by Drew J Jones
Sat Feb 11th, 2006 at 04:29:23 PM EST
It seems like Americans are bombarded with talk of our current-accounts deficit on an almost-twenty-four-hour basis. One of the reasons -- China's artificially undervalued currency, the yuan -- is breeding a great deal of anger among workers, and it is being fueled by the television news media with all the talk of outsourcing and currency pegs and the like. It has led many famous economists, including former Fed chairman Paul Volcker, to caution that a run on the dollar is increasingly becoming a danger to the American economy.
That may be true, but lost in all of this has been an understanding of the actual implications of this trade deficit at the household level. Some of it -- a lot of it, actually -- is the result of Americans going on a spending binge, thanks to low interest rates and their nasty, little partner, the housing boom. And, yes, the undervalued yuan allows countries, like China, to artificially stimulate their exports. But, before we launch ourselves into another Cold War with another communist party, let's think about what the trade deficit actually means.
The road to prosperity is one that China will need to travel along for many more years before its GDP per capita will even begins to resemble those of America and Western Europe. It's population is roughly four times the size of America's, and three times that of the EU. Whereas poverty in America is found in the rural, inland West -- Idaho, Wyoming, and Montana, among others -- where citizens earn average incomes in the neighborhood of $10,000 per year, many in China's western provinces live on only about one dollar per day and suffer from issues like the hideous effects of truly-massive environmental pollution.
But in only thirty years, China has escaped the grip of arguably the most murderous totalitarian political figure of the 20th Century, Mao Zedong, and many of its citizens have found high-paying jobs in China's screaming urban economy. It has been quite a sight to see.
That growing prosperity is limited, however, by the actions of the Chinese government. The government, by propping up the dollar, is essentially holding down the purchasing power of the yuan, restricting the ability of the emerging middle- and upper-classes to buy goods and services produced elsewhere. While this continues to push Chinese exports, these citizens are being penalyzed by their government's modern form of mercantilism -- a theory, attacked by both Adam Smith (in The Wealth of Nations) and David Ricardo, that saw trade as a zero-sum game, with the goal being the accumulation as much precious metal (e.g., gold) as possible by running a positive trade balance.
This is not without some benefit to America. With artificially low purchasing power in the yuan, American citizens necessarily have artificially high purchasing power in the dollar, as it relates to Chinese goods and services. In that way, a friend of mine commented, this could be considered almost a gift from the Chinese. (Don't expect a Thank You card, President Hu.) After all, he said, they're selling their goods to us at lower prices. And while I would hardly call it a gift -- it's a trade, not a gift -- the basic argument holds.
Now it is possible that a run on the dollar is inevitable, at this point -- a harder landing than we would hope for. The trade deficit is truly massive, now 5.8% of annual output ($726b in 2005), and the higher it climbs, the larger the adjustment will be. The figure typically thrown around by economists is a 40% plunge in the dollar. And as pressure builds on Washington to get tough with the Chinese government on currency policy the expected timeframe in which investors believe the dollar will fall will be moved closer.
The adjustment may well be quite painful for households that have grown accustomed to being able to buy cheap products made in Asia. But it will also allow consumption to pick up in China, providing citizens with the ability to buy far more goods and services from other countries. That will stimulate production elsewhere.
The media are wrong to use this issue to fuel hatred of the Chinese by painting trade as a zero-sum game, because many Americans have enjoyed great benefits from the current relationship. But they are right to preach flexible exchange rates and incentives for Americans to save. Painful though it may be to many, the current situation distorts the proper workings of the international economy, and I've got to believe that spells danger.
It's time to let the yuan float. And it's time for Americans to put their wallets away.