Strong vs. Weak Currency
(or how I learned to stop worrying and love the Yuan)
There’s been a lot of chatter in the news about currencies and currency malipulation. This came to a head yesterday when the House of Representatives passed a bill 348-79 which would “allow the U.S. to seek trade sanctions against China and other nations for manipulating their currency to gain trade advantages.” (Washington Post)
China keeps their currency artificially weak which makes exports from China cheaper for US Consumers. China’s government keeps their currency weak against the dollar by selling Yuan and buying Treasury Bills, since the exchange rate of the Yuan is tied to the Dollar.
Meanwhile, the government of Japan is taking the exact opposite tact of the US- they sold $25 billion worth of Yen (2.12 trillion Yen) as an “attempt to weaken its currency,” Business Week.
So the US wants a stronger currency, Japan wants a weaker one. What is going on?
There are advantages to a weak and a strong currency: A country that relies heavily on imports (like the US) would like a stronger relative currency since it makes it less expensive to purchase imported goods.
However increasing imports will hurt domestic manufacturing, leading to a loss of jobs. The US’s manufacturing industry is likely going to see a continued deterioration over the long run; there are several reasons for this, but essentially this is because China has a lower standard of living, which allows them to pay lower wages to workers.
The argument is that if the US had a weaker currency against the Yuan, US-made goods are more affordable to Chinese consumers, which could help reduce America’s large trade deficits. This is a fallacious argument and here’s why:
Since the Chinese are not buying an equivalent amount of American goods and services, they are using the dollars to finance the US government spending- they are buying Treasury Bills, loans to the US Government.
As such the Chinese are the largest foreign holders of Treasury Bills, holding $846.7 BILLION as of July, 2010, out of the $2.7 trillion held by foreigners.
If the Yuan strengthens and the trade balance shrinks, China will buy fewer Treasury Bills, making it more expensive for the US to borrow money. But be careful what you wish for: the US has a $1.27 trillion projected deficit in 2011, and that money needs to come from somewhere!
