In the January 2010 Freeman I did my best to debunk some of the myths that surround the issue of currency manipulation as it affects trade. My column is below the fold.
Americans are importing more from China. Protectionists abhor this fact.
Explaining that American imports from China reflect nothing more sinister than the voluntary choices of American consumers does not satisfy simple-minded protectionists. It is sufficient that these imports take business away from some American producers. In the minds of simple-minded protectionists, international trade is harmful whenever it causes domestic business to lose market share to foreign rivals.
Not all protectionists, though, are this simple-minded. Some of them understand that resources have alternative uses and that prosperity is enhanced when each specific resource is used to produce that good or service that consumers value more highly than any other good or service that that resource could be used to produce. The “sophisticated” protectionist (if we may call him that) also understands the argument based on comparative advantage—namely, free trade encourages resources to be used in their most efficient ways.
But the sophisticated protectionist is still a protectionist. He cannot shake off his uneasy sense that imports somehow harm his country’s prosperity. So he eagerly latches onto almost any excuse to proclaim that he of course staunchly supports free trade “but not when foreigners do” this, that, or the other thing that allegedly nullifies the case for free trade.
The length of such a list is limited only by protectionists’ fertile imaginations: Foreign governments subsidize exporters; taxes and regulations in foreign jurisdictions are less burdensome than taxes and regulations in the home jurisdiction; foreign governments don’t have as much respect for human rights as does the home government does; foreign industries are older and more experienced and hence have an unfair advantage over domestic industries; imports are sold by their foreign producers at unfairly low prices; capital can freely move from one country to another. . . . Truly, the list is long and ever-growing.
An Idea With No Currency
A sound treatment of each item on the list requires more space than is available here. (Suffice it for now to say that none of these alleged exceptions to the case for free trade withstands careful scrutiny.) So let’s focus on just one such reason heard frequently now for why free trade is unwise: undervalued foreign currency.
The protectionist complaint about undervalued foreign currency rests on the indisputable argument that the lower the price of a foreign currency—for example, the Chinese yuan—the greater the quantities of this currency that will be bought. Just as a lower price for apples makes apples a more attractive purchase for consumers, a lower price for a currency makes it more attractive.
If the price of the yuan falls—that is, if it takes fewer dollars today than it did yesterday to buy yuan—people with dollars will buy more yuan.
Yuan, like dollars, are not themselves consumable but instead can be exchanged for goods, services, and assets. In the case of yuan, the goods, services, and assets that they can be directly exchanged for are supplied by the Chinese. So the greater the number of yuan that can be bought for a dollar, the less expensive for Americans are Chinese products relative to American products.
Therefore, a lower-priced yuan causes Americans to buy fewer U.S. products and more Chinese products.
Governments being what they are, it’s undeniable that many of them—including the one headquartered in Beijing—intervene in their economies in countless distorting ways. Let’s assume for the remainder of this article that the Chinese government does in fact keep the price of the yuan artificially low.
Does this policy help the Chinese and harm Americans?
False Savings
A low-priced yuan certainly shifts business to some Chinese producers and away from American producers who compete with them, just as genuine efficiency improvements in Chinese industry take some business away from American producers who compete with Chinese producers. But contrary to protectionists’ claims, Beijing’s efforts to lower the price of the yuan harms the Chinese economy and helps the economies (including that of the United States) whose people trade with the Chinese.
To see why, let’s use a close-to-home example.
When I was a child my elementary school—Immaculate Conception School (ICS)—held two fund-raising fairs each year. At these fairs we kids bought tickets that we could exchange for various trinkets and food. Of course, some items cost more than others. A big stuffed panda bear might have been priced at, say, 50 tickets, a hotdog at three tickets, and a pencil sporting the school logo at one ticket.
Using dollars, each of us students could buy as many or as few tickets as we pleased (or, more accurately, as many tickets as our parents could afford or would allow us to buy).
Suppose that ICS had undervalued its tickets. Suppose, if the “correct” price (by whatever calculus) was $1, ICS sold each ticket for 75 cents.
Undervaluing its currency in this way surely would have resulted in more sales at the fairs. A 25 percent discount on trinkets and junk food is a darned attractive deal for kids.
Would ICS have benefitted itself by such undervaluation of its medium of exchange? Some of its employees would have benefitted. The fairs would have required more clerks and food preparers to handle the larger demand. But it’s clear that undervaluing these tickets would have harmed ICS on net. Instead of raising money for its operations, ICS would have lost money. By underpricing its trinkets and junk food, it would have subsidized its students’ consumption of these things. Undervalued tickets would have enabled its customers (us students) to acquire valuable goods and food at prices below ICS’s cost of supplying them.
No student (including me) would have complained about undervalued fair tickets. Such undervaluation would have been to our benefit.
But the school principal (Sister Quentin, if I recall)—who we can imagine was the architect of this self-destructive scheme—would have realized, on coming to her senses, that artificially stimulating the school’s exports of trinkets and food on fair days is no path to long-run and widespread prosperity for ICS.
The situation with the Beijing government is identical. The real costs of the resources and outputs exported by the Chinese people are not lowered simply because Beijing keeps the price of the yuan artificially low. And the resources spent to supply the extra American demand that results from an artificially low price of yuan—even though they are unseen by the untrained eye—represent a huge cost that harms the Chinese economy.
