Thursday, May 12, 2005
Saying one thing and meaning another: the dollar and the yuan
So the Bush aministration want to devalue the dollar. This explains why they have been willing to let the dollar sink against the euro and the yen. I am not entirely sure why they are doing this. It could be a protectionist measure to boost American jobs and closse their trade deficit, but that doesn't sound like the Bushites. The American economy is driving by consumer consumption and a lower dollar hurt consumption because he price of everything, especially oil, goes up. The American economy is not export-driven so a devaluation does not make immediate sense to me. I can see a lot of arguements against one.
Either they are stupid or I am missing something, and both are valid options.
Jax
Pressure from the Bush administration and the US Congress on Beijing to float the exchange rate of the yuan is increasing. But there is no economic justification for changing China's fixed-exchange rate regime. Rather than yuan revaluation, US demands for exchange rate adjustment in China should be seen for what they are: Washington's explicit support for dollar devaluation.
According to officials in the Bush administration and in the US Congress, the intensification of pressure on China is primarily a response to complaints by US manufacturers. These manufacturers allege that China's exchange rate puts them at an unfair competitive disadvantage. Considering that wages in China are about one-tenth the level of wages in the US, a revaluation of the yuan by 25% - the eventual targeted exchange rate adjustment Washington seeks - would do little to improve the competitiveness of US manufacturers vis-a-vis manufacturers in China.
In addition, because China's exports have a large import component, the revaluation of the yuan would reduce input prices for China's exports, diminishing the impact of revaluation on export prices. Like the issue of competitiveness, the associated issue of China's growing trade surplus with the US is irrelevant to the exchange rate of the yuan.
Since the devaluation of the yuan in 1994, the average annual rate of growth of US exports to China has been 14%. Over the same period, the average annual rate of growth of US imports from China has been 18%. The long-term comparability in US-China export and import growth rates strongly suggests that China's exchange rate is neither under- nor over-valued relative to the dollar. Rather, the large and growing US trade deficit with China reflects the different nature of the two countries' economies.
The consumption- and profit-driven US economy naturally seeks the cheapest source for consumer goods. Thanks to heavy US investment over the past 15 years, China is the cheapest source for these consumer goods. Rather than consumption-based, China's economy is driven by investment and export production. As a result, China does not have outsized demand for consumer goods.
Unless the Chinese suddenly drop their strong bias toward savings, a consumption boom in China is extremely unlikely. Along the same vein, unless private consumption collapses in the US and Wal-Mart goes bankrupt, reversal of the US trade deficit with China will not materialize regardless of a 25% revaluation of the yuan against the dollar. Rather than focusing on the spurious issues of competitiveness and deficits, Washington should ponder the impact of a dollar devaluation on inflation in the US.
Though referred to by the Bush administration as yuan revaluation, what Washington is begging Beijing for is dollar devaluation. Like the 1985 Plaza Accord, Washington is again asking one of its largest trade partners to allow the dollar to depreciate. However, instead of Japan, as was the case in 1985, the US is pushing China to allow the dollar to depreciate against the yuan. The Plaza Accord led to the eventual devaluation of the dollar by about 50% against other major currencies. There is strong reason to believe that what begins as dollar depreciation against the yuan will eventually become another Plaza-style dollar devaluation.
China's foreign exchange reserves, the second-largest in the world after Japan, are expected to reach nearly $750 billion by the end of 2005. These reserves are overwhelmingly invested in US treasury notes. Presumably, Beijing would be loath to take a large capital loss on its investment in these notes in the event of an exchange rate adjustment in China.
Because an exchange-rate adjustment would result from a policy change in Beijing, it is likely that any adjustment would be preceded by the rebalancing of China's foreign exchange reserves, and related investments, out of the US dollar into other currencies. This rebalancing could trigger the devaluation of the dollar against the euro and the yen, currencies which the People's Bank of China would be selling its dollar reserves for.
