Recently, US has increased its pressure on China to stop “manipulating” the value of the Chinese Yuan (RMB). The logic is simple: RMB is undervalued, it caused trade deficits and in turn caused the loss of US jobs. Therefore, in order to create US jobs, trade deficits with China has to be reduced and RMB has to be appreciated. Let us assume this logic is correct for a minute. If the RMB is appreciated, the price of China imports will have to increase. The purchasing power of US consumer will decrease. The recovery of US economy will be in question. The China exports will suffer and china recovery will be in jeopardy as well. It is clearly a loss/loss situation.
There are 3 elements in the above logic: Exchange Rate, Trade Deficits and Jobs:
Exchange Rate
In this Economist article, it suggests that RMB is 49% undervalued using Big Mac price. But the Big Mac theory simply ignored an important factor – GDP per capita. If you consider both Big Mac price as well as GDP per capita, the RMB was fairly value against US dollar in 2009 (International Economy Article by Prof. McKinnon). The real question is will exchange rate has any influence on Trade Deficits.
Trade Deficits
Many economists and politicians believe that they can use the exchange rate to control the trade balance. Since 1970s, Japanese Yen has appreciated from over 300 to below 100. Has US trade deficits with Japan decreased? As China is biggest manufacturer and US is the biggest consumer in the world, the trade deficits are unavoidable. Some can argue that it is necessary: low value-added processes are moved to overseas but high value-added processes remains in the US. When China grows and middle-class is established, its domestic consumptions and imports will increase as well. In fact, China has demonstrated its ability to stablize the global economy in this financial and economy meltdown.
Actually, the trade deficits with China are not as high as published according to this WSJ article. “one-half to two-thirds of the value of ‘Chinese’ imports is added in other countries, including the US”. In another WSJ article, it uses iPod as an example: China only adds $4 to an iPod that costs $150. But it is counted much more than $4 when government calculates trade deficits.
Jobs
Since the start of the recession, the US economy has lost 8.5 millions jobs until last month (March 2010) when it added 162,000 jobs. Some of jobs if not all will come back eventually except the manufacturing jobs. It is not because China, India and other third-world countries took the jobs from the US. US simply cannot compete in low value-added manufacturing process due to high cost – wage, pension, health care and so on. For US to compete in global economy, it need to focus on its strengths – talents, technologies and unmatchable infrastures. Let us not forget what makes United States great : innovations and entrepreneurship.
Conclusion
The exchange rate and trade deficits are really the function of trading partner’s domestic economy and its competitiveness in global economy. In long term, the exchange rate will be fairly valued and trade deficits will be balanced. As US economy is transforming into service-oriented economy, China economy has to move up in the value-chain as well. Protectionism is not a solution for both countries. It is not about if win/win is possible. Win/win is MUST for both countries.
China vs US - Is Win/Win possible?
Recently, US has increased its pressure on China to stop “manipulating” the value of the Chinese Yuan (RMB). The logic is simple: RMB is undervalued, it caused trade deficits and in turn caused the loss of US jobs. Therefore, in order to create US jobs, trade deficits with China has to be reduced and RMB has to be appreciated. Let us assume this logic is correct for a minute. If the RMB is appreciated, the price of China imports will have to increase. The purchasing power of US consumer will decrease. The recovery of US economy will be in question. The China exports will suffer and china recovery will be in jeopardy as well. It is clearly a loss/loss situation.
There are 3 elements in the above logic: Exchange Rate, Trade Deficits and Jobs:
Exchange Rate
In this Economist article, it suggests that RMB is 49% undervalued using Big Mac price. But the Big Mac theory simply ignored an important factor – GDP per capita. If you consider both Big Mac price as well as GDP per capita, the RMB was fairly value against US dollar in 2009 (International Economy Article by Prof. McKinnon). The real question is will exchange rate has any influence on Trade Deficits.
Trade Deficits
Many economists and politicians believe that they can use the exchange rate to control the trade balance. Since 1970s, Japanese Yen has appreciated from over 300 to below 100. Has US trade deficits with Japan decreased? As China is biggest manufacturer and US is the biggest consumer in the world, the trade deficits are unavoidable. Some can argue that it is necessary: low value-added processes are moved to overseas but high value-added processes remains in the US. When China grows and middle-class is established, its domestic consumptions and imports will increase as well. In fact, China has demonstrated its ability to stablize the global economy in this financial and economy meltdown.
Actually, the trade deficits with China are not as high as published according to this WSJ article. “one-half to two-thirds of the value of ‘Chinese’ imports is added in other countries, including the US”. In another WSJ article, it uses iPod as an example: China only adds $4 to an iPod that costs $150. But it is counted much more than $4 when government calculates trade deficits.
Jobs
Since the start of the recession, the US economy has lost 8.5 millions jobs until last month (March 2010) when it added 162,000 jobs. Some of jobs if not all will come back eventually except the manufacturing jobs. It is not because China, India and other third-world countries took the jobs from the US. US simply cannot compete in low value-added manufacturing process due to high cost – wage, pension, health care and so on. For US to compete in global economy, it need to focus on its strengths – talents, technologies and unmatchable infrastures. Let us not forget what makes United States great : innovations and entrepreneurship.
Conclusion
The exchange rate and trade deficits are really the function of trading partner’s domestic economy and its competitiveness in global economy. In long term, the exchange rate will be fairly valued and trade deficits will be balanced. As US economy is transforming into service-oriented economy, China economy has to move up in the value-chain as well. Protectionism is not a solution for both countries. It is not about if win/win is possible. Win/win is MUST for both countries.