Chinese “Yuan” Up on America

From the September 2005 Trumpet Print Edition

In July, China abandoned its peg to the U.S. dollar—which theoretically should help American exports. But are American interests actually in danger?

China has kept its currency, the yuan, pegged to the U.S. dollar for over a decade at around 8.28 yuan to the dollar. While America’s trade deficit has burgeoned and the dollar declined, the U.S. long asserted that China’s fixed-exchange-rate policy undermined American manufacturers.

The theory was that if allowed to float freely in the marketplace, the yuan would be substantially stronger against the dollar, thus making China’s exports relatively more expensive. In turn, U.S. consumers would be less likely to buy Chinese products, and U.S. manufacturers would be more likely to sell their own. Hence, the trade deficit would improve. (The U.S. trade deficit with China is larger than its deficit with all of Europe; it is larger than its deficit with Canada and Mexico combined.)

In a report to Congress on May 17, the Treasury Department warned China “that its currency policies were distorting world trade and it brandished the threat of retaliation against the country’s exports [i.e., tariffs] if Chinese leaders did not change course in the next year” (New York Times, May 17). Federal Reserve Chairman Alan Greenspan had told the Senate Budget Committee in April that China’s peg was beginning to have a detrimental effect on the Chinese economy.

On July 21, China abandoned its peg to the dollar and announced that the new rate, initially, would be 8.11 yuan per dollar—a change of only 2.1 percent, well short of the significant adjustment that Washington was hoping for. (Economists estimate that the yuan is undervalued by anywhere from 10 percent to 40 percent).

However, by abandoning its peg to the dollar, China allows itself the flexibility of further revisions as it deems appropriate. And there’s the rub. China, like any nation, acts primarily in its own self-interest. The peg was beginning to hurt its economy.

It has accumulated a stash of about $600 billion in dollar-denominated securities—enough to buy every major oil company in the U.S., if it could. To the extent the yuan is allowed to appreciate against the dollar, these securities become less valuable and China has even less incentive to buy more, which means it could become more difficult for the U.S. to finance its deficits. Interest rates would have to increase sufficiently to attract the needed funds, and the debt-laden American consumer would be hit very hard.

Paul Craig Roberts, who was assistant secretary of the Treasury under U.S. President Ronald Reagan, put it this way: “When China’s currency ceases to be undervalued, American shoppers in Wal-Mart, where 70 percent of the goods on the shelves are made in China, will think they are in Neiman Marcus. Price increases will cause a dramatic reduction in American real incomes. If this coincides with rising interest rates and a setback in the housing market, American consumers will experience the hardest times since the Great Depression” (American Conservative, July 4).

Only within the last 20 years has the U.S. become a debtor nation—today, it is the world’s largest at that. Now China has substantial leverage over the U.S. economy. As China moves forward, balancing the pros and cons of letting the yuan appreciate, it will not hesitate to act in its own best interests, regardless of the consequences to the U.S.