US patience wearing thin re: Chinese Yuan?

Beware the unintended consequences of short-term thinking

The release of China’s export trade numbers for May have released a torrent of unease from US policymakers and politicians related to the ongoing debate over the valuation of China’s currency.

Across both parties in Congress, calls are increasing to promote legislation that would explicitly limit Chinese imports to the American market. US Treasury Secretary Timothy Geithner noted, ““I think the strength of the sentiment in Congress is overwhelmingly strong , it’s bipartisan and it reflects how important this is to the United States.”

And no one can dispute how important Sino-American trade is to both countries.

China has relied on it for over 30 years to bring millions out of poverty. And despite the rising share of Chinese exports headed to other markets (especially the developing world), the US is still China’s largest export destination, accounting for nearly 20 per cent of exports in 2009. Barriers to trade with the US would thus pose a great threat to China’s continuing economic growth.

And while the US may complain about the policies China has utilized to ensure its competitive advantage, lest the Americans forget that for thirty years China has served as a means of dampening US inflation and enjoying unprecedented purchasing power.

Moreover, China’s growing industrial and consumer demand have it ranked as the American’s third largest export market (and first amongst non-North American markets). And given the year-on-year growth of the Chinese economy, there’s massive potential for China to hold a much larger share of American exports than the paltry 7 per cent it currently represents.

This brings us to the current debate – should China revalue the Yuan relative to the US dollar.

The Americans claim the Chinese must, out of respect for the global trading system and notions of true competition. They believe that the Chinese policy of fixing the value of the Yuan to the USD, rather than letting it float based on the market, has kept the Yuan undervalued by as much as (by extreme estimates) 40 per cent.

Allowing the Yuan to rise to a more competitive, and to US perspectives “fair”, level, would allow the American’s to export more to China and allow some redress to the massive trade imbalance between the two countries. That in turn would stimulate the American economy, and would see job creation increase in export sectors.

Sounds good.

Except, economic theory and economic hypotheses are prone to bring about unintended consequences.

The Americans need to think long and hard about how their efforts to push China to revalue the Yuan aggressively in the short-term could play out.

Their thinking is as follows:

Increased Yuan
= Lower Chinese exports / increased American exports
=
Decreased US trade deficit
= Economic growth and job creation in the US

And while one can’t dispute the likelihood of that happening in the short-term, it’s just as plausible that the following occurs in the mid-to-long term in China:

Increased Yuan
=Lower Chinese exports / increased American exports
=
Decreased Chinese economic growth
=
Decreased job creation in China
=Economic, and possibly, social instability
=
Decreased demand for US exports

So while the US wins in the short-term thanks to a spurt in trade, the long-term effects of a misfiring Chinese economy could pose much greater long-term losses for both trading partners.

Conversely, and as the Chinese would like the world to believe,

Status quo Yuan valuation (with modest increases built in to control inflation)
=
Chinese export growth
=
Chinese growth / increased consumer market demand
=
Increased Chinese import demand
=
US/global export increase to China
= Long-term rebalancing

Conclusion, it’s all murky economics.

There’s no doubt that an undervalued / fixed Chinese currency creates large disadvantages for American exporters but the Americans need to think long and hard about how hard they push the Chinese to revalue.

America’s angered politicians needs to think about the short- and long-term effects of China’s development and how it’s central role in the global economy could be thrown off-kilter with too aggressive a revaluation.

And unfortunately, I’m not optimistic that the US will take the long-term view of this trade relationship.

Sources for Sino-American trade:

http://www.uschina.org/statistics/tradetable.html

http://www.census.gov/foreign-trade/statistics/highlights/toppartners.html

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