Yuan revaluation alone won’t bridge US trade deficit

The United States Treasury Department has postponed the presentation of its semi-annual report to the US Congress in which China might have been condemned for keeping the yuan artificially weak to favour exporters.

US policymakers argue that Beijing deliberately keeps its currency undervalued to boost exports that led to the US’s trade deficit with China jumping to $226.8 billion in 2009 from $84 billion in 2000 and the worst labour market since the 30s’ depression, as unemployment reached 10%.

But it is doubtful that the yuan’s appreciation will be the right prescription to the poor health of the US economy, as its huge current account deficit is because it lacks export competence. Current account deficit, a broadest measure of external trade, shows how much the US must borrow from the rest of the world to fund its spending.

Over the last two decades the US has had expansionary monetary and fiscal policies to promote growth. Such policies led to the availability of loans at low interest rates that fuelled the property boom and lulled people into thinking that there is no need to save. Monetary expansion increased liquidity and consumption in the market. This resulted in poor household savings, which, in turn, increased imports. Together, all these factors contributed to a huge current account deficit in the US.

On the other hand, China achieved a high savings rate that led to country’s large global trade surplus. China’s internal reforms over the past three decades in healthcare, education, housing and other social sectors contributed to more savings. This, in turn, led to a significant portion of its income being generated by exports, driving up China’s trade surplus with the United States.

Moreover, the dynamics of globalisation also supported China’s export momentum. Investments and purchases by global corporations are based on consideration of location economies and experience curve effects and on these fronts it is China which scores. Thus it became the favoured global manufacturing hub, thanks to its low labour costs.

So the solution is that Americans have to save more to revive their economy. There is need also to shift production towards exports. The US will have to reduce its consumption that led to less/more imports and reduce current account deficit.

The revaluation of the yuan will not itself cure the US’s deficit because it is based on a somehow weak assumption that if the yuan will be more expensive relative to the dollar, American domestic production will rise and the trade imbalance will fall.

But that is not so. In case the yuan appreciates, global corporations will shift production facilities to other low-cost countries such in East Asia or in Latin America rather than going back to the United States. Therefore, vanished manufacturing jobs in the United States would not be restored.

No doubt a weak dollar will make the US’s exports cheaper and make exporters happy but at same time; the Yuan’s appreciation will in fact harm the households in America by pushing up import prices, amid unemployment rates of almost 10%. It will fuel a rise in prices of favourite American products those are assembled or manufactured in China. Therefore costs to households will be much bigger than any benefits to exporters.

Global corporations in the US that have manufacturing operations in China will also be hurt by a stronger yuan as they sell back their manufactured goods to consumers in their home country ie the US.

Also a Chinese daily says that, surprisingly, despite a 20% appreciation of yuan from 2005 to 2008, China’s trade surplus increased. On the other hand, since when the currency has stayed stable since 2009, the country’s trade surplus has fallen more than 30% over 2008. That does not prove the theory of policymakers in the US.

Earlier too, as per 1985’s Plaza agreement, when the yen and Deutsche mark were revaluated to reduce current account deficit and to avoid a recession in the US, the dollar fell 51% versus the yen from 1985 to 1987. But up to now, the US has a trade deficit with Japan.

Furthermore, in case of the yuan’s revaluation, China will not be able to earn surplus dollars from exports that led to not lending them to US government securities and in that case the dollar will fall greater. Given these facts, policymakers in the US need to re-think their decision for a revaluation of the yuan and work out ways to reform their domestic economy as the yuan doesn’t eat the jobs.

The writer is associate professor of international business at Nirma University, Ahmedabad and can be reached at deepak@imnu.ac.in. Views are personal.