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China’s exchange rate: Problem?

By Sheyna Steiner · Bankrate.com
Friday, October 19, 2012
Posted: 3 pm ET

In this week's debate, the presidential candidates devoted a lot of attention to China and the valuation of its currency, the yuan. Republican candidate Mitt Romney stated that he's in favor of labeling China a currency manipulator while President Barack Obama maintained that the policies of his administration have led to an 11 percent strengthening of the yuan against the dollar.

Is China actually stealing American jobs with its exchange-rate policies?

"Keep in mind that everywhere in the world, it is far easier to blame foreigners for your problems at home than to actually blame your own policies," says Axel Merk, president and chief investment officer of Merk Investments, manager of Merk Funds.

Exchange rates: Not so simple

The exchange rate with China has a bunch of implications, but here are two:

  1. American exports are expensive there/Chinese imports are cheap here.
  2. Manufacturing has declined in the U.S., and some attribute the rapid decline over the past decade to the growing trade deficit with China.

A currency is valued relative to money from another country, and they're rarely one-to-one. More typically, one of the currencies is worth more than the other. For instance, one U.S. dollar was equal to 12.84 Mexican pesos on Thursday, according to The Wall Street Journal.

When one shifts up, the other goes down relatively.

If the Chinese yuan strengthens against the dollar, the dollar goes down. That should lead to a pick-up in American exports, which should be good for manufacturers and exporters in the United States.

But it wouldn't necessarily lead to significant growth in the manufacturing sector in the United States.

The story from National Public Radio, "Manufacturing jobs aren't coming back, no matter who's president," makes the point that manufacturing jobs have been in free-fall for decades.

"The decline of manufacturing jobs in the U.S. economy is not about who is president or what his policies are. It's the result of long-running, irreversible, historical factors (read: technology and globalization)," according to Jacob Goldstein, co-host of NPR's Planet Money podcast.

Competing on price is extremely difficult for the United States at this point and is actually a losing battle. Producing a lot of cheap goods increases the demand for the ingredients of those goods or commodities -- which causes their prices to go up. On the other side, the cost of doing business in the U.S. is higher than say … Vietnam or China, because U.S. employees have to be paid a certain amount, and there are important regulations on how businesses can operate.

"Manufacturers get squeezed on both ends. You have high input costs, and you have very little pricing power. So you accelerate your outsourcing. The exchange rate that Asian countries have had is one factor in this, but certainly not the only one," Merk says.

As production has shifted toward Asia and become more complicated, one potential outcome is that as the Chinese currency appreciates, their ability to set prices could lead to higher prices in the U.S., which could lead to inflation, according to Merk.

"But now the political argument is that the Chinese are stealing all our jobs, and if we just have a few taxes, they're going to come back." Another complication, he says, is that materials are not local. "The entire supply chain is over in Asia -- China in particular," he says.

For instance, China is dotted with more than 100 industrial clusters made up of specialized manufacturers with their own systems of supply chains and expertise.

But the trade deficit …

The Alliance for American Manufacturing, an industry trade association, believes that currency manipulation has hurt its industry.

China’s currency manipulation has contributed to the dramatic increase in the U.S. bilateral trade deficit with China, which now tops $295 billion a year. China has amassed foreign exchange reserves of more than $1 trillion, far surpassing any other nation’s reserves.

China’s currency manipulation also attracts foreign investment into China and away from American manufacturing facilities. This flow of investment already has cost American workers their jobs. When countries adopt artificial exchange rates not based on market forces, they not only exacerbate the U.S. trade imbalance, but they create global trade imbalances.

But the exchange rate is far from the only contributing factor to the trade imbalance with China, a 2011 report by the Council on Foreign Relations says.

According to the report, "Confronting U.S. - China economic imbalances," the trade imbalance with China could be the result of "increasing productivity in Chinese export firms -- a factor unrelated to exchange rates."

There is also evidence to suggest that much of the U.S. trade deficit from China comes from the many export-oriented U.S. multinational companies that have moved production to China to take advantage of its low labor costs. In 1986, only 1.9 percent of China's exports came from foreign-investment enterprises in China; in 2006, the share rose to 58.2 percent, a (Congressional Research Service) report notes.

Some economists argue that the use of foreign inputs in Chinese exports also dilutes the relationship between exchange rates and U.S.-China imbalances. In a November 2010 paper, analysts Yuqing Xing and Neal Detert use U.S. company Apple and its highly successful iPhone product to illustrate how structural shifts in global production networks have transformed conventional trade patterns. Technological software for iPhones is developed in the United States, while completed iPhones are exported by China to the United States. China is merely an assembly center, adding $6.50 to the $178.96 wholesale value of the product, they say, but when trade statistics are calculated, it ends up getting credit for the full value of the iPhone. "Conventional trade statistics greatly inflate bilateral trade deficits between a country used as an export-platform by multinational firms and its destination countries," they write.

Are tariffs needed?

Vilifying the exchange rate policies of one country may be politically expedient with the prolonged stretch of high unemployment here, but it could backfire by throwing a wrench into the trade industry in the U.S. and somewhat undercuts the U.S. position that we follow strong dollar policies.

Labeling China a currency manipulator would lead to economic sanctions in the form of tariffs or extra taxes on Chinese goods sold here.

"When you impose tariffs, you are hindering that part of the economy, blocking the part of the economy that has been the most flexible and adjusting to the world that we are in. ... You are subsidizing an economy that has not been competitive," says Merk.

"Historically, what happens is that a country that has a trade deficit imposes a trade barrier, that currency weakens," he says.

Instead of a strong dollar, the U.S. ends up with a weaker dollar, which does help exports but also has a couple of downsides, including the fact that it makes it easier for the U.S. to pay back debts, which is good for us but bad for everyone who buys our debt and finances the budget deficit.

"Which is a very dangerous thing to say when you have as much debt as we have," Merk says.

"There are a number of costs involved with trying to debase a currency, and one is inflation. It's being shrugged off by the Fed because historically that hasn't happened when the dollar has weakened. The other one is that you are selling out and making yourself vulnerable to take-over targets," he says. "When your currency weakens, foreigners have more purchasing power, and they can acquire companies in the U.S. or whatever they want to acquire."

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