China: Is China's Currency Peg the Culprit behind US Economic Woes?

2004

Lynette Ong

US manufacturers and bureaucrats alike have been calling for China to abandon its fixed exchange rate regime, citing the reason that China’s ‘undervalued’ currency has given it an unfair competitive advantage thereby robbing thousands of Americans of their jobs.

The argument goes like this: the US manufacturing sector has been shrinking for years, and no jobs have been created despite the feeble economic growth registered since late 2003. It is thought that this is due to the influx of Chinese products in the US market, reducing the demand for US-made goods and American labour. Why are Chinese-made goods selling like hot cakes in the US? This because, according to this line of argument, China’s currency – the yuan – is undervalued, that is, it is trading below the market-determined level. The Chinese yuan is currently pegged to the US dollar at 8.27 yuan/dollar. The ‘undervalued’ currency is said to give Chinese manufacturers an ‘unfair’ competitive advantage that is reflected, for example, in US trade deficits with China - amounting to around US$120 billion in 2003.

This story sounds all too familiar. Twenty years ago, Japan was criticised for having huge trade deficits causing job losses in the US. Japan acquiesced and raised the value of its currency, but that didn’t help Detroit carmakers recapture their lost market share!

Trade is based on comparative advantage – country A exports to country B the goods for which it has a comparative advantage, and country B does the same. The US being an advanced economy has long lost its comparative advantage in the low-end manufacturing sector, which is reflected in the increasing share of the services sector in its economy. US companies continue to move operations off shore seeking to maximize profits by minimizing production costs. China, a developing economy with a huge labour surplus, naturally has a comparative advantage in labour-intensive industries. China imports capital and high-tech machinery from the US, and it exports finished products back to the US.

The trade deficit, however, has more to do with the Americans’ spending and saving patterns than the value of the Chinese yuan. Joseph Stiglitz, the former chief economist at the World Bank and a Nobel Economics Laureate, commented in the Guardian on 15 October 2003, ‘if a country invests more than it saves, it will need to borrow, and the counterpart to that borrowing is a trade deficit’. Critical of the Bush regime, he adds: ‘America’s burgeoning trade deficit is a result of Bush’s unprecedented mismanagement. Tax cuts that the US could ill afford turned a huge fiscal surplus into a massive deficit rather than saving. America is borrowing, much of it from abroad’. Fundamentally, a country’s trade balance has more to do with its domestic economic policies, rather than the exchange rate of its trading partner, which is just the valve controlling the flow of goods.

Further, a major reason why China has become the factory for the world is that previous suppliers of the US market from Mexico, Japan, Taiwan, and Korea, have been relocating their factories to China. Restricting the flow of Chinese goods into the US by forcing an appreciation of the yuan is not going to solve the problem; US importers and consumers will very likely then switch to low-cost products from other developing countries!

WATCHPOINT: With the US Presidential election coming up, will pressures for a yuan revaluation intensify as the US government tries to win the support of politically powerful protectionist factions?

 

About our company:

AFG Venture Group is an Asia and Australia based corporate advisory and consulting firm with over 20 years experience in creating alliances, relationships and transactions in Australia, South East Asia and India; including a 15 year history of corporate and equities advisory in Australia, undertaking merger, acquisition, divestment, fund raising and consulting for private and public companies.

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