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.
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?”