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Actually, Obama – let's keep the renminbi devalued

By Evan Chow
web posted September 12, 2011

MoneyA while ago, you might have read in the paper about China's plan to keep their currency, the renminbi, intentionally devalued on the foreign exchange market. So far, artificially reducing the renminbi's value appears to have worked very well in increasing exports, boosting internal production, and creating jobs. Because of this artificially induced comparative advantage, China has enjoyed enormous trade surpluses and rapid industrial growth. In a 2010 G-20 press conference in Seoul, Korea, President Obama asserted that China should stop this devaluation policy, as to let markets raise the currency's value to its natural level. He said:

"And the issue of the RNB is one that is an irritant not just to the United States, but is an irritant to a lot of China's trading partners and those who are competing with China to sell goods around the world. It is undervalued. And China spends enormous amounts of money intervening in the market to keep it undervalued. And so what we've said is it's important for China in a gradual fashion to transition to a market-based system."

These concepts of laissez-faire for Chinese money sound promising - and perhaps even unselfish, in order to "help" other nations (Obama won the Peace Prize, after all!). While endorsing laissez-faire currency values may help China, though, what President Obama proposes will actually harm the US economy in two specific areas.

First, let's consider our heavy reliance upon Chinese imports. To start with a statistic: in 2009, we imported almost $300 billion from the Asian nation [according to a table on the US-China Business Council website]. We have enjoyed much more purchasing power and a higher standard of living, simply because we can import and purchase so much from China at low prices. Because of China's comparative advantage, you can find "made in China" tags most anywhere in US stores. In addition, we have been able to import most "cheap" goods that don't require skilled labour. This means that instead of having to waste labor and resources on inefficiently producing "cheap" goods, we can focus instead on investments in capital and developing technology. It's inefficient for a small country to have to produce weapons, food, consumer goods, and capital completely by itself. This means we can also focus on those industries where we have an absolute advantage or comparative advantage or both. Even further, this foreign competition has forced our own industries to become more efficient and innovative. If one were an ice cream seller, and he knew that cheap imported Chinese ice cream threatened his business, he would  have to start working harder, or think of something innovative! The artificial devaluation of the renminbi has counter-intuitively proved beneficial for our nation.

If the Chinese currency significantly rises in value, then we would naturally lose these advantages. We would not enjoy a higher standard of living, unless we found the same prices elsewhere. Our economy would become sluggish, as we would have to divert our money toward inefficient industries - just as if Japan had to produce all its food and resources by itself. Due to the necessary resource distribution, we would not be able to invest in humancapital, physical capital, or technology as much. And furthermore, much of the laborforce would waste their education and skills, because their manual labor would be needed elsewhere. To provide a mental picture, image seeing trimmed businessmen ruining their nice coats in greasy factory work. As you would expect, efficiency would decrease. With less foreign competition, many of our own industries and much of our labor would lose that incentive to work harder or smarter.

Second, Obama's proposal for "laissez-faire" Chinese money will further increase our debt to China. As we import Chinese goods, they acquire our dollars. Instead of buying American goods, they instead invest it back in our economy - purchasing securities and bonds. While this means we are indebted to China - it's similar to as if we explicitly borrowed money from them - purchasing Treasury notes lowers our national interestrate. This encourages domestic businesses and people to invest, which grows our economy. The renminbi devaluation helps grow our economy - although it has also increased our trade deficit. As of August 2010, China holds almost $870 billion of our dollars in the form of treasury securities. With the actual dollars acquired from China, our politicians have funded government programs and such.

Increased value of the renminbi will [in a roundabout way] lead to ultimately harmful results. It will encourage Chinese to purchase more of our products (rather than the reverse), and thus, we will have more renminbi than dollars, and they will have less dollars than renminbi. Because they will have less dollar bills, and thus invest less, fewer Treasury notes will be purchased, and interestrates will rise, though the situation will dictate by specifically how much. Although our trade deficit will decrease, our economy may see some decreased growth as well - due to higher interestrates and fewer dollars to invest. And unfortunately, decreased production will not help our trade deficit; the decrease in both will cancel out any relative gains.

Although Obama seems to have been trying to establish "peaceful" relations with other nations, by "helping" and "respecting" other nations he may be, deliberately or not, advancing the decline of his own. Raising the renminbi's value will help China in its purchasing power and imports*; however, it would strip the US of the advantages we've been enjoying. Nevertheless, because of a large current debt – $3.2 trillion – China may eventually find it necessary to revalue its currency, and our advantages may then be inevitably lost. ESR

*China's been doing very well, though, and the tradeoff between purchasing power/imports and exports/internal growth has been exactly what they want. I'm sure they wouldn't mind keeping it.

© 2011 Evan Chow


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