I am always frustrated by the amount of China-bashing that goes on in the United States media. Robin Hanson recently blogged about his survey of the top articles on China written in the NYTimes and Washington Post. He concluded:
Yup, top US newspapers are in full fledged China bashing mode. Anyone think a list of the last ten articles about Britain or Canada would be nearly as negative? The odd thing is that this media tries so hard to appear objective. Yet they are blatant about the most obvious bias one should expect from national news: a bias toward negativity about rival nations. Apparently we are most blind to our most obvious biases.
China has a lot to be criticized for, to be sure, but is all the scrutiny deserved? Its human rights record lags far behind that of the United States and other European countries, yet there are far worse (where’s the daily coverage of Sudan these days?). It’s portrayed as obstructionist in climate change, yet the U.S. is just as unwilling to engage in substantive reform, and we’ve blogged in the past about what the U.S. should be doing even without Chinese cooperation. It’s China’s fault that we had this housing crisis; if only their obsession with saving all the time didn’t provide us with so much cheap credit! China’s investment fuels our deficit spending… not our wildly spendthrift Congress. Most disappointing is how much the U.S. worries about China, when we should be spending more time worrying about ourselves: our education system, our economy, our civil rights record. Whatever happened to personal responsibility?
The most common criticism of China that seems to pop up everywhere I look is China’s policy of keeping its currency, the RenMinBi (RMB), or Yuan, pegged to the U.S. dollar. According to some economists, including Paul Krugman, this keeps China’s exports artificially competitive, and according to less scrupulous minds, hurts American manufacturing and is responsible for our giant trade deficit. But as you suspected from reading the title of this post, those claims are overrated.
China keeps its currency pegged to the dollar through two devices. First, Chinese citizens are not allowed to freely export Chinese dollars, invest abroad in foreign companies (thereby investing in euros, or dollars), and the government controls currency speculation (foreign corporations can still “buy” Chinese currency by investing in China, though foreign investment is also regulated). Second, China purchases dollars in the form of Treasury securities and other financial instruments; by printing more RMB and buying dollars, it devalues its own currency and inflates the dollar to maintain the fixed exchange rate. This allowed China to keep the RMB at around 8.28:1; now it’s 6.8:1, and some experts speculate the true value is close to 4:1.
Just from understanding how China keeps its currency fixed, we can see two immediate problems with China floating its currency. If China allows its currency to float by allowing its citizens to engage in foreign investment, that investment will likely be focused on buying shares in American companies or bidding on U.S. securities. Instead of just China’s sovereign wealth fund buying dollars, now you have a country of billion savers trying to sell their hard-earned RMB and buy dollars as well, creating a risk for the Chinese RMB to actually depreciate against the dollar or euro in unpredictable ways, which is precisely what critics don’t want.
I’d also suggest that we’d have a big problem if countries like China stopped lending us money, particularly now, during the recession. Despite Obama’s promises of a three-year spending freeze, as Thomas argued, the way to get us out of this recession involves spending vast quantities of money–injecting demand and investing in our future. Yes, we should probably save money by cutting Medicare, Social Security, and military spending, but there’s no way that’s happening anytime soon, politically. So if we want stimulus programs–education grants, increased energy and NIH funding, healthcare, infrastructure projects, etc.–we’ll need to continue deficit spending. And if we want to continue deficit spending, we’ll need China to keep buying U.S. dollars to keep their currency fixed, and providing us with cheap loans.
Is China’s easy liquidity such a bad thing? Blaming China for our budget deficits is like blaming drug dealers for America’s drug problem, when the real culprit is American demand. As long as Americans crave heroin, cocaine, and marijuana, countries in South America will continue producing and supplying us with drugs. America’s insatiable demand for cheap Chinese products (paid for with credit cards) is also the root cause of our trade deficit and our perverse appetite for borrowing and risky investments contributes to dangerous bubbles; if Americans stopped shopping at Wal-Mart for ridiculous knick-knacks, driving for the absolute cheapest products, then we wouldn’t have to keep importing hundreds of billions from China more than we export (if Americans were willing to pay more for gas, we’d be well on our way in fighting global warming and achieving energy independence as well). Except it’s hard to blame China like we blame drug dealers because there’s nothing inherently immoral about trying to invest savings and lending money to people who want it, at absolutely reasonable interest rates (that the U.S. government sets). Can’t fault China when Americans don’t buy American.
Would a stronger yuan revive American manufacturing? That, after all, is the primary concern of labor unions who pressure politicians to pressure China about its currency (curiously, there are no consumer advocacy groups that lobby for cheaper products). Not really. First of all, as the Economist reported, Chinese and American manufacturing don’t overlap. If China’s imports become more expensive, then Americans will just shift their demand to cheap products from other countries with weak currency and cheap labor: Vietnam, Malaysia, etc. This would help our trade deficit vis a vis China, but just disperse the difference among other developing countries.
Americans could also just end up slightly paying more for, but still buying, Chinese goods, because the actual price increase will likely be small. Why would the price change be small, if a floating exchange rate causes China’s currency to appreciate by 20-30%? Why, in fact, hasn’t our trade deficit improved after China allowed its currency to appreciate from 8:1 before 2005, to 6:1 today, and has in fact risen from $162 billion in 2004 to $226 billion in 2009? The reason, as Mark Crosby explains, is because China’s exported goods actually contain a substantial amount of imported content. For example, Chinese-made TVs contain around 90% imported content–parts, chips, and other raw materials–from elsewhere in Asia. Those imported parts are priced in U.S. dollars, so China will have to pay the same price for them as they are paying today, and those costs won’t rise. It’s the remaining 10% of the TV that will get more expensive due to appreciation, but by then, the final cost increase will be small. Crosby writes:
A typical estimate suggests that a 20 percent appreciation of the Yuan leads only to about a 4 percent increase in Chinese export prices. The implication of this is that even a very large appreciation of the Chinese currency will have only a small impact on China’s competitiveness, and on China’s trade surplus with the United States. For the United States to start producing TVs again even a Yuan appreciation towards zero isn’t going to be enough!
One final reason I’ll throw out for why the U.S. could regret a decoupling of China’s currency are impacts this could have on China’s economy, its domestic stability, and thus our foreign policy. We want a stable China, and for better or for worse, the current regime is at least the devil we know, and not the most evil devil we could imagine. China depends on a large amount of annual growth to keep its population happy, and the bao ba (“protect eight“) mantra signals to officials across the country that it views 8% growth as the minimum needed to stave off unrest. If China’s currency floating drastically reduces competitiveness (though I don’t think it will, it’s what American labor seems to want), it’s not something we would be very happy with because the ensuing joblessness could create a nightmare for Chinese officials, our companies invested there, and our State Department depending on Chinese diplomatic support.
In sum, revaluing the Chinese yuan/RMB is overrated, particularly for the reasons the American media typically give (trade deficit and competitiveness of U.S. goods). There’s also evidence, recently reported in the Economist and blogged about by Yglesias, that most of our trade deficit is composed of oil imports, not trade with China. If we want to solve our debt problem, we should start buckling down and spending less on things we don’t need with money that we don’t have (as individuals), and stop wasting money on gigantic military incursions (as a country), instead of pointing the finger abroad. This post is long enough already without me giving suggestions and arguments for the other side, but I will briefly add that instead of delivering polemics against underhanded Chinese tactics and using absurd threats of tariffs, if American politicians want to persuade Chinese politicians to appreciate currency, they should try to convince China that it’s in their best interest: in short, stronger spending power for Chinese consumers makes Chinese people happy, and avoiding potential problems (e.g. inflation) when China finds it can no longer keep pegging its currency.