased more US goods with their newly-strong Yuan.

So sure, it will eventually be a good thing if China allows its currency to rise, the currency manipulation issue goes away, and the economic “automatic balancing” feature returns.  But no one is going to make China do it.  China will revalue the Yuan when it is good and ready.

This issue is likely to take a decade or more to resolve.  But it will resolve as China slowly but surely shifts from maker to spender.

We’ll be talking a LOT more about this in various posts over the next year.  It is an issue of paramount importance that will greatly affect the global economy.

US automakers selling more cars,12 Tiffany & Co slinging out little blue boxes, and surging profits of fully-booked Hiltons and Marriotts around the world.  Make no mistake… 1.4 billion Chinese consumers and tourists armed with a stronger Yuan will make waves.  In fact, they already are like this and this and this and this.  Just imagine what they’ll do with 30% more buying power.

The question is not a matter of if but when.  No one knows exactly when the Yuan will be allowed to float freely.  But it will eventually.  Then get ready for the fireworks.

Because that which cannot continue… shall not.

Thanks for reading,
Christopher