Thursday, May 06, 2010

The Irrelevance of Yuan Revaluation

Good article in today's Wall Street Journal by WSJ Asia editor Joseph Sternberg, sub-titled "You're not going to change the balance of China trade by adding 25 cents to the cost of a T-shirt."

To some in Washington these days, adjusting the yuan-dollar exchange rate is the fix for all America's ills. That single number supposedly determines which jobs stay in the United States and which go to China. It dictates which and how many goods move where. It's attributed the mystical power to raise or destroy mighty economies by its movements or lack thereof. Except that the real world doesn't work that way.

Mr. Sternberg then explains why the "revaluationists" have it wrong when they assume that the bulk of the value of imported Chinese products is exposed to the value of the yuan, when in reality only a portion of imports from China are exposed to exchange rates:

Take a $10 pair of boy's summer shorts: $2.50 is cotton, the price of which won't change with a revaluation because it's a globally traded commodity priced in dollars. Another $2.50 (perhaps) is profit. That leaves roughly $5 in Chinese labor and other yuan costs that are affected by a revaluation. Subject that portion to the 5% revaluation (that's at the upper range of current expectations for what Beijing will do) and the shorts now cost . . . $10.25.

And that $0.25 increase from an appreciation (depreciation) of the yuan (dollar) won't have any meaningful effect on the balance of trade like the revaluationists would have us believe. There's also the important issue of shifting production to other countries, which also weakens the revaluationists' case:

When China becomes too expensive, manufacturing moves elsewhere in Asia—not back to America. Rising labor costs, higher taxes on foreign businesses and the like have already pushed ultra-low-price T-shirts and jeans to the likes of Vietnam or Bangladesh. What remains in China are higher-value-added, more profitable name-brand products.

So according to the arguments made here, a revaluation of the yuan won't change anything meaningful, and certainly won't affect jobs in the U.S. And as I have argued before, to the extent that an artificially overvalued dollar (undervalued yuan) has any effect at all, the overall effect is positive for the millions of U.S. consumers and thousands of American businesses that purchase products imported from China.


At 5/06/2010 8:26 AM, Anonymous morganovich said...

this is a bit of a straw man argument.

the throws out a 5% revaluation number for a currency generally thought to be 40 or 50% mispriced.

that would add $4-5 to the price of the shorts and likely make a considerable difference.

i'm not arguing that yuan valuation is the primary cause of our trade deficit, but this argument that it is irrelevant seems awfully weak to me.

At 5/06/2010 8:33 AM, Anonymous Anonymous said...

And, water flows uphill.

Vietnam is more likely to buy from us than China, which will use protectionist valuation to protect domestic industries.

Also, the example does not adjust input costs to currency valuation, so the effect might be quite different...that revalued yuan purchases more foreign cotton at a lower price, increasing in cotton producing countries.

At 5/06/2010 9:02 AM, Anonymous CompEng said...

I'd focus more on the Chinese consumers: how can they afford to buy anything we make, like software, without a Yuan revaluation? One of the reason piracy is so rampant in Asia is that the prices of imports seem so ridiculous.
I suppose iconoclasm is useful, but it certainly seems to give one tunnel vision in some respects.

At 5/06/2010 9:15 AM, Blogger PeakTrader said...

The E.U. fiscal crisis increased demand for U.S. dollars and Treasury bonds.

Falling exports and rising capital inflows should benefit the U.S.

Americans will work less for foreigners and the cost of capital will be cheaper.

It's better to exchange worth less paper assets for goods rather than goods.

At 5/06/2010 9:58 AM, Anonymous gettingrational said...

If yuan revaulation is slight then let the market decide and not the central planners of the PRC.

As Juandos and morganovich have pointed out, re: today's Monster employment survey, long-term unemployment is nearing post WWII highs. Trading jobs for goods is preciously insane. If the yuan rises through market forces then U.S. goods and services have more a chance in the PRC.

The argument that worthless dollars are exchanged for goods is vaucuous and deceitful. The holders of massive amounts of dollars have many avenues to put them to work including: buying commodities, foreign companies (in part or whole)and avoiding internal bank crises through off-balance sheet funding, with foreign reserves, of PRC state owned enterprises.

Let's move on to the realities of a new century with market driven opportunities for all and not the chosen few in both the PRC and U.S.

At 5/06/2010 10:38 AM, Blogger PeakTrader said...

Gettingrational, the real economy shows the U.S. has consumed much more than produced each year, since it became an open economy, around 1980. In 2006, the U.S. consumed $800 billion more than it produced.

How is that possible? Because foreigners are losing up to 10% a year in real wealth not trading their goods for U.S. goods through inflation, low interest rates, and currency exchange rates.

The U.S. has no control over poor foreign economic policies. European countries are on the verge of default and Adam Smith's mercantilism is summed up well:

"Wealth of Nations represents a highly critical commentary on mercantilism, the prevailing economic system of Smith's day. Mercantilism emphasized the maximizing of exports and the minimizing of imports. In Wealth of Nations, one senses Smith's passion for what is right and his concern that mercantilism benefits the wealthy and the politically powerful while it deprives the common people of the better quality and less expensive goods that would be available if protectionism ended and free trade prevailed."

At 5/06/2010 10:52 AM, Anonymous gettingrational said...

Peak Trader, Your quote about Adam Smith and mercantilism indicates feirce objections to PRC trade policies, correct?

How did the U.S. consume $800 million more then it produced in 2006? HMMMMM? That year being the peak of home equity loans based on high estate values? Yes, that is the reason and not some convoluted "free goods" from the PRC. Consumer borrowing provides funding for consumption > production, pure and simple.

At 5/06/2010 12:12 PM, Blogger Benjamin Cole said...

Not sure about manufacturing and location in the future.

China may be the large large cheap manufacturing platform left. Oh sure, there are other low-wage nations, but not with the scale, culture and dedication of the Chinese

Try manufacturing in Nigeria.

And factory wages, as a fraction of the total cost of a manufacturing, are shrinking, due to rising productivity.

China may be a Japan in 25 years--too expensive.

The USA at that point (thanks in part to wages that were stagnant for 50 years) may become a manufacturing platform again, probably for Chinese and Japanese companies. No more productive low-wage platforms left.

People keep saying mercantilism and currency pegging does not work. I prefer free trade myself.

But, the example of China is daunting. Within 10 years, they will surpass us as the world's largest economy. Within a generation, they will be the world's superpower, and we will be so indebted as to longer afford our parasitic global empire of military bases. Likely, about that time, we will be the new Greece--subsidized farms, widespread tax evasion, cooked books, but with a expensive military-foreign policy complex to boot.

Invest in Asia.

At 5/07/2010 2:51 AM, Blogger PeakTrader said...

Gettingrational, if I borrow $1,000 from you to buy your goods and pay you back $500, then I received some free goods.

That's why the U.S. has been able to consume more than produce each year over the past 30 years.

When China buys your inputs at high prices to produce output at low prices, to the point of exporting 40% of its economy, then the Chinese masses cannot afford many goods at world prices.

The communist elites have turned the Chinese masses into slaves and when social costs are taken into account, improvements in their living standards have been much smaller than the 12% annual growth rates suggest.

At 5/07/2010 12:34 PM, Blogger sethstorm said...

Just do the 25%+ tariff, and allow for an extension to establish parity to any country that isn't the US.

Leave them nowhere to run or hide.

At 5/10/2010 4:03 AM, Anonymous grant said...

buy made in usa!

At 9/30/2010 10:17 PM, Anonymous Anonymous said...

@morganovich Of course the numbers you've given are ridiculous. Surely you can't believe that the yuan should double in value.


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