If you have followed the car business over the years, you remember the cry from Detroit in the 1980s, “The Japanese have an unfair advantage and need to let the yen appreciate.” The thought process was that if the yen appreciated, people would stop buying Mazdas and Mitsubishis and instead buy Chevys, Fords, and Chryslers. The present day China-United States currency debate has a lot of moving parts, but is also very similar to the Japan-U.S. situation in the 1980s. No one single factor, including the relative value of the U.S. dollar vs. the Chinese yuan, is driving the massive trade imbalance between the United States and China.
If you have ever wondered why the Chinese currency is referred to as both the yuan and the renminbi, the distinction between yuan and renminbi is analogous to that between the pound and sterling; the pound (yuan) is the unit of account while sterling (renminbi) is the actual currency.
The Long View of China’s Currency appeared in the September 21, 2010 edition of the New York Times. David Leonhardt did an excellent job of providing a historical context in terms of the complexities of the currency markets. We suggest you read the entire article; excerpts are provided below:
Spend enough time with Chinese officials and economists, and you will hear a story about the Japanese yen in the 1980s. Back then, Americans were upset about Japanese imports flowing into the country, just as they are upset about Chinese imports today. So the United States pushed Japan to let the yen appreciate…Tokyo complied, and the yen surged almost 50 percent from 1985 to 1987. Yet the imports kept coming. The trade deficit with Japan actually widened to $108 billion in 1987, from $94 billion in 1985. The rising yen wasn’t enough to halt the growth of companies like Sony and Toyota. They had too many advantages, including lower labor costs.
“Renminbi appreciation may not have a big impact,” Fan Gang, an economist and former government adviser, said last week at a meeting here with American economists and policy makers, “or an impact at all.”
And it’s true that a stronger renminbi would not be a quick fix for our economic problems, as appealing a notion as that might be. The yen isn’t the only parallel here. The renminbi itself rose 21 percent against the dollar from 2005 to 2008, and the trade deficit continued to widen.
But there is also no question that China’s currency remains undervalued, probably by 20 percent or so. The economics are simple enough. The huge demand for Chinese goods should be driving up the price of its currency, but Beijing has been intervening to prevent that. Getting China to stop will be crucial to correcting the global economy’s imbalances. A stronger renminbi will help China’s people — many of whom are hungry for better living standards, to judge by the recent labor strikes — buy more goods and services, and it will also help the rest of world produce more. But change is not going to happen overnight.
But there are two main reasons that a stronger renminbi probably will not lead to a rapid hiring increase in the United States…The first is that China and United States aren’t the only two countries in the world. Basic parts can be made in poorer countries, like Vietnam….The second reason not to view the exchange rate as a cure-all is that economies, like battleships, tend to turn slowly. Companies rarely move production in a matter of weeks.
With the S&P 500 trading above the important 1,131 level, it appears as if the markets are expecting the U.S. dollar to continue to decline in the coming months. The Fed's preparation of the next round of quantitative easing, makes hard assets, such as gold, silver, and copper, more attractive as paper currency hedges. As we covered in Copper May Provide Leadership for Stocks, the conducting metal offers a good way to monitor the health of risk assets and the demise of the U.S. dollar.
