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What is currency manipulation and why should I care?

The US Senate is getting ready to pass a bill that would allow the gov’t to place a tariff on Chinese goods equal to the amount that Chinese currency is undervalued.

If that sentence makes complete sense to you, and you feel like you understand its implications, congratulations! You’ve clearly been working on your economics degree. If you’re like me though, you might want need further clarification. Today we’ll be looking at the general idea of currency manipulation so we can talk about the bill tomorrow.

Is China’s Currency Undervalued?

The answer to this is a resounding “yes.” It’s no secret that China has manipulated the value of its currency for years, unless you live in China where the People’s Daily throws a fit anytime the word “manipulator” is whispered. The current estimate is that the RMB is undervalued by as much as 40%. This means that the value of the Renminbi is set by gov’t bankers, instead of by the open market.

Value of RMB versus USD Note the period from mid 2008 to mid 2010, that's not normal

Currency though, is kind of an abstract concept, so we’ll look at how this happens with something that’s a little easier to grasp:

Open market: Let’s say I have a pile of shiny rocks that many people want. Because of supply and demand, the more people who want those rocks, the higher the price of the rocks goes.

This is how most currencies work, and the USD is often strong, because so many countries use it for trade. There is a (somewhat) fixed supply of dollars, and demand or lack there of moves its value freely. 

Fixed price: Again let’s say I have a pile of shiny rocks, and again many people want them. However in this case, I don’t want the price to change. So every time I sell a rock, I go and find another one. This balances supply and demand, which keeps the price at a set level.

This is the essence of China’s system, every time a businessman wants to buy RMB for doing business in the country, the price of China’s currency would go up unless the gov’t created a supply of RMB of an equivalent value. According to Patrick Chovanec (an economist at Tsinghua university) China has had to print an RMB equivalent for every dollar of it’s $3 trillion foreign currency holdings (read his full article for a much more detailed explanation).

What would a stronger RMB mean for Americans?

For the US an undervalued RMB means that Chinese goods are artificially cheaper in the US, and American goods are more expensive in China than they should be. Also the lower value means that it is cheaper to hire Chinese workers. This translates into factories moving overseas, and lower sales. This is bad for you if you work on a factory line in the US, or are trying to sell goods to China.

On the other hand, if you are an American consumer, or a CEO trying to lower your costs, cheap RMB is actually benefiting you. As Steven Colbert would point out, it’s because of China’s cheap labor that you can buy 10 pairs of socks at Walmart for $2. If those workers’ wages rise from $1 per hour to $1.05 (as it has over the past due to currency appreciation), the consumer is going to be the one paying for that invisible raise (their RMB pay does not change). As the value of the RMB increases, so will the cost of goods from China (which last I checked is almost everything).

What does a stronger RMB mean for Chinese citizens?

For Chinese workers a weak RMB is a mixed blessing. Low wages (partially enabled by a weak currency) have often been cited as a key ingredient in China’s rise. Cheap labor has helped to attract foreign investors and create millions of factory jobs. The weak RMB is great for China’s migrant workers, looking for a foothold in China’s urban centers. As the RMB climbs in value, more of these low skill jobs will move to Vietnam or Bangladesh (not back to the US).

For China’s middle class a strong RMB would make them feel richer. For instance, salaries at the hospital aren’t affected by the exchange rate, so if you are making 8,000RMB per month, over the past year your salary has gone from $1,200 per month to $1,256 per month. As you you start looking for foreign goods to spend your money, you realize that they are actually getting cheaper every month. The purse that would have cost 1,334RMB, is now just 1,278RMB. Not to mention that foreign travel suddenly becomes more affordable.

Middle class Americans who don’t work in manufacturing should be pleased with the flow of cheap goods, and China’s middle class would actually benefit greatly from a stronger RMB. Yet for some reason, the sides are switched, America is pushing for measures to make goods more expensive, and China is resisting the solution to part of its inflation problem. So tomorrow we’ll be looking at why the currency bill won’t help Americans.

In the meantime you may want to read “Is Inflation a Party Crasher?”


  1. Pelo says:

    Personally, I’d rather buy a more expensive shiny rock than a Chinese-made cheaper one any day. These cheap prices seem attractive on the surface, but they hurt the American economy on a much deeper level. I’m no student of Economics, but I understand some of the intricacies of how everything is interconnected. That said, I don’t believe a bill designed to encourage, i.e., push China into devaluing its currency will be effective. I believe the Chinese currency should come down, but trying to FORCE the Chinese into doing it is not the way to go in my opinion. A trade war won’t be in anyone’s interest. As a matter of fact, the passing of this bill may have the opposite effect of what the US wants.

    • Tom says:

      well said, cheap socks are great if you are in the market for really cheap socks, but it does hurt many other kinds of businesses, which is something I will be exploring in a later post.

