| Everyone Suffers |
3 November 2003
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China's Dollar-Peg Will Hurt China
As a matter of national sovereignty, the government of the People's Republic of China has the right to value its currency at whatever rate is chooses. Indeed, it can have a yuan for exports and a renmimbi for domestic transactions and it could offer to trade in wampum, tulip bulbs or salt if it wanted. But under its current policy of pegging the yuan to the dollar, it is ultimately hurting its own economy.
Under classical economic theory, when two countries trade and one runs a surplus, the value of the currency for that country rises relative to the currency of the other. This alters the trade patterns, and eventually, equilibrium is restored.
China is running a trade surplus of $100 billion or so with the US every year. This means that the yuan should rise in price relative to the dollar (that is, it takes fewer yuan than before to buy $1). However, the Chinese government has pegged its currency to the dollar at a rate of 8.7 to the buck -- effectively denying the arrangement any chance at equilibrium. And so more and more Chinese stuff comes into the US, and more and more pictures of dead presidents goes to China.
When China goes to spend those dollars, it will be paying too much in yuan terms for its imports. And because the dollar is the world's reserve currency, this means all its imports, not just those from the US. Long-term, China will get less out of the deal than it could have.
They may claim to be communists, but the leaders of the People's Republic are acting like old fashioned mercantilists, and sadly, that is bad for the Chinese.
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