by Marko Marjanović (author of the new Checkpoint Asia site) for The Saker blog
For decades now China has kept its currency undervalued to the dollar and the US and China have both acted as if this was a boon to China. It is anything but.
Yes, by keeping the yuan low China makes it easier for its good to compete on the American market, but only at the cost of leaving money on the table in every trade. What artificially undervaluing yuan really does is it artificially increases the purchasing power of American consumers and decreases the purchasing power of Chinese consumers.
If yuan is artificially undervalued by 20 percent it follows that an American import company looking to buy goods in China to sell on the American market is able to get 20 percent more than it would be able to in full market conditions. What this means is that the Chinese government intervenes in the market to make Americans better able to outcompete domestic Chinese consumers in the market for China’s own goods.
How in the world is that beneficial? Now, it is true that undervaluing your currency is part of the standard East Asian development strategy previously also used by Japan, Taiwan, Singapore, Hong Kong, and South Korea to successfully develop their economies, however it does not follow from that that every aspect of that strategy is beneficial. To develop one does not need to get everything right, but just a few things. And to race ahead of others one only needs to get more things right than the others. For sure, China has gotten many things right, but pegging yuan to the dollar at an artificially low rate is not one of them.
With a free-floating yuan that was allowed to appreciate to its real market value the Chinese would get to enjoy more of what they produce themselves (ie would enjoy a higher standard of living), and the profits in trade would not be affected a great deal at all, because the reduced volume of Chinese goods which was still going to the US would command a higher price, that same price which they command in yuan.
Instead we have the situation where a developing country has been for the longest time subsidizing consumption in one of the wealthiest. Obviously this does not hurt the Americans. They save money by buying the cheaper, Chinese-government subsidized goods and have that much more money left over to spend on other services and goods which are not sourced from China.
I can’t dig up the source now but I remember reading China a few years ago was subsidizing an average US household to the tune of $800 a year. That amounts to well over $100 billion a year. In fact because a currency undervalued to the dollar is by necessity also undervalued to every strong free-floating currency, such as the euro and the pound, this means that China has been likewise subsidizing Europe to the tune of another $50 billion at least.
What has been its reward?
Its reward for imposing austerity on its citizens and transferring the fruits of that to the Western World, allowing it $150 billion a year in savings that can be spent elsewhere, has been that it is demonized as an economic foe.
By raising the tariff wall Trump is threatening to make it impossible for the US consumers to benefit from Chinese-government subsidies. (Instead the subsidy will be collected by the US Treasury.) However that is really something Beijing should have beat him to.
Trump tariffs are a blessing. China should stop chasing after dollars whose value Beijing artificially overinflates, and which in view of the budgetary demolition derby engaged in by Washington needs constant propping up by the Chinese. Instead China should simply allow the yuan to float and therefore appreciate in value to the dollar. This would instantly transfer over a great deal of purchasing power to the Chinese consumer market making it far bigger. For China this would cover any tariff-driven losses, while the US would find it is having to suddenly pay far more for its Chinese goods and components. First to pay for Trump’s tariff, and then to cover the dollar appreciation to the yuan.
The real bonus would be however, that a free-floating yuan would be a far more credible candidate for a currency of international trade. China has tried hard to internationalize yuan, but with little success, because the fact that yuan is not even a real market currency, but just a dollar copy has naturally hamstrung its efforts. To become accepted, yuan first has to prove its stability on the market as a free-floating currency decoupled from the dollar — which as a currency that is actually artificially undervalued it easily could.
And that takes us to the next harmful oddity of the link to the dollar. Poor countries dealing with heavy inflation often peg their currencies to a stonger western currency because this represents a commitment that they will henceforth pursue hard money policies (at least as hard as the managers of the currency they’re pegging to). However for China whose finances are in far better order than those of the US it is absolutely insane and harmful to link itself to the kamikaze dollar.
With the US debt exploding and so much monetary expansion going on China can only maintain the peg by either propping up the dollar or destroying the yuan. So far it has done a little bit of both. Until 2008 it mainly kept the yuan and the dollar in the same range, by locking up $3 trillion of US debt in its coffers, and since 2008 it has gradually come to follow the US in its policy of “injecting” new money into the economy.
By conventional wisdom albeit these “injections” hurt the currency they are good for the economy. This is nonsense. Logically creating more currency does not create an economic good, it merely redistributes the existing purchasing power in the market of that currency.
The myth endures because it is convenient for governments and their supporters. A government which can create money out of thin air (usually by unbacked lending) is far more powerful in relation to the market and its citizens than one that cannot, and is not constrained by budgets or revenue — right up until it thrashes the currency and becomes totally impotent.
In fact, decoupling availability of credit from the level of capital savings in the economy makes reliable economic planning on the market impossible leading to boom and bust cycles. Far from a downside, it would be a good thing for China to abandon money bomb policies. Luckily Beijing is nowhere near as far down this road as the US is, and could do so much more easily.
So by ending the dollar peg and reconciling itself to an appreciating yuan China would finally:
— End over $150 billion in yearly subsidies to Western consumers
— Boost Chinese living standards by over $150 billion in yearly spending
— Eliminate the need to spend (or hold) trillions in US treasuries to prop up the dollar
— Eliminate the need to mimic US currency-depriciating policies
— Set the yuan on the path to displace the dollar as the currency of international trade
Imagine a world where the US can no longer willy-nilly sanction anyone it pleases. A world where unilateral US sanctions on the poor “rogue” nation of the day merely mean that America is cutting itself off from them, but they can still freely trade with everyone else because all of that happens via Chinese banks.
Imagine a world where the Empire is actually again constrained by US revenue. Where it can no longer run deficits of any size it damn pleases. Imagine a world where the US actually has to pay for its imports with exports because nobody is in a particularly urgent need of its paper.
This is what I’m talking about. A free world. But I guarantee you it won’t happen for as long as yuan remains a second-rate copy of the dollar, no matter how actually undervalued. Beijing needs to let yuan grow up and enter the exchanges without the presence of its overbearing commissar parents.
It is the currency of the the largest exporter, with the largest trade surplus, and the largest reserves. It will do well. Why are we still trading in and accumulating the currency of the country with the largest deficits, largest debt, and last able to finance its humongous imports? There is no need. We have something much better, if only Beijing can stand to let go off some of the illusion of control. If Trump pushes it to do so we should build him a monument.
Marko Marjanović is the former deputy editor at Russia Insider of four years. Before that he ran a blog on Eastern Europe for five. He now publishes the news site Checkpoint Asiawhich serves delicious Empire hatred.