Understanding Why The China Currency Issue Matters

Dave Johnson

China has been very smart about looking out for its own interests.

As a developing country China had natural advantages in selling goods made in China and in attracting manufacturing from other countries. A significant advantage was that their currency was valued very “low,” meaning there was not a lot of demand for Chinese currency, and they had to offer more of their own currency to acquire the currency of other countries in order to import goods. This low currency rate meant that Chinese resources and labor were inexpensive compared to countries with stronger currencies, so goods made in China cost less.

Over time the Chinese government and Western countries invested in developing China’s manufacturing infrastructure, helping to bring people out of poverty and frankly to channel potential conflict pressures into the marketplace. So China was able to put resources into industrial investment instead of military. This was generally good for China and the world.

There came a point where China had developed sufficiently to be competitive in its own right. Natural market forces should have brought balance, but those forces were instead interfered with. The best example of this is the value of their currency. As China developed demand should have increased for its currency, raising its price or making it “stronger.” A stronger currency would have caused goods made in China to rise in price, allowing goods made in other countries to compete in the world, and in China. And it would have enabled China to buy more from the rest of the world. This is balance. This is how a true free market can be beneficial for all involved.

But China did not want to lose the advantage that a very cheap currency brings them so they interfered with this market process. They use the proceeds from their manufacturing to buy up currency from competing countries, changing the supply and demand equation and keeping their currency low. If China is willing to pay more to buy you dollars or pounds, why accept less? Meanwhile this pricing advantage brings more sales of their goods, increasing their manufacturing advantage even more.

The result of this currency manipulation is that goods made in China still enjoy a price advantage of up to 40%! And that advantage is increasing. (Which means if China allows its currency to appreciate 5% in the next year, while their advantage also increases by 5%, they start up and end up with a 40% advantage.)

The world is unable to compete with this 40% advantage. At the same time China now controls enough of the world’s manufacturing that they are starting to change the terms of deals for companies trying to do business in China.

The Chinese currency problem certainly is not going to go away. It is a huge bubble, that is expanding rapidly, The sooner this is dealt with the better.

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