Angry Bear

Angry Bear: "a revaluation of the Chinese currency is more likely to cause expenditure-switching away from Chinese production and towards production in other nations such as the U.S."



A lot of speculation on the role of international economics in the Coming Perfect Storm centers on the effects of an increase in the value of the Chinese currency relative to the U.S. dollar. This is critically important, because the Chinese and other Asian central banks have been buying up U.S. government debt in the last couple of years, at a rapid clip. The purchases of U.S. debt is what keeps the U.S. dollar/Chinese Renminbi exchange rate "fixed." Ditto for the Korean Won, the Japanese Yen.



China has maintained their own currency at a ridiculously low value relative to the dollar, in order to make investment in Chinese manufacturing for export to the U.S. (and to a lesser extent, Europe) almost fantastically profitable. That's why you can buy a toaster at a drugstore for less than $10, and why well-made clothes are so cheap that department stores are consolidating. And, it is why Chinese output and employment in manufacturing has been soaring.



When speculating about the likely effects of revaluation, it would be helpful if analysts kept in mind just how ridiculously undervalued the Chinese currency is, and why. The why is that manufacturing in most of China is still risky and costly, despite dirt-cheap wages. The Chinese must import a lot of expensive stuff, and not just raw materials, and manufacturers must overcome many obstacles to attain quality production, including on-again, off-again electricity, transportation snafus, etc.



At some point (and we may, in fact, be near that point), revaluing the Chinese currency will actually aid the Chinese, by reducing the cost of imports used in manufacturing and increasing the welfare of Chinese consumers, who depend on imports. Rapidly improving efficiency in the manufacturing sector may be able to compensate for a modest exchange rate adjustment. For the Chinese, exchange rate adjustment could trigger some short-term problems, but it has definite upsides: immediate increase in income from exports; immediate reduction in the cost of imports. For China, exchange rate adjustment could result in a small, but noticeable increase industrial profitability and consumer income.



The effect in the U.S. does not have any upsides to it. Oh, sure, we might get increased demand for U.S. exports, but the key word is "might." Major U.S. exports -- movies, airplanes, wheat -- are not all that price-sensitive. Meantime, we get to pay $11 for that toaster, instead of $10. Interest rates rise, even as the economy is hitting a "soft patch." The Housing bubble bursts, and employment in housing construction and appliances for new houses, plummets.



Right now, Americans are enjoying a $100 of income and consumption, while earning only about $90. Exchange rate adjustment for the U.S. means a reduction in consumer income of five percent or more. That's a lot of pain.