The problem with the US trade deficit is structural rather than caused by currency pegging. US claims that, it is at disadvantage vis-à-vis China because of inappropriate exchange rates and hopes to bring down the trade deficit by devaluing dollar vis-à-vis Yuan. But data of the last few years shows that though dollar gained strength vis-à-vis Yuan, it has significantly lost its value against other currencies (like Yen) but still hasn’t seen any improvement in trade deficit with the respective countries (Japan).
One thing to be noted is what happened during the 1970s and 1980s. Though Yen (America by then accused Japan similar to what does against China of currency manipulation) raised drastically from around more than 300 Yen a dollar to almost below 100 Yen dollar, the trade balance of U.S still suffered. Though by then the reason is altogether different (Business and manufacturing efficiency), the point I wish to stress here is that, U.S, instead of looking within itself, has tried and trying to solve its problems by manipulating others.
The problem here is that the bigger firms of U.S has altered their approach in business, either moving out the production shop out of U.S or outsourcing the job to other emerging economies in order to achieve cost advantage, while working only on R&D and strategically & technically important manufacturing activities in their country (as explained by the theory on International product life cycle). Until the companies move back to America, the country’s trade deficit will only continue to increase. What are conditions, which favor the companies, return to their motherland? Will they return? Will discuss these in the next blog entry.
I am not sure how pertinent this is, but here goes...
ReplyDeleteWhen u say "wont work" I think you mean it wouldn't really help US trade deficit. If thats the case then consider the current scenario...
China stocks up huge volume of American Dollars, and doesnt go in for currency re-evaluation, thus keeping its export prices competitive(as compared to $) in American markets. Correct me if Im wrong-- in a way China is not only selling US its products but giving US the money to buy these products too.
While this might seem to be a favorable situation to be in, its clearly not sustainable.
Then What's the fear?? One fine day China decides to dump these dollars in the market. This I presume is the greatest problem America perceives from these imbalances. But is that really likely?? If China decides to dump these dollars its products would no longer be competitively priced and at the same time American and other customers would lose the purchasing power of these Chinese products.
While you have mentioned the nature of the cause of the currency problem, and problem be examining the causes and solutions in the next post, please post your take on the problem itself(whatever I have mentioned above). Or correct me if I misunderstood something.
I completely agree with your argument. But the thing is you have assumed extreme hypothetical scenarios, which as you yourself have identified are not wise decisions.
ReplyDeleteThe question of sustainability of the china funding American expenditure: As long as the debt burden doesn't overwhelm, this model is entirely sustainable. China can be compared to the moneylender. It is true that if the lender continues to squeeze more interest out of poor, the latter may go bankrupt or commit suicide making the model unsustainable. But what if the moneylender makes sure that the situation doesn’t goes out of control? Believe you would have heard China recently (2 days back) re-assuring that it won’t use the dollar reserves as a nuclear weapon against American economy. And as you have rightly pointed, by doing so, China will destroy its own wealth. Rather what I feel is China with constructive dialogue will keep pressurizing the U.S to take care of its currency and if situation warrants it may voluntarily devalue its own currency to an extent for the survival of its cash cow.
Or let us even the take the worst-case scenario. Even if China wants to dump dollars, it will happen over a period of time and on its process the dollar will keep losing its value and at one point, the U.S might regain its competitive advantage (But for that the value of dollar should go very low, which is not practical while dollar remains to be reserve currency). To understand this further we have to look at what is that gives China the competitive advantage, which will be taken further later.
My take on the issue is that, though it is true that U.S loses some of its competitive advantage due to a stronger currency, it essentially is not the core of the issue.
Even with all the above arguments, the issue may look tricky. Something is missing right? Yes, the gap is that, by having this model, China is doing injustice to its citizens. Had it allowed the Yuan to rise, its people would be able to enjoy more goods at cheap prices.
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ReplyDeleteThe last statement of yours... couldn't agree more...
ReplyDeleteChina has made itself economically powerful but on the global scene but this achievement has come at too high a price -- Depriving its citizens from taking the advantage of its economic prowess.