The Treasury Department said Wednesday that China was not lifting the value of its currency fast enough. Apparently, Secretary Jack Lew got orders from the White House to start bashing China again and its currency regime. Seems President Obama has responded to calls for more manufacturing jobs, but is his response well thought out?
When the White House tells China to push up the value of its currency and knock ours down, it ends up reducing America's real terms of trade. By that I mean it reduces the quantity of goods that we can afford to buy. Yet this has not had any positive effect on the growth in manufacturing jobs.
If you look at the chart below, you will see what I mean.
Since 2005, when the Bush Administration first started hammering China on its then-fixed-dollar/yuan exchange rate of 8.25, the U.S. dollar has depreciated 30% against China's yuan (blue line). Similarly, total nonfarm manufacturing payrolls have declined by 300,000. In short, there has been no gain in manufacturing jobs because of this currency policy.
On the other hand, it has resulted in a rise in the price of Chinese-made goods, which is the equivalent of a tax on the middle-class and poor Americans who tend to be the main consumers of these imports.
What's lost in this policy is a simple fact: Imports are a real benefit while exports are a real cost. The current administration and the prior one didn't understand this. They responded to populist cries for "action" and their actions took the form of bad policy.
A nation that exports must use its capital, resources and labor to produce real products, which are then sent away for foreigners to consume. In exchange they get the purchaser's currency. Meanwhile, the real output that they export will have to be produced again or found elsewhere because it will be needed for domestic consumption.
A nation that is, on balance, a net importer gets the benefits of real product that is produced somewhere else, using other nations' labor, resources and capital. In exchange the importing nation exports its currency.
For years, China had been happy exporting its real product to the U.S. in exchange for dollars, which we easily manufacture. This was a real benefit to consumers in America, particular lower-income consumers, as they were able to get their hands on cheap, affordable goods.
Moreover, for China to maintain its competitive advantage on exports, it had to suppress the wages of its workers. Per capita income in China is about $9,300 whereas in the U.S. it's about $51,000. While that difference is still large, it is narrowing. In the last two years alone, per capita income in China has risen by more than 16% while in America it has risen by only 2%. At the current pace, the income of a typical Chinese worker will overtake that of an American worker in less than two decades and with this currency policy in effect it may happen even sooner.
How is this good?
The answer is it isn't. Racing to the bottom to generate a few manufacturing jobs fixes nothing. What policy-makers and current and future administrations should understand is that imports are a benefit and exports are a cost in real terms.
Since the current belief is the opposite, however, and since there is no evidence that this will change anytime soon, it should be taken as a sign to investors that you must own the stocks of large, multinational U.S. companies. They will benefit the most.