The rebalancing of reserves by the People's Bank of China could inspire similar reserve rebalancing among other central banks in Asia and the rest of the world, all of which have substantial holdings of US dollars and US treasury notes. By begging Beijing for a dollar devaluation, Washington is inadvertently laying the groundwork for a much larger devaluation of the dollar, higher inflation, higher interest rates, and slower economic growth in the US. (Link)
Either they are stupid or I am missing something, and both are valid options.
Jax
Pressure from the Bush administration and the US Congress on Beijing to float the exchange rate of the yuan is increasing. But there is no economic justification for changing China's fixed-exchange rate regime. Rather than yuan revaluation, US demands for exchange rate adjustment in China should be seen for what they are: Washington's explicit support for dollar devaluation.
According to officials in the Bush administration and in the US Congress, the intensification of pressure on China is primarily a response to complaints by US manufacturers. These manufacturers allege that China's exchange rate puts them at an unfair competitive disadvantage. Considering that wages in China are about one-tenth the level of wages in the US, a revaluation of the yuan by 25% - the eventual targeted exchange rate adjustment Washington seeks - would do little to improve the competitiveness of US manufacturers vis-a-vis manufacturers in China.
In addition, because China's exports have a large import component, the revaluation of the yuan would reduce input prices for China's exports, diminishing the impact of revaluation on export prices. Like the issue of competitiveness, the associated issue of China's growing trade surplus with the US is irrelevant to the exchange rate of the yuan.
Since the devaluation of the yuan in 1994, the average annual rate of growth of US exports to China has been 14%. Over the same period, the average annual rate of growth of US imports from China has been 18%. The long-term comparability in US-China export and import growth rates strongly suggests that China's exchange rate is neither under- nor over-valued relative to the dollar. Rather, the large and growing US trade deficit with China reflects the different nature of the two countries' economies.
The consumption- and profit-driven US economy naturally seeks the cheapest source for consumer goods. Thanks to heavy US investment over the past 15 years, China is the cheapest source for these consumer goods. Rather than consumption-based, China's economy is driven by investment and export production. As a result, China does not have outsized demand for consumer goods.
Unless the Chinese suddenly drop their strong bias toward savings, a consumption boom in China is extremely unlikely. Along the same vein, unless private consumption collapses in the US and Wal-Mart goes bankrupt, reversal of the US trade deficit with China will not materialize regardless of a 25% revaluation of the yuan against the dollar. Rather than focusing on the spurious issues of competitiveness and deficits, Washington should ponder the impact of a dollar devaluation on inflation in the US.
Though referred to by the Bush administration as yuan revaluation, what Washington is begging Beijing for is dollar devaluation. Like the 1985 Plaza Accord, Washington is again asking one of its largest trade partners to allow the dollar to depreciate. However, instead of Japan, as was the case in 1985, the US is pushing China to allow the dollar to depreciate against the yuan. The Plaza Accord led to the eventual devaluation of the dollar by about 50% against other major currencies. There is strong reason to believe that what begins as dollar depreciation against the yuan will eventually become another Plaza-style dollar devaluation.
China's foreign exchange reserves, the second-largest in the world after Japan, are expected to reach nearly $750 billion by the end of 2005. These reserves are overwhelmingly invested in US treasury notes. Presumably, Beijing would be loath to take a large capital loss on its investment in these notes in the event of an exchange rate adjustment in China.
Because an exchange-rate adjustment would result from a policy change in Beijing, it is likely that any adjustment would be preceded by the rebalancing of China's foreign exchange reserves, and related investments, out of the US dollar into other currencies. This rebalancing could trigger the devaluation of the dollar against the euro and the yen, currencies which the People's Bank of China would be selling its dollar reserves for.
The rebalancing of reserves by the People's Bank of China could inspire similar reserve rebalancing among other central banks in Asia and the rest of the world, all of which have substantial holdings of US dollars and US treasury notes. By begging Beijing for a dollar devaluation, Washington is inadvertently laying the groundwork for a much larger devaluation of the dollar, higher inflation, higher interest rates, and slower economic growth in the US. (Link)
