A dragon and its treasure: The Chinese yuan

The title of this post refers to the Chinese People's Republic as a dragon. Chinese economic policy is almost as mythical as the creature often used to portray the nation. Incredible growth, enormous exports, vast amounts of financial reserves and yet lead by a party that calls itself 'communist'. In a series of three posts I would like to examine some of the myths that surround Chinese economic policy. First up is the supposedly undervalued currency and its perverse effects on global trade.

The Chinese leadership is often accused of keeping the yuan, the currency of the China, artificially low. An undervalued currency holds a significant advantage: it suppresses domestic prices of raw materials and labor. In essence you make domestic production artificially cheap, compared to foreign production. This causes  Chinese rubbish to be priced too low and thus to sell better than American, Japanese or European rubbish. The Chinese government rejoices when it checks its export numbers. Other industrialized countries are less happy for they see their trade balance - the worth of export minus import - become less balanced.

The trade balance of countries around the world, based on IMF statistics for 1980-2008. Notice the high deficit for the United States, which is largely benefited Japan in the eighties and China since WTO-admission in 2001.

The question that keeps us busy is twofold: is China keeping its coin artificially cheap and, if so, then how do we deal with it? The grievances of China's trading partners are without a doubt legitimate. It needs however to be said that, ever since 2007, the Chinese government has taken measures to adjust its underpriced coin. Indeed since June 2011 the yuan has appreciated over 7% against the dollar. And considering the spread between China's inflation rate and the much lower one of its trading partners, relative costs in China have risen even more. All this show us that the yuan is not as much undervalued as it used to be.

Myth 1: "The Chinese yuan is kept artificially low
and thus the Chinese policy distorts global trade"

Yet China-bashing is more popular than ever, especially in the United States. On October 11, the US Senate approved a bill that allows its government to take measures against what it deems undervalued currencies. This strategy might be politically successful as it might get one votes from people who lost their manufacturing jobs allegedly due to cheap Chinese imports. Yet from an economic point of view the results would be devastating. A trade war between two economic behemoths, who are also each other's principal foreign debtor/creditor, will disrupt today's fragile economy even further. To ward cheap Chinese products from your market would by the way mostly harm the consumer. And China only needs to challenge such a policy before the WTO to enforce free trade. After all the international economic regime regards undervalued currencies to be a prerogative of the IMF.

Then should we stay inert and leave the matter be? There is something to say for abstaining from action. Though the yuan is far from flee-floating, it is steadily gaining in value. A more 'flexible' yuan offer chances for China to hasten the reorientation of its economy from exports to domestic consumption. This is something the Chinese authorities recognize and seek to achieve, even more so when a global recession might be just around the corner.