China’s Currency Manipulation—How Does It Work? Is It A Problem?

chinese currency devaluation has benefited China enormously, but harmed America

Understanding Currency Devaluation & China’s Other Predatory Trading Tactics

For everyone pushing for more trade with China, there’s something you should know.

They fight dirty.

Over the last few decades, China’s applied relentless economic pressure on America, using a number of sophisticated trading tactics—from currency devaluation to dumping.

Why?

Why else?  To get rich.

China used America to springboard their economy into the modern age: our capital and technology built China from the ground up.

It was great for China, but not for America.  Not by a long shot.

In this article, I’ll explain China’s dirty trading techniques, focusing in on currency manipulation, and make the case that we shouldn’t be getting into bed with China—fool me once, shame on me; but fool me twice…

What Is Currency Devaluation?

China has many tricks up its sleeve, but the biggest and baddest is currency devaluation.

We always hear politicians talking about it, but no one does anything about it—probably because most of them don’t understand it.

Even republican pundits, like Ben Shapiro don’t really have a firm grasp of what currency devaluation actually is—Ben confuses natural hyperinflation with managed currency devaluation.

They’re not the same thing.

So what is currency devaluation?

Basically, it’s when a country artificially lowers the value of its currency relative to another currency—it’s currency manipulation designed to make a currency cheaper.

Why would a country want to do this?

Usually because it makes your stuff cheaper: this boosts boosts demand for your exports (people like to buy cheap stuff) and increases foreign direct investment (people invest in cheap places).

Theoretically, this currency manipulation shouldn’t be possible, and therefore shouldn’t work.

Let’s look at how trade between China and America ought to work in a hypothetical example.

1.  America buys Chinese goods with Chinese currency (the Renminbi).

2.  This boosts demand for Renminbi, which increases its value.

3.  Theoretically, if Renminbi are more expensive, then Chinese goods are more expensive, and therefore less attractive to American consumers.

4.  This teeter-totters until a price equilibrium is found for China’s currency.  That’s how free markets work, after all.

But that’s just theory.

In practice, China’s currency devaluation worked wonders.

Why?

China knew that American investment, and specifically technology, would grow its economy in the long term.  In fact, it couldn’t grow, at least not rapidly, without it.

American investment provided the capital, technology, knowledge, and machinery China needed to modernize its economy.

Therefore, it was in China’s interests to ensure this investment poured in.

To do this, China devalued its currency.

How?

China bought trillions of American dollars, which inflated the dollar’s value (because of increased demand) while deflating the Renminbi (because of decreased demand).

This ensured that China’s exports were cheap, and that China was an attractive place to invest.

That’s how, and why China devalued its currency.

Why China’s Currency Devaluation Worked

Lots of people (like Ben Shapiro) don’t think currency devaluation is a problem, and therefore, we shouldn’t bother taking action against countries that manipulate their currencies.

Why?

Because they think the market will find an equilibrium price—they have total faith in the market.

They shouldn’t.  The market won’t necessarily find an equilibrium price because we’re not talking about a closed system.  Frankly, the economic model underpinning the economically liberal view of currency manipulation is incomplete.

How so?

Currency markets measure total demand for a currency, but they don’t distinguish whether the demand is caused by exports, or by the sale of assets (past production, like property) or debts (future production, like T-Bills).

Therefore, currency values can be kept artificially low (or high) by selling or buying assets and debts.

This allows a country to optimize its currency for selling exports (at the expense of the other two), which stimulates economic growth.

special-olympics-dream-house-front-california-design-houses-concrete-modern-house-design-in-two-storey-house-design
Foreign buyers scoop up over $100 billion worth of US property per year.

It’s a gamble.

It only works if the economic growth caused by a lower currency outweighs the potential economic downsides.

It’s been great for China—they’ve been growing at nearly 10% per year for decades, they’ve created a middle class larger than the whole of America, and they’ve advanced their technology from rickshaws to rockets.

And all of it happened because China’s cheap currency attracted American investment, and provided them with a market for their output.

This brought trillions of dollars into China’s economy ($5.2 trillion since 1985), and better technology.

At what cost?

China’s backed away from officially devaluing their currency, but we can still see the residual impacts.

