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China's offer on yuan peg wholly inadequate

By Peter Morici
web posted April 12, 2010


The Washington Post reported on Friday morning that Treasury Secretary Timothy Geithner and Chinese Vice Premier Wang Qishan were close to a deal that would permit the Chinese yuan to appreciate by 3 percent this year.

This is wholly inadequate and would do little to resolve the U.S.-China trade imbalance, which was $227 billion in 2009 and 60 percent of the total U.S. trade deficit. The balance was largely oil.

Our modern free trade system, facilitated by World Trade Organization agreements, is intended to permit countries to both export and import to obtain the gains in productivity and income attendant to specialization through comparative advantage. When trade imbalances occur that exceed private investment flows motivated by differences in developmental opportunities, exchange rates are the adjustment mechanism, similar to prices in markets for commodities.

Simply, when currencies are freely traded, demand exceeds supply for the currency of trade surplus countries, especially recipients of private investment like China.

YuanIn China's case, more U.S. businesses want to buy yuan with dollars to obtain Chinese products and invest there than Chinese businesses want to sell yuan for dollars to obtain U.S. products and invest here. That should push up the value of the yuan, making Chinese products more expensive, U.S. products less expensive and bringing trade accounts into closer balance

China, by pegging its currency to the dollar, frustrates this process and abuses the WTO system. A huge importer of private foreign private investment, it would not have a trade surplus, and certainly not a huge trade surplus with the United States, but for the fact that Beijing intervenes in currency markets.

China's yuan is likely undervalued by 40 percent, and Beijing accomplishes this by printing yuan and selling those for dollars to augment private transactions. In 2009, those purchases were $450 billion or about 10 percent of its GDP and 28 percent of its exports of goods and services.

The U.S. trade deficit with China and on oil causes a shortage of demand for U.S. made goods and services and stifles investment in U.S. export industries, which are the most productive and R&D-intensive industries.

In 2010, the trade deficit with China is reducing U.S. GDP by more than $400 billion or nearly three percent. Unemployment would be falling rapidly and the U.S. economy recovering more rapidly but for the trade deficit with China and Beijing's currency policies.

Longer term, China's currency policies reduce U.S. growth by one percentage point a year. The U.S. economy would likely be $1 trillion larger today, but for the trade deficits with China over the last 10 years.

A three percent revaluation of its currency will do little to change those numbers. In fact, because of Chinese modernization, the intrinsic value of China's currency rises each year. Hence, a three percent revaluation over the next year would not even amount to the change in yuan undervaluation.

As the U.S. trade balance with China grew worse, Beijing could say "see exchange rates don't matter."

Beijing is playing the Obama Administration for fools. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.

 

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