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Sunday, August 07, 2005

The Winners and Losers from Revaluation of the Yuan

Eduardo Porter of the New York Times talks about revaluation of the yuan and notes that there will be winners and losers.  A summary and brief discussion of the costs and benefits of revaluation, including some that are omitted from Porter's remarks, is provided at the end:

A Rising Yuan Won't Lift All Boats, By Eduardo Porter, NY Times: Over the last couple of years, a good number of economists, accompanied by a horde of American manufacturers, union leaders and politicians, have called on China to release the yuan's peg to the dollar. … To believe the politicians and their friends, a rising yuan … would make Chinese products more expensive in dollar terms, giving a break to beleaguered American manufacturers … And American workers … might find themselves back in the game. … But even a yuan revaluation of 40 percent wouldn't significantly improve the overall balance of trade of the United States. For that to happen, the currencies of other developing countries would have to rise in tandem. If they didn't … manufacturers would move Americans to buy their products only from low-cost countries like Bangladesh, reallocating, but not reducing, America's external shortfall. … Still, assuming against all odds that all this happened, what would the results be for the American economy? Nicholas R. Lardy, a China expert at the Institute for International Economics who has been calling for the yuan to rise, says some American manufacturing jobs could be saved. He acknowledges that it wouldn't help all industries. … Yet for manufacturers of products like semiconductors or molded plastics - which aren't so low tech that they moved overseas long ago, but are not so high tech that labor costs are of no relevance - a currency shift of 20 or 25 percent could be important. … Perhaps. Yet the long downward spiral of American manufacturing employment hasn't responded much to currency realignments. … What is virtually certain is that if the yuan appreciates substantially against the dollar and reduces the American trade deficit, some American jobs will be lost. That's because less money would flow from China into American assets. Interest rates would certainly rise. With less of a trade drag, the economy would likely risk overheating, prompting the Federal Reserve to press on the monetary policy brakes. … Indeed, economic sectors that are particularly sensitive to rising interest rates are likely to suffer most. One is the stellar performer of the current economic expansion: housing. So consider this possibility: China yields to American prodding and lets the yuan rise sharply. American manufacturers get some slack. Housing and construction go south. Somebody protect us from what we want.

This leaves out an important element, the effect of revaluation on the price of consumer goods, so let me summarize and extend these remarks.  Suppose the yuan is revaluated.  Then:

1. Consumers are worse off due to the rise in the price of consumer goods.  If revaluation is bilateral and production moves from China to other countries, this effect may not be as large in the long-run.  If the dollar devalues against other currencies generally, the effect on prices paid by U.S. consumers will be larger.
2. Borrowers (households, business, and government) are worse off due to rising interest rates which increases the cost of loans and the cost of financing government debt.  Part of this is a transfer from borrower to lender, but there is a net drain as well due to debt held by foreigners.
3. U.S. manufacturers are better off, but this requires the dollar to devalue against other currencies generally, not just against a particular currency such as the yuan.
4. If businesses do better, then employment will increase as well making labor better off.
5. If employment and manufacturing do increase, there are transitional costs to consider as the article notes.  Rising interest rates will cause less activity in sectors such as housing and more activity in other sectors such as (hopefully) computer chips.  But during the transition unemployment could potentially increase.  Nevertheless, to the extent that such rebalancing is healthy for the economy in the long-run, there is a long-run benefit that follows the short-run cost, but the cost does need to be acknowledged.

I see the benefits of revaluation, which rely mainly on the assumption that U.S. manufactures will become more competitive, as much more tenuous than the costs of revaluation such as higher priced consumer goods and increased borrowing costs, particularly in the short-run.  It might help businesses compete down the road, and it might help to rebalance the economy away from housing, but it will also make goods and houses more expensive.

    Posted by on Sunday, August 7, 2005 at 10:44 AM in China, Economics, International Finance, International Trade | Permalink  TrackBack (1)  Comments (7)

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