  2. The first place to be hit adversely by such a Bill would actually be Hong Kong. There are XXX key reasons (and I’ll state them in concise, conclusive fashion):

    1. The Hong Kong dollar is peg to the US dollar at HK$7.80 to US$1. To all practical intents and purposes, the HKD is USD.

    2. The HK economy is NOT part of the Chinese economy (although HK is LEGALLY part of the PRC). HK is economically entirely separate from the PRC. Because of (a) the HKD-USD peg and (b) the fact that a substantial degree of the HK economy is geared towards trade with the USA, any econ/trade/commercial/logistical effect on the USA will be felt FIRST in HK – since HK is the starting point of the HK-USA supply chain.

    3. Hongkongers, living in a 100% capitalist economy (much more so than the USA itself is), knows full well the meaning of “currency manipulation” – which practically speaking is just another euphemism for hedged forex trade. (If you’re in the financial printing business like I am, then you should know this to be true.). We in HK know that EVERYBODY is a currency manipulator – if not, there would be no such thing as forex trading. Ask your favourite Wall Street forex broker for an explanation as to why buying and selling forex and profiting from the ‘spread’ is NOT currency manipulation.

    4. The biggest currency manipulators (for want of a better term) are: Russia, China, Singapore, Japan, UK (on/off), Hong Kong, Taiwan, Australia and … of course … the good ole USA. These countries CANNOT keep their forex markets running but for currency hedges (a.k.a. manipulation).

    5. The Bill now in the works in the USA is more political and politicising than straight economics. The difficult for most people (including myself!) to fathom and tease out the political hot air from the economic technicalities is that two aspects are married together in a highly disingenuous, convoluted way so as to allow ANY kind of theory to applicable and explainable. That, my friends, is actually quite amazing to me, and it suggests that the powers-that-be in charge of this Bill are highly cognisant of the ‘true picture’ of the currency situation – or else they wouldn’t have been able to come up with such a Bill.

    6. Hongkongers are natural-born speculators, and it doesn’t take much for us to suss out how this Bill will affect us first. Always ask a greedy, money-grubbing market mercenary like a 12-year-old Hong Kong kid for market predictions.

    So there, my twopence worth. Sorry for being longwinded again.

    • Baobo says:

      I didn’t know about Singapore. Is this something to do with Soros funds? (he is a CIA front, by the way)

      • No, nothing related to Soros or his stuff. The Singapore government trades forex, equities, bonds and other securities in open competition with other public- and private-sector securities establishments, mainly through various statutory bodies operated by the government (i.e. statutory public corporations). I thought this was so well known that I was risking being Captain Obvious – maybe I’ve become a wee over-familiar with this in my line of work. Anyway, so now we all know.

        It’s no secret that the Singapore government trades – it just doesn’t publicise its commercial involvement. It’s no conspiracy either – it’s just straightforward, sound monetary and fiscal operation by its central bank authorities. The city state is smaller than Hong Kong (which is seriously small already, at under 300 square miles) and (like Hong Kong) has to import 99% of its essential goods to survive on a daily basis. Without forex trading by the government, it wouldn’t survive. It’s not like in the USA, where things can get grown or made, whether sensibly or insanely.

        It’s the same story with the PRC. The whole country is in severe shortage of arable land – 10% of the world’s total arable land to support over 20% of the world’s population. If I were running the PRC (and I’m no pro-PRC type), I would OVERTLY manipulate the Renminbi to the hilt just to bash the rest of the world’s face in. In my book at least, even two meals a day for 1,300 million mouths to feed is considered heavy-duty pressure. Don’t get me wrong, I don’t like what I’m seeing in China, I don’t like the way they get things done, but I could appreciate where they’re coming from (sometimes).

  3. Mike says:

    Another possible reason America shouldn’t be so quick to encourage forcing the Chinese to make its currency float is that as long as the RMB is pegged to multiple currencies it will never become a competing reserve currency, which is something the Chinese and much of the world has been clamoring about since even before the 2008 financial collapse. If America wants to be able to keep being able to print out dollars to pay for stuff we can’t otherwise afford the longterm goal should be to make sure China keeps their money pegged to other currencies and therefore undervalued.

  4. Hua qiao says:

    Not wanting to steal Tom’s thunder, I suggest everyone go read Chovanec’s blog and then go on to read Michael Pettis in that order. Patrick’s writing is much more accessible and always spot on. Michael’s posts are brilliant but written more like a mathematical argument and sometimes a little hard to follow. They are the best and most consistent China economic analysts and, amazingly teach at Tchinghua and Beida respectively.

  5. Actually several factories have opened up in my area in the last year after moving operations back from China because they recognized the trend of the rising rmb and possible American actions to stop China’s currency manipulation. My state of South Carolina is offering big perks to companies who open up shop here long term. If the US just offered some incentives like bigger tax breaks if a company hired at least 80% of it’s entire workforce in the US then I think it could make a big impact on bringing jobs back to the states.

