Thursday, October 13, 2011

Different Perspective On China's Currency Manipulation

Some Americans share the belief that because lots of Chinese yuan's exist out there, they have a competitive advantage in the export market, and are making a killing selling their products to America.  However, it is not the number of yuan's that matter, but the change in yuan's over a given time period, and whether those changes were expected.

To illustrate, would our trade flows be any different if, instead of the yuan, China used a different currency called the screw-US, and if there were two times as many screw-US's in this new world than there are yuan's in the real world?  Surely, an American dollar would purchase more screw-US's than it can yuans, but does that mean Chinese products will be cheaper?  Of course, not, because the price of Chinese goods in screw-US's would be twice the current price of those goods in yuan's.

It is not the amount of yuan's that matter, but the unexpected changes in the yuan.  If the Chinese government prints more yuan's without telling their citizens or the world, the exchange rate would indeed change such that more U.S. dollars bought more yuans, and Chinese products would become cheaper--temporarily.  However, unless everything I know about the world is wrong, that increase in yuan's will eventually translate into higher Chinese prices, and Chinese goods will no longer be so cheap.

Moreover, if everyone knows how many additional yuan's will be printed in the next month, that expected rise will be manifested in higher Chinese prices, a lower exchange rate (more yuan's for every dollar), and there will be no change in trade flows.

I say all that to say this:  if it is only the unexpected change in yuans that matter, and if we forced China to reduce its yuan's by a certain amount--an amount known with certainty--how would that benefit us?

It would not, and that is why trade policy is better understood from a public choice perspective.

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