Published at Forbes. A shorter version published in The Tennessean, Sunday, January 29, 2012.
One good thing about President Barack Obama's State of the Union address this week was that he refrained from describing China as a currency manipulator. He did note the need to protect intellectual property rights, though the protection of property rights was not at all central to the theme of the president's speech.
The president's thinking on trade matters is better represented in his announcement of the “creation of a Trade Enforcement Unit that will be charged with investigating unfair trading practices in countries like China.” One task of this new unit will be to push China to increase the value of its currency.
This is not a new task, but it might be helpful that the unit is focused also on the encouragement of greater trade freedom and protection of property rights. Nevertheless, the whole effort is confused by allegations of currency manipulation.
As China emerged from decades of communist repression, its leaders knew that their currency would never be trusted at home or abroad if it maintained an independent monetary policy. Accepting this, for many years China chose to fix the exchange value of its currency to the dollar. What they did, in essence, was to adopt the US dollar as their monetary standard. As long as the exchange rate was fixed, the US dollar served as the Chinese monetary base. The Chinese currency itself was merely for daily domestic use.
Several countries and jurisdictions, such as the United Arab Emirates and Hong Kong, have long had fixed exchange rates between their currencies and the US dollar. Other countries, such as Ecuador and Panama, have been using the US dollar as their de facto currencies. We don't hear complaints about these countries' currency policies.
The currency complaints against the much larger China are purely instrumental, intended to serve protectionist political constituencies in the US. Charges of “currency manipulation” come mainly from politicians who need to please groups, such as trade unions and local manufacturers, who feel threatened by international competition.
Governments have often resorted to currency devaluation as a means to give domestic exporters a competitive advantage. Such a policy of “competitive devaluation” can, at best, give a short-term stimulus to a small subset of the economy. In general, it fails. It has always been a very poor substitute for domestic economic policies of low taxation, light regulation, a small government-sector, and a sound currency.
The Chinese currency is still not convertible, which means that there are controls on the access that Chinese residents have to foreign currencies. Historically, such controls have been applied in attempts to maintain demand for an overinflated currency. But the only goal that it really succeeds in achieving is increased control over citizens and the concentration of power in some government bureau. By standards suitable for public statement, such controls always fail.
Those who insist that the Chinese currency is undervalued should explain to us what the correct exchange rate is and how they determined it to be such. But they can't do that without revealing the subjectivity of the whole exercise. What they really want is to push competitors perpetually to do the opposite of competitive devaluation.
Meanwhile, they are quite content to pretend that the dollar, over which the US government has monopoly control, with the power to inflate the currency and to manipulate interest rates, is a “free-market currency” as long as we advocate flexible exchange rates.
Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.
Copyright © Richard J Grant 2012