Five or six years ago in the green room of the D.C. satellite of Fox News I met Sen. Lindsey Graham (R-SC). Upon discovering that I once taught economics at Clemson University and had lived in Seneca, SC (where he has a home), he inquired about my opinion of Chinese currency manipulation. No more than ten words of my reply escaped my mouth before it become clear that Sen. Graham was not really interested in my opinion. Instead, he assumed that I shared his notion that the Chinese government manipulates the yuan in order to render that currency unfairly undervalued against the U.S. dollar – and that this undervaluation, in turn, harms the American economy. Upon realizing that I regard his notion as economically mistaken, he tuned me out and became noticeably contemptuous of me – me who, I’m sure, he then pegged as an egghead academic who doesn’t understand reality in the crisp, clear, and complete way that he, a politician, understands it.
I pressed on, posing to the politician a number of relevant questions – questions such as “How can Beijing artificially devalue the yuan without such devaluation causing the prices of Chinese exports eventually to rise?”; “Even if Beijing manages for a long time to keep the value of the yuan artificially low, because such an effect will necessarily raise Chinese producers’ costs of purchasing the many inputs that they buy on global markets, why are you so confident that China’s economic growth is fueled by currency devaluation?”; “Even if Beijing manages through currency manipulation to artificially reduce the prices that Americans pay for exports from China, why is that bad, rather than good, for Americans?” The senator answered none of my questions. Fortunately for him – and for me (because I thoroughly dislike being in the presence of all but a tiny handful of politicians) – he was soon whisked away to his t.v. appearance.
I recalled this unpleasant meeting when I read this excellent essay (gated) in today’s Wall Street Journal by Dartmouth economist (and Tuck School of Business dean) Matthew Slaughter. Dean Slaughter very nicely explains some of the basic economics of why charges of currency manipulation – such as those trumpeted by Sen. Graham and, especially lately, by Donald Trump – are trumped up. (Politicians and rent-seeking business people aren’t the only people to complain, using faulty economic logic, about currency manipulation. Some Nobel-laureate economists also sometimes issue such complaints when doing so suits their partisan agenda.)
Here are some slices from Dean Slaughter’s essay:
Reasonable people can and do disagree about how countries conduct their monetary policies: what price should the central bank fix, or at what pace should that fix evolve. But to label as manipulation the conduct of monetary policy itself betrays a fundamental confusion about the operation and goals of central banks. If Zhou Xiaochuan,governor of the People’s Bank of China, is a currency manipulator, then Janet Yellen is an interest-rate manipulator.
Movements in the nominal yuan exchange rate have almost no long-term impact on global flows of exports and imports or on broader considerations such as average wages. The exchange rate that matters for trade flows is the real exchange rate, i.e., the nominal exchange rate adjusted for local-currency prices in both countries.
The real exchange rate, in turn, reflects the deep forces of comparative advantage such as technology and endowments of labor and capital. These forces drive trade regardless of monetary policy.
Long-term movements in nominal exchange rates often have nothing to do with the evolution of global trade flows. In the generation after the Bretton Woods system dissolved, the dollar steadily depreciated against the Japanese yen, from its fix of 360 yen per dollar to an average of just 94 in 1995. Over that time did the U.S. swing into a massive trade surplus with Japan? No.
From $1.2 billion in 1970 the U.S. trade deficit with Japan rose by a factor of 50, to $59.1 billion in 1995. From 2004 to 2014 the dollar similarly depreciated—note, not appreciated—against the yuan by about 25%. Over that decade the U.S. trade deficit with China soared—not fell—from $161.9 billion to $342.6 billion.