Yuan may be less undervalued than it appears

By Wei Gu
March 22, 2010

Some U.S. Congressmen want to slap duties on Chinese goods unless Beijing revalues the yuan. Yet China’s premier Wen Jiabao insists the currency isn’t cheap. Goldman Sachs also thinks the yuan may be fairly valued. The argument that the renminbi may be less  undervalued than it appears is persuasive.

The yuan has a fair value of 6.856 to the dollar, according  to Goldman’s chief economist, Jim O’Neill. That would make it 0.4 percent overvalued. That view pits Goldman against the International Monetary Fund, the World Bank, and the oft-cited  Peterson Institute, which claims the yuan is undervalued by as  much as 40 percent.

Economists endlessly debate the “correct” way to value currencies.  Goldman’s method looks at relative prices and per-capita income, and accounts for factors such as rising productivity.

The other camp starts from an ideal world where countries have balanced current accounts and optimal levels of employment, and then works backwards to see what the value of the currency should be.

The evidence on the ground suggests people are getting less bang for their yuan. A Starbucks grande latte costs $3.75 in the  United States but $4.10 in China in dollar terms. A movie ticket goes for $10 in Shanghai, versus $12.50 in New York for a comparable seat at the same film.

One flaw in the argument that the yuan is undervalued is  that it may assume that countries should all have balanced trade and capital accounts. Moreover, it assumes that if that isn’t the case, the exchange rate must be to blame. Yet free-floating currencies are no panacea. Japan still ran a current account  surplus even after revaluing in the 1980s.

The best test of whether the yuan is fairly valued would be to leave it to float. But that won’t happen soon. Chinese policy makers are fearful that unpegging the currency would lead to damaging fluctuations. They see a stable currency as protection for China’s underdeveloped financial system.

In the meantime, a revaluation may do less than U.S.  politicians think to help rebalance trade and boost jobs.
China’s trade surplus widened even as the yuan appreciated 20 percent in 2005-8. The revaluation lobby is loud, but its case is far from conclusive.


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If China wants to ship goods to the U.S. in exchange for nothing, would Americans want to accept the free goods?
So what is the fuss about an under-valued yuan?

The living standard of Americans will drop if the value of yuan is raised. Most factories in China producing exported consumer goods are jointly owned by the Chinese and foreigners (Americans, Japanese Etc) or China would not know what merchandise to produce. To raise the value of yuan would produce a windfall for investors of those factories. I suspect the American investors are lobbying for a more expensive yuan so they would get higher profits after converting yuan received back into dollar.

Posted by jlpeng | Report as abusive

the living standards of americans has done nothing but dropped since china was awarded mfn status. their mercantalist policies, exploitation of labor and the enviroment and huge trade surpluses have unbalanced the global economy and was one of the chief reasons for the economic meltdown. this country would have been better off had clinton and bush had not given away our economy to china

Posted by jwws9999 | Report as abusive

I don’t know what the US is all up in arms over. Exports from the US are at near record levels and American companies are faring quite well. Don’t mess with that

Posted by Story_Burn | Report as abusive

“If China wants to ship goods to the U.S. in exchange for nothing, would Americans want to accept the free goods?
So what is the fuss about an under-valued yuan?”

The fuss is about employment, market control and fair competition. If the Chinese are shipping unreasonably cheap goods to the US, this damages US manufacturers now, and ultimately makes the United States dependent on the Chinese and/or one or two other foreign suppliers. American manufacturers will first be beaten into the ground by the exchange-rate and “team play” in the Chinese command-economy (whilst the Chinese ironically benefit from the American free market, a principle to which they do not subscribe), and then once the Chinese think they have cornered the American market, after it’s already too late for the bankrupt American manufacturers to find their feet again, the Chinese will suddenly revalue their currency (when it’s most convenient for them) and fleece the American consumer. And by that point in time, it will be nigh-on impossible for the Americans to pay back their debts, because the US export market will have been trashed. The US dollar will lose its hegemony, domestic suppliers will have disappeared in some markets, and all the Americans will be slaves.

Quality of life is not just about being able to purchase cheap goods on easy credit. It’s also about meaningful employment.
“The living standard of Americans will drop if the value of yuan is raised.” Yes. So any American politician who forces the Chinese to revalue their currency must balance the outcry from the American consumer against the pleas from American workers and exporters.

Unfortunately American consumers (and to a lesser extent Europeans) are addicted to cheap goods and easy credit. We’re all getting fat on Chinese hard work, and it isn’t good for anyone. We’ve got to realise what’s happening before it’s too late. It’s time to get out of debt, work hard and out-compete those “nice people” that want to steal our lunch.

