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Is America a Loan Shark or a Borrowing Walrus?

A large Pacific Walrus bull watches the camera. The adult bulls can weigh up to 3,700 pounds.

Paul Solman frequently answers questions from NewsHour viewers and web users here on his Making Sen$e page. Wednesday’s query is answered first by Paul, and further down by Yoram Bauman, our frequent economist contributor from China:

Name: Rob Griffith

Question: Everyone talks about China keeping its currency undervalued to increase exports. How do they do this? I.e., what steps do they take to keep their currency undervalued compared to other currencies?

Paul Solman:

  1. They don’t let their currency trade freely on the open market, imposing all sorts of controls and restrictions.

  2. They then set the exchange rate with the U.S. dollar by fiat, daily.

  3. To further support the manipulation, they use the dollars they amass from exports and lend them back to us. The mechanics: they buy our bonds — which are nothing more than the IOUs we give them for their loans.

Slowly but surely, the Chinese have been revaluing their currency upward. When we were in China for the NewsHour six years ago, one U.S. dollar could be exchanged for 8.0895 Chinese yuan. Today, one dollar is worth only 6.34363 yuan. That’s an “appreciation” of nearly 20 percent. And the pace has picked up in the past year or two.

Of course, the proverbial “critics” charge that revaluation isn’t happening fast enough, that the yuan (aka RMB or renminbi — “people’s money”) is still 30 percent or more undervalued. That would imply an exchange rate of 4-point-something RMB to the dollar. But at the rate China has been revaluing, that would happen in a handful of years.

Why wouldn’t the Chinese revalue right away, as President Obama so publicly pushed President Hu to do just the other day? Perhaps they’re looking at Japan, which began amassing huge stores of U.S. dollars via exports, starting in the 1970s. Like China, the Japanese bought our bonds — still do. But they let their currency — the yen — trade freely in the foreign exchange markets and float: find its own “true worth” via the forces of supply and demand.

Actually, it was President Richard Nixon who started the process by “floating” the DOLLAR in 1971. A month later, it was worth only 308. And today, 77.04.

Granted, we’re talking 40 years later. But one U.S. dollar today buys a mere 77.04 yen. Thus, all else equal, Japanese exports to the U.S. are almost five TIMES as expensive as they were in 1971. And a revalued yen is often given as the reason for the Japanese economic slowdown. Japan is still a rich country, since its constantly revalued currency could increasingly buy more and more from the U.S. and elsewhere. But, as its goods and services, priced in yen, have become more and more expensive to the rest of the world, it has had to move production off-shore, to rely less and less on exports.

China still has many hundreds of millions of its citizens down on the farm. It wants to bring them to the city, where they can earn more. How does it do so if they can no longer work in export-driven factories whose products have become too expensive? This is why China tries to manage the revaluation process slowly. Can you really blame them?

Meanwhile, we asked Our Man in Beijing, “standup economist” Yoram Bauman, to weigh in too. Here’s his response:

Yoram Bauman: Good question, Rob. Start with the basic idea that exchange rates are determined by supply and demand: some folks want to trade U.S. dollars for Chinese yuan (also called RMB), others want to trade yuan for dollars, and the exchange rate adjusts to balance those out. The short answer to your question is that the Chinese government (or for that matter the U.S. government) can participate in this process: by trading yuan for dollars, the Chinese government can “put a finger on the scale” that makes the dollar stronger than it would be otherwise. (“Stronger” here means that a U.S. dollar buys more yuan, which is good for Chinese exporters.)

Yoram Bauman at the 2010 Texas Book Festival, Austin, Texas, United States

For a longer answer, note that the U.S. runs a trade deficit with China: we buy more from them than they buy from us, so Chinese companies end up with about $25 billion a month in U.S. dollars that they “don’t want”. The Chinese government weighs in by effectively buying these U.S. dollars, i.e., it gives these companies Chinese yuan in exchange for their U.S. dollars. And then the Chinese government turns around and uses all those dollars to buy U.S. treasury bonds, currently over a trillion dollars’ worth.

It all sounds a bit odd, almost as if the Chinese are loaning us money so that we can buy stuff from them. And there are definitely tensions on both sides. Many people I talk to here in China — regular folks like taxi drivers and restaurant managers — know all about the U.S. Treasury bonds that China owns, and they’re not happy about it. One man told me that the U.S. was a “loan shark” (at least that’s how my dictionary translated “gao li dai”), when in fact the U.S. is more like a borrowing walrus, floating in an ocean of our debt.

In any case, the whole situation is a far cry from the textbook ideal of mutual gains from trade. My joke about it is that Chinese people tell me, “Those U.S. Treasury bonds are a lousy investment. We’re pissed off that you sold them to us!” And I say, “That’s funny, because we’re pissed off that you bought them!”

This entry is cross-posted on the Rundown– NewsHour’s blog of news and insight. Follow Paul on Twitter.

Pacific walrus bull photo at top by Flickr user USFWS/Joel Garlich-Miller via a Creative Commons license. Photo of Yoram Bauman by Larry D. Moore, via Wikimedia Commons and under a Creative Commons ShareAlike license.

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