Yen-Yuan: China Currency "Valuation"

Irrelevant for US Trade Deficit

11 September 2010

For more than a decade, Beijing has kept the value of the renminbi, also known as the yuan,
more or less constant to the dollar,

a strategy that critics say increases the price of American exports to China and fuels the
rapidly growing trade deficit with Beijing.

Lost in the noise, however, is the question of whether de-linkage would actually have
any effect on the trade deficit.

On this, the United States’ 40-year history of pressuring Japan to let the yen appreciate
against the dollar is instructive.

It indicates that de-linking the yuan would make barely a dent in America’s trade
deficit.

Luckily, this history also points to a different, more effective way for the United States
to benefit from China’s economic growth.

The Japanese story began in August 1971 when, with the American economy under strong
inflationary pressure,

President Richard Nixon took the dollar off the gold standard, letting its value fall.

At the same time, with our trade and current-account balances going from surplus to deficit
because of rapid export growth in Germany and Japan,

President Nixon began pushing the other industrialized countries to allow their currencies to
appreciate.

With Japan — whose yen was fixed at 360 to the dollar — Nixon played hardball,
temporarily imposing a 10-percent surcharge on imports and banning soybean exports to the
country.

The strategy worked.

That December Japan and nine other countries agreed to let their currencies fluctuate against
the dollar within a narrow range of exchange rates.

The yen shot up to 315 by the end of the month.

Still our trade deficit with Japan continued to grow.

At the end of 1970 it stood at $1.2 billion; by the end of 1972, with the yen at 302 to the
dollar, it was $4.1 billion.

Thanks to changes in the global economy, the multilateral currency agreement soon
failed, and this allowed the value of the yen to continue rising.

By 2006 it stood at 119 to the dollar — more than three times as expensive as in 1971 —

and yet the deficit hit an all-time high of $90 billion.

What happened?

Whatever effect yen revaluation might have had was outweighed by two far more
potent forces:

American consumers’ insatiable demand for Japanese products

and Japanese producers’ ability to cut their costs and stay competitive.

There is no reason to believe that things would be any different with Chinese goods
today.

So, might it work to instead use tariffs to make American goods more competitive in
China?

Probably not.

The problem is that the United States lacks the domestic industry to make many of the
things we currently buy from China.

And China would retaliate with tariffs of its own, hurting our exports to the country,

which have recently been growing faster than those to anywhere else.

Fortunately, there are other ways to deal with our trade deficit with Beijing.

For one, America could substantially increase its exports, a goal embraced by the Obama
administration’s

National Export Initiative, which calls for doubling American exports in five years.

This initiative focuses on the 99 percent of American companies that do business

exclusively within the domestic market.

Many of them are in sectors where our technology leads the world — like biomedical
and clean-tech products.

Many of these companies are too small to move into the global market on their own,

but with federal support they could significantly raise American exports.
For maximum effectiveness, President Obama should pair his export initiative

with a push for China and other countries to increase their direct investment in the
United States.

Here again, our history with Japan is instructive.

As Japan’s surplus with America ballooned during the 1970s and ’80s,

its companies began building factories and making other substantial investments in the
United States as a hedge against protectionist measures —

after all, tariffs wouldn’t apply to products made by Japanese companies

here.

This was a boon for the American economy: through 2007, Japan had invested almost
$260 billion, supporting more than 600,000 jobs.

Chinese companies should be persuaded to do the same today.

American purchases of Chinese goods have helped create vast pools of Chinese capital, and
there are things to do that can bring some of that money back home.

Fighting China over the yuan is a losing battle, according to this provocative analysis from
the New York Times.

There are better ways to use the global economy, and China’s rapid growth, to put
money into the pockets of American workers.