U.S. Should Cut China Slack on Valuing Yuan: Laurence Kotlikoff
China is being singled out for a reason. Its current account surplus with the U.S. this year may run to $250 billion, far more than any other country. To many, this shows China is manipulating its currency, destroying jobs and limiting growth in the U.S.
Nothing could be further from the truth. But the truth is much harder to find these days than scapegoats. Fortunately, economics can move the debate beyond finger pointing.
Countries that run current account surpluses save more than they can fruitfully invest at home and invest the difference abroad. Countries with current account deficits do the opposite. They save less than their economy’s investment needs and attract investment from abroad.
Surplus countries take some of the seed corn they’ve saved and plant it in deficit countries. This physical movement of the seeds, or capital, is recorded as an export of the surplus country and an import by the deficit country.
Nations with current account surpluses are net exporters and have trade surpluses. Those with current account deficits are net importers and run trade deficits. Indeed, apart from the net income foreigners earn in the U.S. and invest here, their current account surplus equals their trade surplus, and their trade surplus is, apart from a minus sign, our trade deficit.
Making U.S. Crazy
If China’s trade surplus is really due to it investing in the U.S., why does this drive us nuts? Would we prefer the Chinese invest in, say, Iran? The more China invests in the U.S., the more capital U.S. workers get to use, making them more productive and helping them earn a higher wage.
Yes, the Chinese are investing, in part, by buying Treasuries, yet doing so leaves others to invest directly in U.S. companies. The form of their investment doesn’t change the bottom line: the Chinese are doing us a big favor by investing here. The real question isn’t whether China’s investment in the U.S. is good for the U.S.
The key question is why we aren’t saving enough to fulfill our own investment needs. The answer is a decades-long fiscal policy that has been taking more resources from young savers and giving them to old spenders. This has driven our national savings rate down the tubes.
In 1965, Americans saved 14 percent of their national income. Last year the figure was negative 1.5 percent. What’s worse, our domestic investment rate -- the ratio of domestic investment to national income -- was only 1.8 percent.
The U.S. can’t grow if it doesn’t invest and without foreign investment the country would now be disinvesting. The Obama administration should consider this before urging the Chinese to aim for smaller surpluses.
U.S. officials should also stop accusing the Chinese of manipulating their currency. Yes, China is pegging its currency to the dollar. But this isn’t evidence, per se, of currency manipulation. As a result of the 1944 Breton Woods agreement, the U.S. spent decades fixing its currency to those of other nations. No one accused it of unfair trade practices.
A fixed exchange rate is fully compatible with free trade because the dollar price Chinese exporters charge for their goods is the result of two things: the exchange rate and the cost, in yuan, to produce the good.
Getting the Chinese to make their currency more expensive (forcing us to pay more dollars for one yuan) won’t make Chinese exports more expensive to American consumers since the internal cost in China of producing these products will fall. The Chinese restrict their supply of yuan to make the currency appreciate relative to the U.S. dollar. When fewer yuan circulate in China, prices there fall.
Is Yuan Undervalued?
There is a good reason for this economic outcome. In the end, how many Chinese toasters swap for a Boeing 777 is not a matter of how many pieces of paper with pictures of American presidents are swapping for pieces of paper with pictures of Mao. Instead it depends on the underlying real demand and supply for toasters and 777s.
Where’s the proof the yuan is undervalued? You won’t read studies claiming our real terms of trade with China are out of whack or find a black market in yuan. Instead, you’ll see studies that measure how much China would have to revalue to dramatically lower its current account surplus. But these studies ignore that such a revaluation would lower Chinese domestic prices for toasters, leaving the net cost of Chinese products to Americans unchanged.
Too many economists seem to disregard the basics of international trade when they equate China’s trade surplus with currency manipulation. One prominent economist recently described China as “engaged in currency manipulation on a scale unprecedented in world history.”
New Economic Order
Let’s get a grip. China is a poor country. The fact that it holds some of its wealth in dollar-denominated assets is not proof of currency manipulation. Moreover, as China’s economy grows, the amount of its overseas investment will increase too. We need to get used to the Chinese investing in our country because that is tomorrow’s natural economic order.
As for now, forcing the Chinese to print fewer pieces of paper with pictures of Mao and, thereby, make their currency relatively scare isn’t going to make toasters relatively expensive compared with Boeing jets. Nor will it change our national savings behavior or current account deficit. These two real problems will change only when we stop robbing young Peter to pay old Paul.