"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Sunday, October 3, 2010

The Dark Side of the Yuan

The political debate in America concerning the “unfair manipulation” of the Yuan by the Chinese Authorities is intensifying . Last week (Sept. 2010) in the House of Representatives a huge bipartisan majority approved legislation that would potentially pave the way for sanctions against China over its currency policy.
Trade Wars? Not yet, to me it looks more as “Election wars” , that sort of initiatives launched a few weeks before elections aimed to appease a furious a population still bearing the burden of a false “Recovery”.

However, the pressures on China to modify its currency policy and adjust it to "market values" are more serious and persistent than a populist gesture. According to many American political and academic voices, the Chinese policy of pegging its currency to the USD has distorted the trade terms between the countries which brought about the loss of millions of American jobs and trade imbalances that helped to create the pr recession financial bubble. According to that view, the artificial low value of the Yuan turns to be an unfair competitive edge which reduces manufacturing costs in Dollar terms at China, forcing local companies to transfer production and jobs abroad. The trade loss is compensated by a flow of money back to USA , inflating the financial bubble.

From a rather simplistic perspective the above description sounds plausible, albeit its logic chain is based upon a serie of debatable hypothesis, one of them related to the concept of a “ fair value” for a currency . In order to overcome that "fairness "obstacle economists developed the denominated “Power Purchasing Parity” (PPP) parameter, a tool that establishes the value of exchange of currencies according to what they are able to really buy instead of their current market value. For example if a cup of coffee in Barcelona costs 1.2 € and the same cup of coffee in America costs 1.2 $ , the effective exchange rate should be 1 (1.2/1.2) and not 1.35.

How it is possible to calculate that figure ? PPP measurement method is applied to the overall economy by translating the production of the country from local currency ( Prices x Quantities = GDP ) to USD ( at current USD) and to PPP ( at PPP USD)as well. Since GDP is Quantities multiplied by Prices , we can subtract the quantities from both equations and remain with the ratio between PPP and current USD. A value of 1 would indicate a fair value of the currency and below that a underestimated currency.

With that question in mind I took IMF figures for 2009 and compared between GDP at current and PPP values for the Chinese economy. The result was a ratio of 0.56 , which means that a Greenback in China is able to buy almost the double of products than in US, or that the the Yuan is a “weak” currency since it can buy less products than the USD. The conclusion is that the Americans are right in that specific claims. In any case, the currency exchange value is just part of the story and if we have the whole picture it might change our perception.

First of all, the actual unfair value of the Yuan is a 16 years old , to be precise since the first mandate of President Clinton, and was maintained along recessions, buoyant years, bubbles... and somewhat eased app. 3 years ago, before the crisis emerged ( 23% devaluation). Therefore, in a wider perspective to claim that the currency "manipulation" is the reason for the actual crisis is a bit strange and dubious claim. On the top of it, the US itself was ( and is still !) interested in that mechanism since it became a central piece in maintaining a steady pressure on local prices , wages and inflation. That mechanism ( including the purchasing of Debt) is one of the explanations to the low inflation and low interest rates in the Western economies along the last 30 years, much more than the Genius of central bankers

Second Point is to analyze the wider context : Is the Chinese low value policy so singular ? According to IMF figures it looks that China low value currency policy is the rule rather than the exception, as most of the countries maintain a low currency lower than the “fair” value. ( see graph)

The third point is related to the distributional aspect of the global economy : As can be seen from the next graph, the low value of the currency is common among poor countries and less common among rich countries. It is not a coincidence : The low value of the currency is equivalent to reducing the international value of the work of the country´s citizens and increasing in relative terms the purchasing power of currencies abroad. Is like giving a subsidy to the foreigners.

This should not take us by surprise. Any tourist who traveled to developing countries has probably asked himself how it comes that the same product or service is sold for such low prices ( in comparison to her country). The same question applies when you shop in the Supermarket and can buy an African pineapple for Christmas Eve at a lower price than a cup of coffee.. The answer is partially related to currency values.

The above graph shows that for the 85% of the humanity, the trading terms of their work is lower than should be , while 15% are above that line. In a less political correct parlor, the exchange rate system seems to be just another mechanism that serves 15% of the world population to exploit the remaining 85% : The work of , for axample a Bangladeshi embedded in the exported products is sold in cheaper terms than it should be while he buys the fruit of rich country products in dearer terms than should be. Good deal, isn´t it?

That detail , that huge advantage for the American consumer will be lost if Chinese appreciate their currency. I guess that Congressmen didn´t mention that,and why should they? After all they don´t get their votes or contributions for the campaign from Shanghai , Cairo or Minsk workers and the cry for "jobs" is nowadays above all. However that is the most serious evidence for the real state of affairs.

Nevertheless, the trading terms should be accommodated to reflect a more just and fair distribution of the fruits of the human labor. I would suggest to improve the working conditions, the social security and the wages in China and everywhere in the third world . Such a policy will not only improve the competitiveness of the American worker but open new markets for the American industries .But that is for another ( or many ) post....

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