Wednesday, June 13, 2007

Short term currency worries

The recent Sino-American dispute over the undervalued renminbi has caught DeTocque's wandering eye for the moment... Its domestic implications in US politics have not gone unnoticed. (See FT article here.)

The issue boils down to the fact the Senators, Congressmen, and Hank Paulson all want the Chinese currency to be worth a bit more (say about 10% more according to recently published reports) on the open market. Politicians may claim bipartisan support for a new Senate bill, but really anyone would support a bill that increases your constituents' exports...

By (admittingly) keeping the renminbi undervalued, the Chinese government has fueled a record trade surplus with the US in recent years (meaning the Chinese have exported about $233bn more to the US than they have imported from the US). So, the US is seeking to rectify that imbalance by legalizing US interference in the currency market -- the Americans would buy renminbi with dollars, thereby increasing the value of the renminbi and allowing newly, more wealthy Chinese consumers to more cheaply purchase US goods. Net result: Chinese buy more Fords, US bonds, Big Macs and iPods because their currency is worth more. Good for Joe Schmoe in Iowa, and good for his Congressman.

However, the Chinese government actually has a very good reason to keep the renminbi undervalued -- though their economy is going like gangbusters, per capita GDP is still tiny compared to the US. Now pretend for a second that all these Fords and iPods started flooding into China because Chinese purchasers opt for a relatively cheaper US car (of higher quality) over an absolutely cheaper Chinese-produced version (of still lower quality)... In other words, you average Chinese citizen could have never dreamed of a top-of-the-line US product and had always opted for the cheap-o domestic version. Suddenly, with the stronger renminbi, the US product is more within reach, so they go for it.

Two things result: 1. the Chinese inflation rate increases at a hurried pace for domestic AND imported goods, and many people are suddenly priced out of the market (read: disaster). Prices have gone up so fast and wages haven't kept pace... 2. No one but a local would ever want a Chinese company's computer. If their sales go down as consumers opt for American versions, Chinese computer company's profits shrink, and the economy slows.

With that, the Chinese just can't raise the value for practically humanitarian reasons -- the local level of the Chinese economy would be severely and catastrophically effected. The renminbi will gain value through nature market forces as the Chinese economy continues to get up to speed. American politicians should let it do so.

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