Published on

Chinese Currency Adjustment A Mixed Blessing for US

Christmas came early for John Snow. The U.S. Treasury Secretary has been hectoring the Chinese government to let its currency, the yuan, appreciate against the dollar. Now Beijing has announced it will do just that. 

The adjustment is small, only 2%. It will do virtually nothing to reverse the mammoth U.S. trade deficit with China. As such, it will not long deter the Bush administration from demanding still more adjustments. But Snow may yet come to regret his wish. 

The U.S. and China are locked in a love-hate relationship. The U.S. provides a huge market for low-cost Chinese goods meaning low inflation for the U.S. and booming factories for China. But the poorer Chinese do not buy nearly as many higher priced U.S. goods. As a result, the U.S. has run a large and growing trade deficit with China, buying more than it sells. Last year that trade deficit amounted to $160 billion. 

From the Chinese side, that $160 billion is a one year surplus that, year by year, accumulates as "foreign reserves." Those reserves now total over half a trillion dollars. Rather than putting them into a drawer, China invests them in U.S. Treasury bonds. That's where things get interesting.

Chinese purchases of Treasury bonds drive up the demand for dollars, raising the dollar's price. A higher priced dollar means a lower priced yuan. In this way, the Chinese government ensures that Chinese goods remain cheap in the U.S. and that Chinese factories continue to hum. 

Though this sounds one-sided, the U.S. government has been an all-too-happy party to the arrangement. The reason is that it has been running the largest budget deficits in history, spending far more money than it brings in. Last year the budget deficit reached $413 billion, a record. 

The government funds this deficit by borrowing-by selling Treasury bonds. And one of the biggest buyers has been-that's right-China. If China did not buy so many Treasury bonds, the U.S. government would have to raise interest rates to induce other buyers to step in. Or, to put it another way, the low interest rates currently enjoyed in the U.S. have been made possible by loans from China. 

The recent U.S. housing boom-some call it a bubble-has been funded in large part by such loans, the same loans that have made the yuan so attractive and Chinese goods so cheap. That's where the problem comes in for the Bush administration. 

Low cost Chinese production has eviscerated U.S. manufacturing. Over the past five years, the U.S. has lost 3 million high-wage manufacturing jobs, a staggering one quarter of its total. Some of those jobs have been replaced with service jobs. But when a $24 an hour steel worker becomes a $6 an hour greeter at Wal-Mart it is not generally counted a net plus for the U.S. economy. 

As a result, Bush has been getting hammered in polls suggesting he is not doing enough about the economy, especially about the job drain to China. Bush, of course, doesn't want to do anything that would interfere with corporate profits which are made fatter by shifting jobs to China. So the response has been to send out Snow to harangue the Chinese about their currency. This is where Snow-and Bush-may come to regret what they wished for. 


Never Miss a Beat.

Get our best delivered to your inbox.

If the Chinese stop holding down the value of the yuan they will have much less need to buy Treasury bonds. Without China in the market, the government will have to raise interest rates to attract other buyers. 

Housing, the most interest-sensitive sector of the economy, would take the first hit. It is the paper wealth created by the dramatic run-up in housing prices that has buoyed U.S. economic growth for the past four years. If the bubble bursts it will wipe out trillions of dollars of consumer wealth. 

At the same time, without the Chinese propping up the dollar, its value would fall. A weaker dollar means the price of all other imported goods will rise. 

Sixty dollar a barrel oil may be only the beginning of its ascent and its impact would ripple through the entire economy. To combat the inflationary effects of a falling dollar, the Fed would have to continue to raise interest rates, exacerbating the problem with housing and everything else bought on credit. 

In other words, if this game of financial chicken continues, the U.S. may soon be faced with rising interest rates, falling production, declining wealth, and rising prices, all at the same time. It will be an exact replay of the economic debacle of the 1970s-stagflation. That is not a coincidence. 

In the early seventies, the U.S. was mired in another intractable foreign war, flooding the world with dollars, and running huge budget deficits. And just as it is now, it tried to pay for them, not by raising taxes, but by printing still more dollars. But OPEC nations saw that Nixon had rescinded the conversion of dollars for gold and realized they were getting only paper for their finite supplies of oil. In 1973, they tripled the price of oil and then, in 1978, they tripled it again. Inflation soared, interest rates skyrocketed, the economy tanked, and it took the better part of a torturous decade to work it all off. 

The situation is a little different today but it is the similar dependencies and interdependencies that should signal our concern. Also, the U.S. is no longer the world's largest creditor. Instead, after five trillion dollars of debt run up under the last three Republican administrations, it is now the world's largest debtor. This makes the situation even more precarious as the debt carrying load becomes an ever greater burden to the U.S. economy. It also limits the degrees of freedom with which the U.S. government can operate to cushion any fall. 

The yuan is almost certainly undervalued but the problem for the U.S. is the huge budget deficits being run by the Bush administration. Those deficits have mightily enriched Bush's wealthy clientele-as they were intended to do. And they have created a short term illusion of prosperity for the rest of us by allowing the government to spend beyond its means, at least for a while. 

But they have done so by making the U.S. economy critically dependent on Chinese loans. In other words, control of U.S. financial destiny is increasingly in the hands of China and unless Bush miraculously reverses his love affair with deficits that dependency will only grow. As so many Third World nations have found out, when a country loses control of its economic destiny it eventually loses control of its political destiny as well. 

To be sure, John Snow didn't create the problem, Bush did. But Snow may soon come to regret his own wish.

Robert Freeman

Robert Freeman

Robert Freeman is the author of "The Best One Hour History" series which includes "World War I" (2013), "The InterWar Years" (2014), "The Vietnam War" (2013), and other titles. He is the founder of The Global Uplift Project which builds small-scale infrastructure projects in the developing world to improve humanity’s capacity for self-development.

This is the world we live in. This is the world we cover.

Because of people like you, another world is possible. There are many battles to be won, but we will battle them together—all of us. Common Dreams is not your normal news site. We don't survive on clicks. We don't want advertising dollars. We want the world to be a better place. But we can't do it alone. It doesn't work that way. We need you. If you can help today—because every gift of every size matters—please do. Without Your Support We Simply Don't Exist.

Please select a donation method:

Share This Article