How to Think About the RMB, "Currency Manipulation," and Trade War

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Where to begin on this topic? Let me start with several "to be sure" statements and then the clearest formulation of the issue I can manage.


 "To be sure":
- In general, I am skeptical of free-trade absolutism, and am a believer in the ability of nations to engineer their way to better trade and economic outcomes than pure laissez-faire would deliver. As explained in a serious way here and a sarcastic way here;

- In general, I am in the "Oh calm down!" camp when it comes to the "Chinese menace," whether that menace takes the form of "stealing all our jobs" or of "controlling our financial destiny." On why not to worry about job-stealing, here; on finances, here; on general US-Chinese competition here.  

- In specific, what I have seen in Chinese factories makes me doubt that changing the value of the Chinese RMB would make any noticeable difference in "bringing jobs back to America." The wage differences between the country are so enormous, and the productive and exporting infrastructure in China is so well advanced, that you could double the RMB's value against the dollar and still make it more attractive to produce somewhere in China than in the Midwest. That is why I think typical American complaints about "currency manipulation" are ill-founded. They imagine that a cheap currency is what has built China's industrial empire. That's a factor, but a secondary one.

"Nonetheless": 
We've reached a stage where the Chinese government's insistence on holding the RMB's value steady against the dollar -- rather than letting it rise, as it naturally would because of China's huge trade surpluses -- has become pernicious and destructive for the world economy. Why? The reason is the one laid out here* nearly a year ago:

During a worldwide economic slowdown like the one of the past two years, the immediate problem is a failure of demand. There is too much productive capacity, relative to private and public purchases. Thus factories -- and, more important, workers -- stand idle. The point is elementary, and is the reason governments around the world, from China to Britain to the US, have been pumping new "stimulus" (demand) into their economies. But it also means that anything one government does to depress demand -- or to shift some other nation's demand to its own factories -- has a beggar-thy-neighbor effect and slows down recovery world wide. 

That is what China is doing by controlling the value of the RMB. For reasons laid out here,** the only way the Chinese government can control the currency's value is to enforce savings on the Chinese public. When a Chinese-made computer or motorcycle is sold for dollars in the United States, the Chinese central bank (to oversimplify) seizes part of the dollar proceeds and sends it back for investment in the United States or elsewhere, before anyone in China has a chance to spend it. It goes into Treasury notes, the US stock market, or some other dollar security. That means that it is not used to buy some foreign product (which would increase demand elsewhere), nor is it traded for RMB on a foreign currency exchange (which would raise the RMB's value, decrease the dollar's, and overall increase the purchasing power in a Chinese person's hands.) Again the details are complicated, but the point is plain:

If the Chinese government were not controlling the value of the RMB, China would be producing more "net demand" for the world economy now -- buying more of other nations' products, or exporting less of its own surplus. This is a simple arithmetic truth, and one whose significance was described a year ago by the stalwart Michael Pettis of the Guanghua School of Management in Beijing. I quoted him as saying: 
The real counterpart to Smoot-Hawley [after this crash] would be Chinese protectionism --or rather, any effort by China to defend its huge trade surpluses, as the U.S. once did. China's government is unlikely to rely on outright Smoot-Hawley-style tariffs. Instead it could increase subsidies to exporters; it could try to push the RMB's value back down, after three years of letting the currency rise; it could encourage manufacturers to restrain wages; it could impose indirect barriers to imports, as with its recent pressure on China's airlines to cancel outstanding orders for Boeing and Airbus airplanes. By early this year [2009], China's government was in fact doing every one of these things... This is an economic problem for other countries. But it could be an even more serious political provocation, if China is seen as forcing its share of unemployment problems onto everyone else.

That's where we are now. China's government has helped its own economy recover by holding the RMB's value steady against the dollar rather than letting it rise. But in doing so it has made recovery harder in the United States and -- more dramatically -- Europe and Japan, since the RMB has joined the dollar in falling in value against those currencies. This is not a matter of "manipulating" a currency, and I wish American politicians would stop using that term. But it is destructive to overall world prospects for recovery, because it is hurting everyone else. You don't need any advanced trade theory or specific industrial analysis to know this. It is necessarily true as a matter of basic math: a depressed world economy needs more demand, and an artificially low national currency means artificially restricted demand from that country.


The best way to change the Chinese government's policy is a separate matter, for another installment. For the moment the point is: don't think about "currency manipulation" as being a tricky way to have a wind-turbine built in Shanghai rather than Sheboygan. Instead think of artificially suppressed Chinese purchasing power as putting a drag on the whole world's economy. That's what has to change.
___
* Unfortunately this part of our archives is messed up, and the links to subsequent pages don't work. Here are the right links for pages 1, 2, and 3

** These links are also messed up. Here are the right ones for pages 1, 2, 3, and 4

Also, links for "How the World Works" article are messed up. Correct ones here for pages 1 and 2. Hmm, maybe a new item for the post-website-redesign To Do list. UPDATE: Archive links are now fixed; links in main text should work fine. Thanks to web team for quick repair.
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James Fallows is a national correspondent for The Atlantic and has written for the magazine since the late 1970s. He has reported extensively from outside the United States and once worked as President Carter's chief speechwriter. His latest book is China Airborne. More

James Fallows is based in Washington as a national correspondent for The Atlantic. He has worked for the magazine for nearly 30 years and in that time has also lived in Seattle, Berkeley, Austin, Tokyo, Kuala Lumpur, Shanghai, and Beijing. He was raised in Redlands, California, received his undergraduate degree in American history and literature from Harvard, and received a graduate degree in economics from Oxford as a Rhodes scholar. In addition to working for The Atlantic, he has spent two years as chief White House speechwriter for Jimmy Carter, two years as the editor of US News & World Report, and six months as a program designer at Microsoft. He is an instrument-rated private pilot. He is also now the chair in U.S. media at the U.S. Studies Centre at the University of Sydney, in Australia.

Fallows has been a finalist for the National Magazine Award five times and has won once; he has also won the American Book Award for nonfiction and a N.Y. Emmy award for the documentary series Doing Business in China. He was the founding chairman of the New America Foundation. His recent books Blind Into Baghdad (2006) and Postcards From Tomorrow Square (2009) are based on his writings for The Atlantic. His latest book is China Airborne. He is married to Deborah Fallows, author of the recent book Dreaming in Chinese. They have two married sons.

Fallows welcomes and frequently quotes from reader mail sent via the "Email" button below. Unless you specify otherwise, we consider any incoming mail available for possible quotation -- but not with the sender's real name unless you explicitly state that it may be used. If you are wondering why Fallows does not use a "Comments" field below his posts, please see previous explanations here and here.
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