China's exchange rate policy

“Just before his confirmation as Treasury secretary, Timothy F. Geithner turned up the heat on the Chinese regarding the dollar-yuan exchange rate. President Obama, he said, "believes that China is manipulating its currency. Countries like China cannot continue to get a free pass for undermining fair-trade principles."

Like many economists, I cringe whenever I hear the term "fair trade." It is not that I am against fairness — who is? — but the word "fair" is so amorphous in this context as to defy definition. Most often, the slogan "fair trade" is little more than a rallying cry for protectionism. ....

Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.

There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy. ....

Mr. Geithner and other China critics might also want to ponder how the Chinese keep the yuan undervalued. The essence of the policy is supplying yuan and demanding dollars on foreign-exchange markets. The dollars that China accumulates in these transactions are then invested in United States Treasury securities.

So when the Treasury secretary complains about the undervalued yuan, his message to the Chinese boils down to this: Stop lending us money. ....

As the United States embarks on a path of unusually large budget deficits, the nation's chief financial officer should pause and think carefully before turning up the heat on one of its biggest creditors.”

N. Gregory Mankiw, "Economic View: It's No Time for Protectionism", New York Times (8 February 2009).

http://www.nytimes.com/2009/02/08/business/economy/08view.html


LW: Very clear thinking from Harvard economist Greg Maniw, professor of economics at Harvard and author of a best-selling economic principles text. Mankiw is a Republican, but his message is basic economics, not partisan at all. There is much more in the full column, which is worth reading.

DOW: I agree with Larry. Given our present policy approach, we have become dependent on China to finance our budget deficit. If we go down this road we have to be careful about what we say about their policies. It would be unwise to complain about the undervalued yuan if it is a key source of the financing for our outsized budget deficits.

But we should ask why we put ourselves in this position. It is not just that we are dependent. That is bad enough. But now we are dependent on an undependable rival facing its own internal economic problems over which it has no real control. Obama is not just gambling that his policies will turn around the U.S. economy; he is also gambling that the Chinese will be willing and able to fund much of the deficit his policies create.

I for one do not think this is wise.

Thanks to Larry Willmore for this Tdj.