For example, foreign investors (Chinese, as well as other countries that practice currency manipulation) own 20% of all US equities (up from 12% in 2007)—they exchanged goods for our ownership of our companies.

But the biggest piece of evidence is China’s ownership of our national debt.

China’s bought over $1.3 trillion in US Treasury Bills and currently holds an estimated $2.6 trillion in US currency reserves (although the precise figure is a Chinese state secret).

All totaled, foreigners hold 47% of our national public debt (over $6 trillion worth) and 43% of all US corporate bonds.

Basically, Americans invest in China, and buy their goods, while China buys US debt and property.

Beijing’s “Bird’s Nest” Stadium—built with American technology and money.

China’s Other Predatory Trading Tactics

That’s how currency devaluation works, but China’s also used many other techniques to get the best of America.

China routinely violates World Trade Organization agreements by maintaining barriers to entry into their domestic market.

Commonly, this involves imposing absurd, or completely incomprehensible regulations to keep foreign companies out, but sometimes China simply grants Chinese companies tax breaks relative to foreign companies etc.

China’s also been known to “dump” their products in foreign markets, ie. flooding foreign markets with below-cost products in order to kill local competition, and then raising prices once a monopoly is established.

For some reason, libertarian economists (of the sort that love Ayn Rand) don’t even acknowledge this as a problem, because they think it’s impossible to sell at below-market rates.  Willful blindness.

China also helps out their exporters by suppressing labor costs (discounting them by as much as 47-87%, depending on the industry), in order to attract initial investment and technology.

But perhaps the most important of China’s dirty tactics are their exporter subsidies.

Between 2000 and 2006, roughly 33% of Chinese exporters sold over 90% of their goods abroad—for context, only 0.7% of American exporters did the same.

How did they hit such unnaturally high numbers?  Chinese export industries rewarded with preferential land-use policies, easier access to finance, or exemptions from various industrial or commercial taxes, in direct contravention to WTO rules.

All this highlights just how dedicated the Chinese are to preying upon Western markets.

The Future Of Trade With China

China doesn’t fight fair: Chinese companies are free to compete in America, but American companies cannot compete in China.

But why should they?

Predatory trade is far more lucrative than free trade—I don’t care what you learned in your college economics class, your professor was wrong.

Theory always needs to take a backseat to reality.

The truth is that China got rich by taking advantage of American markets, by devaluing their currency, by practicing de facto mercantilism—all the things classical economists say can’t work.

Turns out, they were wrong.

China’s returned to its historical position as the world’s major trading nation, and they did it without liberal economics.

Here’s a word of warning: China’s trade paradigm with America is deliberately predatory, and all we’re doing by pursuing freer trade with them is pitting our companies against the power of their dictatorship.

Our companies are getting squashed like bugs, and it’s killing our free market—in trying to keep the American government out (by lowering tariffs), we’ve let China’s government in.

That’s a bad trade.

To protect our free market, we must fight fire with fire, and impose massive tariffs on Chinese products—otherwise we don’t have a chance.

At the end of the day, economic globalization isn’t always a good thing.

Sources & Further Reading on Chinese Currency Manipulation:

Bergsten, Fred C. and Joseph E. Gagnon. “Currency Manipulation, the US Economy, and the Global Economic Order.” Peterson Institute for International Economics, Policy Brief, 2012.

Defever, Fabrice, and Alejandro Riaño. “China’s Pure Exporter Subsidies.” CEP, Discussion Paper 1182, 2012.

Frank, Robert. “Wealthy Foreigners Bought $100 Billion in US Real Estate.” CNBC, June 22, 2015.

Jackson, James K. “Foreign Ownership of US Financial Assets: implications of a withdrawal.” Congressional Research Service, 2008.

United States Census Bureau, “Trade in Goods, 1985-2016.” Accessed May 20, 2016.

World Bank, “GDP by PPP Statistics.” Accessed May 15.

—“Total Reserves (includes gold, current US$).” Accessed May 15, 2016.

About Spencer P Morrison 62 Articles
JD candidate, writer, and independent intellectual with a focus on applied philosophy, empirical history, and practical economics.Author of "America Betrayed" and Editor-In-Chief of the National Economics Editorial.

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3 Comments on "China’s Currency Manipulation—How Does It Work? Is It A Problem?"

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robert
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This is such a load of bs

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