  6. […] value of the currency is controlled and remains […]

  7. Lao Why? says:

    If you have a trade surplus, you will be a lender to the deficit countries. That is an arithmetic fact. So the carping and lecturing by China to the US and Germany to the peripheral EU states is misplaced. If you don’t want to be a lender, then you must consume from those states. But if those states don’t make items you want or of good quality or at a reasonable price, then in an open market, the exchange rate will adjust to make those goods more attractive. (the issue is a little more complex but this is a basic truth). So now China does not want to allow that market adjustment and thus maintains a controlled currency where it decides the exchange rate. Most people would say they do this to ennsure employment and promote exports but China’s propaganda people go ballistic when this assertion is made (even though Wen Jiao Bao admitted this last year).
    The Bill in Congress will not be effective because it is just one part of the problem. For trade to balance, US and other western good imports will need to increase but many would assert that China does not want to open its market in a fair and even manner to foreign firms. It will use the plethora of laws and regulations to tilt the playing field towards favored mainland firms. Go read Am Cham’s report on the various ways competition is stifled. Anyone living in China knows it is easy for those in power to bend the rules and subtly use system to favor the “chosen ones”. Happens all the time. Happens with SOEs at the expense of SMEs and privately owned firms. Why would such behavior not happen when the SOE is up against a foreign firm?

  8. Hua Qiao says:

    You can really only peg to one currency. Otherwise, an arbitrage possibility will occur. As an example, the RMB has been pegged to the USD and, prior to the PIIGS meltdown, as the dollar weakened, the RMB actually weakened vis-a-vis the euro.
    Currency intervention versus currency manipulation is in the eye of the beholder. So if you say the 2 terms are equivalent, then yes, any central bank buying or selling currency beyond normal trading and investment capital flow needs is a manipulator.
    Japan certainly intervenes in yen/dollar markets to help fight the strengthening of the yen. Switzerland announced its desire to offset the huge demand for CHF as euro holders looked for a safer currency. Two things however, stand out about China. One is that it is the second largest economy and roughly 30% of its GDP revenue comes from exports (after netting imports, its about 9% of GDP). Secondly, it consistently runs a large trade surplus and therefore generates net dollars to be invested back in the US which suggests that the currency is significantly undervalued (although I think Tom’s number might be a little high). So unlike Japan, which is inconsistent in its frequency of intervention, China’s “purchasing of dollars” generated by its export sector as well as incoming investment is a regular event.
    Hong Kong, with all due respect, is too small to worry about. Indeed, that is really the story: China has “flown below the radar screens” of concern (although the US has been talking to China about this since 2001). But now the economy is big enough that everything China does impacts the rest of the world. It cannot continue with an export driven economy at its size and growth rate when the US and Europe are “loaned up.”

  9. […] Seeing Red in China Your guide to modern China Skip to content HomeAbout…About TomAbout Yaxue CaoAbout CaseyComplete ArchiveSuggested SitesChina Books to ReadThe Best China MoviesMap of China中文 ← What is currency manipulation and why should I care? […]

  10. 王帅 says:

    Is just political dust , since 5 years ago the rmb is very very under valuated not fresh news and really america doesnt need to do the items that China export for example textiles , toys and generally small commodities this items only pollute the water and air . Yes they have car plants , IT Parks but only to assemble and most are companies from Taiwan like Foxconn
    The future Looks like a japanization of the economy , strong currency , companies working for local market and goverment along chinese consumers subsiding exportations but China is far far away from japan regarding gdp per capita . It would be great watch how new generations will handle the crash,

  11. […] value of the currency is controlled and remains […]

  12. […] When the markets started to drop off in 2008, the gov’t took a number of actions to try and prevent a financial collapse in the middle kingdom. They made it easier for companies to get loans, pushed a massive economic stimulus, propped up domestic consumption by offering discounts on things like home appliances and cars, increased college enrollment to delay entrance to the job market (while preparing the next generation of white collar workers), and fixed the RMB to the USD (this one I’ve already discussed). […]

  13. […] Rate Risk – This means the potential loss that could happen if a bank or other financial institution would suffer if there was a major change […]

  14. Chibunna says:

    China’s Currency manipulation, what is your solution?

  15. Anonymous says:

    Of course, “manipulating” exchange rates in this way used to be orthodox policy, and everyone engages in a little currency massaging do they not? The trick is to tell when massaging eases intro manipulation and since who’s to say, this is always an intensely political process.

  16. Pansy says:

    Asking questions are actually pleasant thing if you are not understanding anything entirely, except
    this paragraph presents pleasant understanding even.

  17. Maybe you can write next articles referring to this article. I desire to read even more things about it! Nice post. I was checking continuously this blog and I am impressed! Extremely helpful information specifically the last part 🙂

  18. Bridgette Travers says:

    ” I didn’t wait to rip it open Avelina

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