By Devaluing Its Currency, China Exports Its Unemployment
On Tuesday, China announced the largest one-day devaluation of its currency in more than two decades. Make no mistake—although authorities claimed this policy was a shift toward more market-driven movements, the value of the currency is tightly controlled by China’s central bank. By choosing to devalue its currency, Chinese officials are trying to solve their domestic economic problems—including a massive property bubble, a collapsing stock market, and a slowing domestic economy—by exporting unemployment to the rest of the world. The United States, which is the largest single market for China’s exports, will be hardest hit by the devaluation of the yuan. Manufacturing, which was already reeling from the 20 percent rise in the value of the dollar against major currencies in the last 19 months, can expect to see even faster growth in imports from China.
The devaluation of the yuan (also known as the renminbi) will subsidize Chinese exports, and act like a tax on U.S. exports to China, and to every country where we compete with China, which is already the largest exporter in the world. It will provide rocket fuel for their exports, transmitting unemployment from China directly to the United States and other major consumers of imports from China. Already in 2015, the U.S. manufacturing trade deficit has increased 22 percent, which will continue to hold back the recovery in U.S. manufacturing, which has experienced no real growth in output since 2007.
The Chinese devaluation highlights the importance of including restrictions on currency manipulation in trade and investment deals like the proposed Trans-Pacific Partnership (TPP), which includes a number of well-known currency manipulators. Millions of jobs are at stake if a clause to prohibit currency manipulation is not included in the core of this “twenty-first century trade agreement.” This devaluation by China, which is not a member of the TPP, will raise pressure on other known currency manipulators that are in the agreement—such as Japan, Malaysia, and Singapore—to devalue their currencies, which could more than offset any benefits obtained under the terms of the TPP.
This also highlights another threat posed by this agreement, which reportedly contains relatively weak “rules of origin” in many key industries, such as electronics and auto parts. For such industries, TPP members will be able to import dumped and subsidized components from China and re-export them to the United States, duty-free. Thus, the TPP could become a Trojan horse for back-door imports from China. Those components will be substantially cheaper after this week’s devaluation of the Chinese yuan, and they will ultimately be re-exported to the United States, where they will eliminate hundreds of thousands of good jobs in these industries.
These developments illustrate the toothless nature of the Obama’s administration’s proposals for addressing currency manipulation in the TPP through “transparency” clauses. All the transparency in the world will not stop countries in the TPP from devaluing if currency policies in China transmit unemployment to its neighbors in the region. That is why the TPP must include strong penalties for currency manipulation in the core of the agreement.
Ignore the shadow dance
The United States has given China a huge opening to devalue its currency through its frequent exhortations for China to “allow the market to play a greater role in determining the exchange rate,” as noted in the U.S. Treasury’s most recent semi-annual report to Congress on exchange rate policies. In announcing the devaluation, the People’s Bank of China (PBOC) was only too happy to claim that it was simply making the exchange rate “more market based.” But such claims (by both Treasury and the PBOC) are mere political sloganeering; they are no substitute for real economic analysis.
China is in no position to liberalize its financial markets. Its domestic capital markets are too thin and too weak, and the structure of its economy is too imbalanced to support fully open financial markets. China has no choice but to maintain a fixed exchange rate; the only question is whether or not the level of the exchange rate is competitive. China has been investing hundreds of billions of dollars every year in foreign assets (mostly U.S. Treasury bills, and in the past few years, in companies and private stocks and other financial assets through its “sovereign wealth funds”). But for these investments, the value of the yuan would have increased rapidly. On the other hand, the stability of the yuan also depends critically on China maintaining tight controls on its internal financial markets (thereby limiting outflows of domestic capital), because Chinese investors have too few investment options in the Chinese market, due, for example, to the absence of a large and sophisticated bond market.
Economists and monetary officials are well aware of what would happen if China were to liberalize its foreign exchange markets too quickly. This happened in Japan in 1980, and the results are well known, as explained by Professor Mitsuhiro Fukao at a 2003 conference of the Bank of International Settlements. In December 1980, Japan passed a new foreign exchange law that largely liberalized foreign exchange transactions (which had previously been controlled by the government, as is now the case in China). Japanese private investors had few domestic investment alternatives, and demand for foreign assets soared, driving up the value of the dollar and driving down the yen, which fell steadily between 1980 and 1985. This resulted in a growing trade deficit in the United States, and pressures in Congress that led to the Plaza Accord, an agreement between the United States, Japan, and European nations that reduced the value of the dollar against the yen and other major currencies between 1985 and 1987.
International officials are well aware of the risks of opening China’s financial markets too quickly, because it also has very weakly developed domestic capital markets (much like Japan in 1980). When China evaluated a plan to liberalize its financial markets in 2013, IMF officials warned that such changes could “lead to a massive exodus of money from the country if not handled properly.” As a result, China does not need to intervene heavily in order to devalue the currency; it can simply stand aside and let private investors accomplish the same goals, and that is what China did this week in announcing the policy changes that resulted in its largest devaluation in more than two decades.
Chinese officials sit atop an economic powder keg. Growth is slowing in China, its stock markets are in free fall, and it has failed to address a massive property bubble that is potentially much worse than anything experienced by the United States or Europe in the Great Recession. Chinese leaders have, once again, chosen to take the easy way out by exporting their unemployment problems to their neighbors through currency manipulation.
China should, instead, focus its resources on restructuring its own domestic economy. China needs to increase domestic demand for its own products by raising wages, increasing domestic investment, and ending wasteful subsidies to powerful state- and government-owned industries. China’s trading partners can help by taking strong steps to put an end to currency manipulation by China. China needs external pressure from other countries to overcome internal resistance to the tough domestic policy reforms that are so sorely needed. It is time for the U.S. and other countries to put an end to currency manipulation by China.