...The true aim of the revaluationists is a change in the terms of trade with China. Their hope is to discourage imports from China by making them more expensive, not through protectionist tariffs or outright trade barriers but rather via an obliteration of China’s longstanding dollar peg and a substantial appreciation of the yuan.
The revaluationists better be careful what they wish for. While a stronger yuan would make China’s exports dearer (at least temporarily), it also would make its imports cheaper. And there’s the rub. Less expensive imports of raw materials, industrial equipment, manufacturing technology and the like would eventually translate into lower export prices (and higher quality goods) as input costs declined and labor productivity rose. Thus, any gain from a shift in the terms of trade would be transitory.
This is a good point, a stronger yuan would make imported inputs cheaper and have a countering effect, though not completely, on the higher currency.
China’s export advantage will last as long as its labor costs remain low. These costs should rise, though, as the ratio of investment capital to labor capital increases, because greater automation and enhanced productivity typically leads to higher incomes and improved living standards. But that’s in a free market. What will happen in China’s hybrid capitalist-communist system is a matter of conjecture.
I think China has a significant labor surplus which won't change for some time until the effects of this one-child law for the Han Chinese eventually kick in.
The yuan isn’t convertible, meaning its foreign exchange is set by fiat and the normal linkages between domestic money supply and foreign exchange rates therefore may or may not pertain. This isn’t to say, however, that no connections exist between China’s domestic economy and its forex rate. They most certainly do. In the latter half of the 1990s, for example, when the dollar deflated as a result of unaccommodating Fed policies, the yuan-dollar peg transmitted the deflation to Chinese domestic prices. Indeed, were China to up-value its currency, it could expect another bout of deflation.
The last thing a rapidly growing economy with shaky financial foundations needs is a bout of deflation which is bad anytime, anywhere. Just remember the example of a $100,000 house with a $500,000 mortgage.
Yuan deflation surely isn’t in China’s interest. Neither is it in America’s interest, for a sizable Chinese currency revaluation would “substantially dampen” U.S. economic growth, as Larry Kudlow has made abundantly clear (“The China Mess,” April 19).
Indeed, 'cheap' Chinese imports aren't as cheap anymore.
Finally, any disruption of Chinese monetary stability would have adverse repercussions for the growing global trend toward dollarization. Indeed, dollar pegs like China’s shouldn’t be discouraged but rather encouraged.
The bit that I disagree with the most in the piece. Artificial market controls, like pegs, are useful for a time in a developing nation's development. However, invariably, the existence of an artificial control creates the opportunity for pressure to grow behind it. And with the exception of the Hong Kong dollar peg, they've all gone. It's much easier to hold a peg when the currency isn't convertible (open to speculative attack) but Brazil and Argentina had non-convertible currencies and they went painfully.
In fact the best time for a currency to go off any controlled regime is when its strong and bumping up against the top of its band - like the yuan today. However, as I noted here, for the Chicomms I really don't think its a good idea though it wouldn't make me terrifically upset if they did it and it went horribly pear-shaped.
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