So much has been written about China’s devaluation of its currency last week that it’s hard to believe that all the major angles haven’t been covered. In fact, they’ve been generally neglected, and none more so than what matters most to the U.S. economy – how the yuan’s government-controlled movement affects the prices, and therefore the competitiveness, of Chinese imports that compete with American counterparts in the American market.
The big takeaway is that although of course China’s policy of artificially manipulating the yuan’s value versus the U.S. dollar has a lot to do with whether American customers buy Chinese- or U.S.-made goods – with big effects on American growth and employment levels – currency movements are far from the only determinant. As a result, U.S. policymakers need to keep in mind all the other measures China uses to gain trade advantages for reasons having nothing to do with free trade or free markets.
Let’s start to show why by looking at where the yuan stood on July, 2005. That month, a dollar bought about 8.28 yuan, an exchange rate that had stayed constant since the fall of 1998, thanks to Beijing’s determination to peg its currency to the dollar even though economic conditions signaled the yuan should have been getting much stronger. But on July 21, China began letting the yuan float versus the dollar to a limited extent – that is, allowing market forces to play a limited role in setting the exchange rate.
This tightly circumscribed “float” continued through July, 2008, when the weakening global economy persuaded China to reestablish the peg. During those three years, the yuan strengthened versus the dollar by more than 16 percent – which should have provided a major competitive boost for American goods and services competing against Chinese imports (as well as against Chinese rivals in China’s own market).
But U.S. Labor Department data on import prices shows that those from China rose by only 5.18 percent during that period. Clearly, something else was influencing Chinese cost levels – notably a wide range of state-provided subsidies. But largely because Washington ignored all these Chinese government props, those three years were a time of huge American manufacturing trade deficits with China, which translated into major production loss and even worse job destruction.
More evidence that Chinese price levels were huge outliers: During this period, the dollar weakened by 14.94 percent versus a statistical basket consisting of most other foreign currencies (the Federal Reserve’s “Broad” index). That’s slightly less than it weakened versus the yuan. Yet the prices of U.S manufacturing imports overall (a good point of comparison since manufactures dominate what America buys from China), rose by 15.90 percent – more than three times faster than the prices of China’s imports.
These divergent relationships have persisted through the various ups and downs experienced by the dollar, the yuan, and other foreign currencies since then. To some extent, that’s not terribly surprising, given all the other factors that affect the prices of traded goods, and given that prices never change in lockstep with exchange rates. But what is surprising – and disturbing – is how consistent China’s outlier behavior has remained over the decade since that first July, 2005 loosening.
During this period, until the Chinese devalued on August 11, the yuan became 25.10 percent stronger versus the dollar, while the dollar became 4.46 percent stronger than that Broad index of foreign currencies. Yet import prices from China rose by less than half the amount that overall U.S. manufacturing import prices (4.26 percent versus 11.50 percent). And not surprisingly, despite widespread claims that China is steadily losing competitiveness versus rivals both from the United States and from other developing countries, China’s merchandise trade surplus with the United States is still rising strongly – though its latest 9.80 percent year-to-date increase through June lags the growth of the world’s manufacturing trade surplus with America (15.85 percent).
Asking Washington to focus on that full range of artificial Chinese competitiveness supports seems pretty unrealistic given the bipartisan, decade-long failure to do anything about currency manipulation. Unfortunately, that’s also largely why a return to full health for the U.S. economy, fueled by investment and production rather than borrowing and spending, seems pretty unrealistic, too.
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