A common theme this election cycle and over the last four years has been Chinese currency manipulation. China has kept the value of its currency artificially low, increasing the cost of U.S. exports to China and decreasing the costs of U.S. imports from China. Every coin has two sides; and it is clear that changes in value of the Chinese currency simultaneously help some groups while hurting others. Most of the media and political focus has been on the U.S. groups that get hurt, while stories about the benefits are neglected. It is likely that the benefits outweigh the costs — possibly by a landslide.
When China keeps the value of the renminbi (or yuan) low in terms of dollars, it means that one yuan equals more dollars. Hence, the yuan buys fewer U.S. goods and U.S. exports to China decline. The Chinese policy of keeping the value of the yuan low clearly hurts U.S. exporters to China. In 2012, U.S. exports to China are likely to be just over $100 billion. However, this is only 0.6 percent of all U.S. output and is dwarfed by private consumption, which is over two-thirds of GDP.
Another potential cost is that decreasing exports and increasing imports raises the trade deficit with China, which represents U.S. debt obligations to China. If we trade one Dell laptop for an equally valued Lenovo laptop made in China, we have balanced trade. However if we import Chinese clothing or toys without exporting something of equal value we end up paying in dollars. When imports are larger than exports, we run a trade deficit.
Why does this U.S. trade deficit represent a U.S. international debt? It is because China is holding dollars that it can neither play with nor wear. These dollars are only good for buying U.S. goods, when China chooses to cash them in. They represent goods that we eventually have to export. This accumulated debt to China from both persistent U.S. trade deficits and Chinese currency manipulation amounts to nearly $1.2 trillion, held primarily by the Chinese government.
While these balances of dollar-denominated assets would wreak havoc on the U.S. economy if China were to abruptly change course and start using them to buy U.S. goods, it it is also true that this course is highly unlikely because it would drastically increase the value of the yuan. This would, in turn, decrease Chinese exports to the U.S. and to the rest of the world, and exports have been the main driver of Chinese growth.
However, there are benefits to the United States from China's low-currency-value policy as well. A cheap yuan means a dollar buys more Chinese imports. The clothing and toys that we buy become cheaper. This benefits everyone who wears clothes or plays with toys. U.S. imports from China (about 2.5 percent of U.S. nominal GDP) are worth nearly four times as much as U.S. exports to China.
In addition, China's policy of keeping the value of the yuan artificially low means that it must sell its goods to the U.S. in exchange for little green pieces of paper. China's policy has made it a consistently willing recipient of U.S. dollars. This has been particularly important for the U.S. over the last four years during the Great Recession, which has seen the U.S. Congress and Federal Reserve borrowing trillions of dollars to finance stimulus spending and monetary intervention.
China's role as an ever-ready purchaser of dollars has helped keep U.S. interest rates and inflation low, thereby stimulating U.S. investment and growth. The $3 trillion expansion of the Federal Reserve balance sheet and the $5 trillion federal deficit over the last four years has not raised interest rates or inflation, in large part because the U.S. has always had a ready buyer of those dollars in China.
In a forthcoming paper in the Journal of Macroeconomics, Rick Evans has shown that the U.S. actually can tax foreign countries that hold dollar-denominated assets by expanding the supply of dollars in this way.
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