China manipulates the value of its currency compared to those of other nations. It does this to keep its exports cheap to buyers and to keep other nations’ exports expensive for Chinese buyers.
China does this, however, from a position of weakness, not strength. In emulating the cheap currency export promotion policy Japan and other East Asian nations have pursued for decades, China mounted a tiger’s back. Dismounting is not simple.
For years, the Chinese currency was pegged to that of the United States at 8.28 yuan per U.S. dollar. Since 2005, the yuan has gained in value. It now takes only 7.4 yuan per dollar.
This is a 10 percent revaluation of the yuan (or a 10 percent devaluation of the dollar). But some critics argue the price of the dollar must fall even further, to 5.8 yuan per dollar, to eliminate trade-distorting manipulation.
Suppose that in early 2005, Chinese businesses exported goods worth $100 billion to the United States. Taking those dollars to the Bank of China, they got 828 billion yuan in return to pay for labor and raw materials and in profits.
The Bank of China then purchased $100 billion in U.S. Treasury bonds with the dollars bought from exporters. Now, suppose that in 2007 it sells the bonds and brings those dollars back after letting the price of the dollar drop to 7.4 yuan. The Bank of China now has only 740 billion instead of the 828 billion of new yuan it issued to buy the Treasuries. If the dollar had slipped to the level that would please the U.S. Congress – 5.8 yuan – it would have only 580 billion, 248 billion less than issued in 2005.
The yuan value of China’s dollar investments would have fallen in exact proportion to the depreciation of the dollar.
U.S. consumers would get products that were artificially cheap in dollar terms. Chinese exporters would get money for expenses and profits. Chinese workers would get more in wages than they would have gotten without the Bank of China’s intervention.
But the Bank would have lost 30 percent of the value of the money it created. That much of the “seigneurage,” or value that accrues to a government when it creates money, flowed to others in China and the rest of the world. The Bank of China would have to write that much off its balance sheet.
Yes, the balance sheet of a Central Bank that can create and destroy money is fundamentally different from that of a private business. But large central bank write-offs create political problems.
One can also argue the 248 yuan that would be written off was intended to subsidize Chinese exports and employment. It would do just that. Of course, some of the subsidy would go to relatively wealthier U.S. consumers via cheap products. That is not unlike the way some of the U.S. Treasury’s outlays for cotton subsidies benefit foreigners by driving down world cotton prices and lowering clothing costs in many countries. That does not make either policy sensible, however.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.