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China's cheap currency, one of the great boogeymen of international economics, will come roaring back to front pages across the country before next week's summit. But as many smart writers (David Leonhardt and Jim Fallows, to name two) have pointed out, the best argument for raising China's undervalued RMB is not that it will immediately repair out trade imbalance.

The best argument for China to raise its currency is about what's best for China -- and the world.

THE EXCHANGE RATE MYTH

First, let's review the common, if incomplete, case that China's undervalued currency is blasting open our trade deficit. China keeps its currency, the RMB, weak to make its products more affordable. As a result, we buy lots of cheap Chinese goods, and the Chinese, with their weak currency, can't afford more of our expensive exports. This creates a big China-U.S. trade deficit. It also moves U.S. factories to China, where companies can make their wares for less money. Thumbnail image for 675px-US_Trade_Balance_1980_2009.svg.pngWere the RMB stronger, Chinese goods would be more expensive and the Chinese consumer would be richer. So we'd buy fewer Chinese toys, they'd buy more American tools, and factories would return to Ohio. Stronger RMB = Trade balance and jobs!

That's the theory. Here's the problem, or three problems. First, if Americans keep buying the same stuff from China, because we can't get it cheaper anywhere else, imports will rise and our trade gap will stretch. Second, American companies won't come back to the U.S. if China's currency strengthens; they'll either stay in China and charge more for their products, or they'll find another cheap country to build their next factory. Third, Chinese price controls might be more important than the exchange rate. When the RMB appreciated 20 percent between 2005 and 2008, that actual price paid for a Chinese import went up only 2 percent, in part thanks to government controls and subsidies.

"We've made such a big deal about the exchange rate," said Barry Bosworth of the Brookings Institution, "but it's not the most important issue for the United States." That would be price controls, he said, like tariffs and buy-China rules that limit the market for U.S. goods and fleece U.S. companies for profits when we do secure contracts with Chinese companies.

WHAT CHINA SHOULD WANT

If the media overstates the United States' case for a stronger RMB, it might understate China's interest in a stronger currency. The country's currency game is having the nasty side-effect of raising prices for Chinese consumers.


Prices for Chinese goods are rising dramatically, up five percent over a year ago (and that official number might understate true inflation). Some background: the Chinese government unleashes RMBs to buy up foreign currencies flowing into China through trade surpluses and investment. This is a deliberate strategy to hold down the value of China's currency to make its exports more attractive, as the New York Times explains.

But by circulating lots of money into a hot economy, China is fanning the flames of inflation. For American buyers, inflation means higher prices, just like a stronger RMB. But for the Chinese, inflation is worse than currency appreciation. Inflation makes you feel poorer, whereas a stronger RMB would make the Chinese feel richer.

"Forget about U.S. interests. It's in China's interest to appreciate the currency," Bosworth said. It's also in the world's interests. A stronger RMB means a richer Chinese consumer -- a fatter wallet looking to spend in the international market. As other currencies rise in response to China, the United States and other trade-deficit countries might even see their imports in considerably higher demand.

WHAT THE U.S. SHOULD WANT

If a higher Chinese currency benefits the United States only indirectly, what should we root for in the China summit? According to David Leonhardt, the most important issue between the United States and China is intellectual property theft. Technology companies "continue to notice Chinese government agencies downloading software updates for programs they have never bought, at least not legally," Leonhardt wrote. "No wonder China has become the world's second-largest market for computer hardware sales -- but is only the eighth-largest for software sales."

Bosworth counters: "I am not interested in the intellectual property issues. I think that's a lot about rich American companies that want to make more money overseas." Making more money overseas, even for rich American companies, might translate into more jobs at home. But the more important factor, Bosworth said, is for the United States to fight China's rules and rediscover our own export muscle.


"First, we need to reduce tariff restrictions on capital goods in China," he said. Second, we need to reform China's "local content" rules, which require companies to build a certain percentage of their products locally. "We sell lots of cars to China, but there are still local content regulations require GM to make some of its parts in China and share space with local partners. We lose a lot of money this way, and firms are leery about sharing their technology."

To reemerge as a dynamic export economy, Bosworth said, you have to restructure U.S. manufacturing to focus on our competitive advantage, which is capital goods, not consumer goods. [Quick explainer: Capital goods are used to make consumer goods. Mining equipment is a capital good. Microwaves built with metals unearthed by the mining equipment are consumer goods.] The United States' most successful exports are capital goods, like Boeing aircraft and Caterpillar tractors. At a national level, we can make our goods cheaper and more attractive by devaluing our currency. At the international level, our goods will be more attractive when other countries grow faster and get richer.

"In the long term, we have to raise our national savings to finance our own investment to reduce capital inflows," Bosworth said. "China has to do the opposite."


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