A Revalued Yuan: Be Careful What You Ask For

U.S. Treasury Secretary Timothy F. Geithner made a brief stop in Beijing on Thursday, meeting for 45 minutes with China Vice Premier Wang Qishan in a private room at Beijing Capital Airport. Although details of the discussion have not been released, the obvious purpose of the meeting was to discuss face to face whatever agreement the two countries have made regarding the currency issue.

In an effort to repair the relationship between China and the United States, it appears that a deal was made over the past week between the presidents of the two countries. Faced with nearly 10 percent unemployment, the Obama Administration has been under growing pressure from many congressmen to brand China a “currency manipulator” in a report which it was due to deliver on April 15. In exchange for the administration delaying this report, Chinese President Hu Jintao has agreed to give President Obama “face” by attending the nuclear summit he is hosting in Washington this coming week, and by taking steps to revalue the yuan.

All three are relatively minor concessions in my opinion. Labeling China as a currency manipulator would touch off a major trade war, something that nobody wants and that would only harden positions on both sides. As the second leading economic power in the world, China wants to be involved in meetings discussing global events, so attending the nuclear summit is something it should do anyway. And as many China watchers have noted, China was likely to begin allowing its currency to appreciate against the dollar for its own reasons. Once again, no big concession. The consensus opinion is that China will unhinge the peg to the U.S. dollar in the coming days and allow the value of the yuan to appreciate gradually.

Apart from the political hay which President Obama will likely make of any decision by China to allow its currency to appreciate, what will a revalued yuan mean for ordinary Americans?

I have always believed that the currency debate with China has more to with politics than economics, because the connection between changes in currency policy and trade is not clear. As I have noted in previous posts, Japan’s exports to the United States continued to increase in the mid-1980s, even after the country allowed the yen to appreciate significantly against the dollar. Similarly, China’s exports to the United States increased by 40 percent from July, 2005 to July, 2008, a three year period which saw the yuan appreciate by 21 percent.

While a stronger yuan — and a weaker dollar — is widely considered to be a good thing for U.S. manufacturers, it will cause problems for Americans. As pointed out by a CNN.com article over the weekend, a revaluation won’t bring many jobs back to the United States. “Much of the nearly $300 billion in Chinese exports annually are not going to suddenly start being produced at U.S. factories simply because of a rise in the value of the yuan. Labor costs are still going to be lower in China.” To make its point, the article quoted Mark Vitner, a senior economist with Wells Fargo Securities, as saying, “The labor-intensive parts of the manufacturing base that have been lost here are never coming back.”

In exchange for little gain, the article listed the following risks of a higher yuan:

• Higher Prices for Chinese Goods. Chinese products will become more expensive for U.S. consumers.
• Higher Interest Costs. China has been keeping the yuan cheap by buying massive amounts of U.S. dollars and Treasury securities. If the yuan is allowed to float freely, China won’t need to buy as much. And that could mean higher interest rates on U.S. Treasury notes, and higher borrowing costs for many U.S. homeowners and businesses.
• Higher Commodity Prices. A slide in the value of the dollar, which in turn could raise the price of imports from elsewhere in the globe for products such as oil.

I was taught in my economics courses at Yale that a country is best served by a strong currency. In pressing so hard to lower the relative value of the dollar, the Obama Administration should be careful what it asks for.

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