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Yuan vs. Dollar

Posted By on January 28, 2009

The other day Timothy Geithner, Obama’s new Treasury secretary, accused China of manipulating its currency, and caused a minor kerfuffle.

Here’s the thing, though.  There’s no debate that China manipulates its currency.  Of course it does.  The question is whether it’s good or bad for us.

China, like the US, has the ability to make unlimited amounts of its own currency.

Suppose it decides to use some of that currency to purchase somthing of ours – American currency, for example, or US Treasury bonds.  What is the effect of that?

It increases the demand for US dollars while simultaneously increasing the supply of Chinese yuan.  That makes the dollar rise, and the Yuan fall.  That’s good for Chinese exporters.

Not only does it make Chinese products cheaper, China effectively manufactures demand for its products by selling yuan into the market.  Because the yuan is ultimately good for only one thing – buying Chinese goods and services – every yuan must eventually find its way back home.  When it does, it creates jobs for Chinese workers.

Sounds good, right?  China gets to accumulate dollars, while creating employment for its people.

Here’s the problem, though.  The US just like China, can create unlimited amounts of its own currency.  And the US dollar, like the yuan, is ultimately good for only one thing – purchasing goods and services from its country of origin.

Imagine, for a moment, that that wasn’t so – that dollars don’t have to make their way home.  What happens to them then?  Do they sit in China forever?

And if so, wouldn’t that be a pretty good deal for us?  I mean, dollars cost us nothing to create (paper currency costs a bit, but the kind that sits in bank accounts is free – it’s just zeros and ones on a hard drive somewhere.) And we can create an infinite supply of them.

As long as we knew the Chinese would always be content to accept dollars for actual real goods and services, we could all retire, and live off of them instead.

Of course, that’s not going to happen.  At some point the Chinese will realize they’ve accumulated enough dollars, and that they need to start buying stuff with them.

When that happens, the dollar will fall, the yuan will rise, and the Chinese will become buyers of American products – putting American workers back to work again.

In other words, we’ll be working for them, instead of them working for us.

The weird thing about it, though, is that that because they’re manipulating their currency, the price they’re paying for US dollars is more that what it should be, or more than what it otherwise would have been.  (That’s the point of doing it.)  In other words, they’re paying too much for what they’re getting.

Not only that, but when they go to sell, they’ll get less than what they should get, simply because they’ve accumulated so many of them.  (Think in terms of a ‘dollar glut’.)

So despite all the rhetoric, it’s not at all clear that their manipulation of their currency hurts us.  In fact, they’re arguably getting the raw end of the deal.


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