Posted by compsci | Report as abusive

compaci: Consider what kinds fo goods are being produced in China: textiles, cheap electronics, low quality machinery…These goods were the staple of the American economy…50 years ago. Our economy is built on super high tech that China cannot possibly hope to match by any stretch of the imagination, such as the latest and greatest in biotechnology, the defense industry, and high quality computer systems (we build computer labs for China and ship them over there so they can use cheap labor to make the chips). Furthermore, the technologies of the future (nanotech, energy, biotech) not to mention the worlds best universities that encourage Chinese students with bright minds to become part of America all ensure that we have a competitive edge against China that will be maintained for years to come. I know it sounds cut-throat, but trading the American textile industry for a considerably large amount of capital for the American consumer is a great deal.

One final point: the United States outsources to a lot of countries. In fact, our overall trade deficit is proportionally the same, on average, year to year. What has happened is that a lot of the trade with other countries has been moved to China. If that becomes more expensive, I guarantee that this will simply be transferred over to other developing countries, like Vietnam, Brazil, and Malaysia (to name a few) and while we will see a drop in our trade imbalance with China, the overall deficit will continue in the same numbers, though it will be spread out over multiple countries. For more about China and US relations see http://www.philosoguy.com/111/india-and- china-and-pakistan/

Posted by pcasinelli | Report as abusive

A low yuan also makes US goods very expensive in China. If China was importing more US products, Americans would have more jobs and this trade issue wouldn’t exist.
But Chinese tariffs and taxes are still very high. For example, in Shanghai, imported cosmetics can be bought for half the price at the airport than in downtown. Imported cars are also twice more expensive than locally produced ones.
Non-tariff barriers also exist. Only a handful of foreign movies are allowed in the theathers each year, even if DVD copies of all the other ones can be bought for less than a dollar at every street corners. Facebook, twitter, youtube, and blogspot are simply blocked by the Chinese censorship. The Chinese iPhone had to be crippled because WIFI is not allowed on mobile phones in China.
Opening the Chinese market, as promised when entering the WTO, is probably the best solution. But China just want it all: selling its goods everywhere, and only buy a few things.

Posted by youpii | Report as abusive

Let’s go back to USA before civil war. You have an industrialized north, democratic were the economy is based on productivity and innovation. You have the South, democratic in name only and were the economy is based on cheap labor from African slaves. Because of artificially lower cost many North’s companies were moving their operations to the South. Many antiabolitionist were in support of maintaining slavery. The unfair competition resulted in civil war and we know what was the result.
Now many people compare China with the USA in the early 1900, but I beleive it is more like the civil war time. CHina is based on cheap labor ($1/hr is basically slavery), Chinese can’t move freely they need licenses to work in a particular region. Also the social gap is huge and social mobility is very low. Many USA companies are moving operations to China because of cheap labor costs. You have also the “antiabolitionist” Goldman Sachs in defense of cheap labor China. So the situation look similar.
For me a prefer a progressive China with freedoms, democratic were the economy is based on productivity and not a Cheap Labor China on the back of millions of Chinese who are basically in slavery.

Posted by axiom321 | Report as abusive

Maybe some of you should go to rural china and do some farm work 15 hours a day and see if you wouldnt jump at the chance to do factory work that offers 4-5x times the wage for 1/3 the work.

And $1 in the US does not buy you the same as $1 in china, the only exception being the prime areas of some major chinese cities.

“$1/hr is basically slavery”

lol wow, you dont have a clue. Get out from behind your textbook and travel and see the real world

Posted by common_sense | Report as abusive

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Posted by uberVU – social comments | Report as abusive

If you chart the two currencies over two years you would see two matching plot lines. Even if they had reached a balance when the Yuan previously moved it would be a matter of chnace if they were correctly aligned today.

Freeing the currency should be a basic requirement for being part of the global trading system. Anything else is protectionism.

Where it gets murky is that all countries undertake levels of protectionism. The US has many lobby groups for industries that do not want free and open trading in various sectors. Many countries subsidise industry sectors (through duties, laws, etc) to protect jobs or “in the national interest”.

One thing people will have to come to grips with about China – is the size of the population. This is a country five times the US. So unlike Guatemala, Haiti and other sources of cheap labour, China has a size to see it move beyond being (to use a reference from above) an ‘Uncle Tom’.

Posted by soundsgood | Report as abusive

[…] and is adamant that the yuan is not valued too low. According to some economists, he may be more right than we give him credit. A UN report also highlights the importance of a stable yuan to regional and global […]

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