For Now, China Must Ignore Calls for Stronger Yuan

The U.S. economy lumbers along while China's gross domestic product grows at double-digit rates—and a lot of Americans say China isn't playing fair. Among the leading voices is that of New York Times columnist Paul Krugman, who has argued for months in columns and blog posts that by not letting its currency, the yuan, appreciate against the dollar, China is being mercantilist and predatory. In what seems to be a first for a modern-day Nobel Prize-winning economist, he seems to be trying to inflame the public to start a trade war with China, claiming that 1.4 million Americans have lost jobs because of an artificially low yuan.

At a time when the U.S. unemployment rate is just below 10%, not much grabs Congress' attention better than accusations of 1.4 million jobs lost to China. However, China bashers are raising expectations too high with dubious assertions that if the yuan were revalued, manufacturing jobs would suddenly move back to the U.S. and the trade surplus would be reduced. If manufacturers found costs were too high in China, they wouldn't return to the U.S. They would just move to countries such as Vietnam and export back to the U.S. from even lower-cost production centers. Nor do Krugman and others take into account the damage a rising yuan could inflict on low-earning workers in China. The Chinese government is under intense pressure from factory owners not to revalue the yuan more than the 20% it has risen since 2005.

With fears of Greece collapsing and setting off a domino effect across Europe, the world's road to recovery is not guaranteed. The global economy is too fragile—and the Chinese export sector too vulnerable—for China to start tweaking its currency.

Poverty still endemic in China

How much would a rising currency hurt China's economy? My calculations suggest that if the yuan appreciated too soon, five million Chinese would lose their jobs and millions more would be gravely affected. This would be on top of the 20 million who lost their jobs when factories were shut at the start of the financial crisis. That is the reality the Chinese government faces, and which Krugman ignores.

It is easy to understand how so many are startled by China's growing global might. Because the country has become so powerful so fast—China is on track to become the world's second-largest economy this year—it is sometimes hard for Americans to understand how poor many Chinese remain.

Despite having a 350 million-strong middle class and nearly a million U.S.-dollar millionaires, China also has millions who have to work seven days a week for 16 to 18 hours a day. These factory workers live in cramped, Spartan dorms hundreds of miles from home, seeing their families only during the Chinese New Year break. The hardship is a far cry from that of 30 years ago, when death from famine and easily curable diseases was common, but there is still much to be done.

What should China do?

Poorer Neighbors suffer from low yuan

When it is time to appreciate the yuan—and that time will come, once the world economy gets back on its feet—I think the government should do a one-time, 10% appreciation. Appreciating the yuan on a gradual, monthly basis (as the government started doing in 2005) causes hot money to flow into China in search of a guaranteed bet on the yuan's steady rise. In order to prevent an influx of speculative capital, the government should revalue the yuan in one shot and make it clear that another appreciation—outside of a little band—won't happen for a long time. That may not satisfy such critics as Krugman, but I doubt that any of China's realistic courses of action would.

China should also make sure that it continues to trade in sufficient volume with its poorer neighbors. Those are the countries—not the U.S. or Europe—affected most by an artificially low yuan. For the most part, China's neighbors have remained muted in their criticism because China has taken up so much of their trade and continues to do so.

The last thing the world needs is growing hostility between the U.S. and China. A trade war between the world's two economic superpowers could cause a double dip in the economy. So far the Obama Administration and the Chinese government have been acting responsibly: They have allowed for smaller spats over cheap tires and chicken feet to occur, in part to help placate domestic powers without succumbing to nuttier calls for protectionism.

Finally, it is doubtful that constant public pressure by governments to push China to revalue the yuan will work; such calls are almost certainly counterproductive. Reform-minded Chinese officials will be forced to stand strong to appease hard-liners within the government and not come off as too weak. A better strategy should push for change behind the scenes. Krugman is not wrong that at some point the yuan should appreciate, but that time has not yet arrived.

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