Rooted in Reason: Nurturing the Seeds of Liberty

New Intern David Jaress makes his first blog post! by grassroothawaii
June 25, 2010, 10:38 am
Filed under: Uncategorized

By David Jaress

Trade between China and the United States has been a sensitive issue for some time.  Unlike free-floating currencies such as the euro, China has been artificially fixing the yuan’s (also known as the renmenbi, or RMB) exchange rate since the 1990s.  Until this past weekend, the PRC had achieved this by buying up American dollars: whenever a Chinese business exported a good to the United States, China’s central bank would purchase their dollars with an ever-increasing supply of yuan.  By doing so, China has been able to keep the price of the yuan within strict boundaries, never letting price of the RMB in dollars fluctuate by more than 0.5% on any given day.

While still far from free-floating, China has recently begun pegging the RMB to a larger selection of currencies in response to American political pressure.  Although this is far from allowing the RMB to appreciate naturally, harsh political reactions on America’s part have the potential to only make matters worse.  U.S. Senator Charles Schumer (D – N.Y.), for one, has proposed imposing duties on foreign imports which are deemed to benefit from unfair currency subsidization.  Fixing the country’s trade imbalance is not that straightforward however, and imposing such duties will likely end up hurting consumers and businesses in Hawai’i more than helping.  While the yuan should be allowed to rise and fall with the flow of trade, establishing import duties on Chinese goods will only raise costs for Hawai’i consumers and businesses dependent on Chinese manufacturing without the benefit of increased exports.  Since much of what China imports from America consists of component parts which are modified and re-exported back to the U.S., less imports from China will likely cut exports of component parts by American businesses; a study by Spanish bank BBVA and the Bank of Finland found that a 10% appreciation of the yuan would reduce China’s imports of component parts by 6%.

A free-floating currency, on the other hand, would balance out America’s trade deficit while benefiting U.S. exporters.  As the price of the yuan rises with demand for Chinese goods, the relative price of American goods to Chinese consumers would begin to fall.  Although this would mean more expensive Chinese products for Americans, it would also mean more business for U.S. exporters and gradually less foreign debt.

While the U.S.’s desire for a more free-floating RMB is thus justified, protectionist policies aimed at forcing the market to be more “fair” have harmful potential effects for Hawai’i consumers with only dubious promises of benefits.  After all, since 2007 China’s current-account surplus has already dropped from 11% of their GDP to 6.1% without Senator Schumer’s legislation.  Thus, although political pressure to free up foreign currency markets should continue, the U.S. and Hawai’i would do best to be patient and refrain from making matters worse through the brute force of trade barriers.


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