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As Chinese President Hu Jintao visits Washington one subject being discussed is China's currency manipulation. China keeps its currency "weak" because it mean goods made in China have a huge price advantage in world markets. This is part of a larger national strategy to take over key strategic industries. This video, How Currency Choices 'Made in China' Have Big Impact on U.S. Economy, aired on Tuesday's PBS Newshour and explains how and why China does this:

(Note - if video is not working, you can see it here.)

Good For China, Bad For Everyone Else

China's currency manipulation -- just one part of its larger national industrial/economic strategy -- has paid off handsomely for China as a country and for those Chinese who have benefited from these policies. By keeping the price of goods made in China so low they have attracted one after another factory, then company, then entire industries.

But China's mercantilist policies have created huge imbalances in the world's economy. Low growth and joblessness in countries that have lost factories and industries is causing disruption. Inflation is a growing problem inside China. World pressure is increasing. And China's enormous trade imbalance with the United States is a key part of our own economic troubles.

You Can't Trade Chinese Currency

If the playing field were level China's currency and the resulting pressures would adjust through market trading. As China's economy strengthens more people and companies would need to purchase their currency for all kinds of reasons. The resulting greater demand would drive up its price, making their currency "stronger." Right now, knowing that the currency is 30-40% misaligned it would make sense for people to just take money out of the bank to buy Chinese currency and wait, gaining that 30-40% when it adjusts.

But you can’t. China does not allow its currency to be traded. That is part of the manipulation scheme. You cannot buy Chinese currency, so market pressures cannot force an immediate adjustment. Instead these pressures just build.

Adjustment That Is Not Adjustment

Lately, though, China has been loosening up a bit. For example, you can actually open an account at the Bank of China's New York Branch. You put dollars into the account (up to a low limit) but while your money is in the account it is valued in Chinese currency. So as the money sits in the account its value fluctuates against the dollar. When you take your money out, it is still the same amount in Chinese currency but because of fluctuations in China's currency that translates to more or fewer dollars than you put in. Since China's currency is greatly undervalued, it will almost certainly adjust upwards and you will be taking out more dollars than you put in. (Investment advice: do it.)

In response to world pressure and this slight loosening China's currency is adjusting slowly, rising by 3-5% against the dollar. But this adjustment is very likely the amount that natural forces would have appreciated their currency anyway in this time frame. Even if China's currency was currently in balance it would adjust 3-5% anyway. This means it starts 30-40% out of balance and the imbalance is still 30-40% after this adjustment. So this level of adjustment is really not correcting the larger imbalance at all.

Adjusting Too Fast Is Dangerous

China's currency is adjusting too slowly to make a difference. However, very rapid changes would mean trouble for everyone. This is a huge, dangerous bubble on a scale comparable to or even worse than the housing/Wall Street bubble that nearly destroyed the world economy when it burst. A rapid adjustment would just create different, huge problems. For example, we have given up much of our advanced manufacturing, especially in electronics and cannot just start again without rebuilding the infrastructure of tools, expertise, supply chains, etc. So with a rapid currency adjustment we would have to pay much higher prices for things until we could make them here again. And China has raised expectations of improvement in their population, so a rapid adjustment and resulting loss of employment improvement would cause tremendous social disruption for them.

Certainty Is Needed

The solution is to have clear policies that guarantee China's currency adjusts to market levels over a period of time. This must be accompanied by a guarantee to bring their trading policies to a level playing field. And if China refuses to coopreate the American government must implement and enforce policies that force these changes. Once American business leaders understand with certainty that they party is over and goods from China are going up in price they will begin the process of rebuilding our manufacturing infrastructure in order to be ready. And China would be forced to implement internal policies that get them ready.

Selling China The Rope

How did all of this misadjustment come to pass? How did we allow this huge bubble to build up? How did China go all these years with policies that let them capture so many jobs, factories, businesses and key industries?

The difference: China has a national strategy and we do not. They look at the overall, longer-term picture, seeing themselves as a country of people with a common interest. We do not. They understand that attracting industries to China is good for China and its people in the long term. We do not. We follow an ideology that says that the interests of individual companies and a few wealthy people are the same as that of the country-at-large, and if companies can make larger profits in the short term and a few people can get wealthy closing factories and moving them to China that's just fine, even if it means a loss of jobs and of the country's overall ability to make a living in the long term. Our "free market" ideology conveniently leads to great wealth for a few at the expense of the rest of us and our future. And, as always happens, the beneficiaries here and in China use their increased wealth and power to influence policy to keep the good stuff flowing their way. We don't learn the lessons of history, they don't forget.

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