China's currency manipulation helps Fed manipulate interest rates

Section:

Chinese Currency Plays Complex, Crucial Role in U.S. Economy

By Terry Savage
Chicago Sun-Times
Monday, October 29, 2012

http://www.suntimes.com/business/savage/16020443-452/chinese-currency-pl...

The Chinese currency has taken center stage in some of the economic policy debates leading up to the election. That is because of the perception that China is the source of all our jobs woes as their economy continues to grow at a rate four times as fast as ours. The theory is that by keeping their currency artificially "cheap" against the dollar, it encourages America to import more goods from China -- while encouraging job growth there to make all those products.

But this discussion of the Chinese currency leads to some interesting revelations of our general ignorance about Chinese currency and our trading relationship. For instance, what is the proper name of the Chinese currency?

You’ll hear two terms -- and both are correct, technically. The renminbi is the name of the currency system, literally meaning "the people's currency." The yuan is the main unit of currency within the renminbi. There are also the jiao (1/10th of a yuan) and the fen (1/10th of a jiao).

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This is similar to the British currency system, which is known as "Sterling," while the unit of currency is called the British pound. In America we refer to our currency system and the individual currency using the word "dollar."

You will often see the renmimbi written as RMB -- which is pronounced basically the same as the spelled-out word. Since both renminbi and yuan can be used interchangeably, RMB is the easiest way to talk about the Chinese currency.

Where Americans get in trouble is with the pronunciation of the yuan. It is not pronounced like the "won" in won-ton soup.

Because of the tonal quality of the Chinese language, I am told that few Americans will ever pronounce it correctly. The easiest written explanation I have seen is this: "It sounds like the abbreviation for the United Nations. Saying 'U.N.' without taking a pause between the 'U' and the 'N' sounds very similar to one way a native Mandarin speaker would say the name of the Chinese currency."

Now that you know how to pronounce the Chinese currency, it's important to understand how it relates to the U.S. currency. As you already know, most currencies around the world "float" in relation to the U.S. dollar. Thus the dollar may buy more euros on any day depending on the "strength" of the dollar and the economic crisis in Europe. Same thing with the Japanese yen and other major currencies.

But the RMB (the term I'll use throughout this column) does not float freely against the U.S. dollar. The Chinese government sets a trading range for the value of its currency against the dollar. Since the launch of the exchange rate bands in 1994, they have been changed and expanded several times, most recently last April.

The "trading range" is based on an exchange rate set daily by the Peoples Bank of China (similar to our Federal Reserve). It is called the "parity rate." Since April 2012, the range in which the RMB is allowed to rise or fall is 1 percent above the parity rate. (Previously the range was only 0.5 percent above or below the parity rate.)

The RMB is trading at its highest level against the dollar since modern currency trading was allowed in 1994. The RMB is now trading at 6.2417 to the dollar. In fact, the RMB is up 0.8 percent against the dollar for the year. And it is up 9 percent since 2010.

That has a direct impact on the prices we pay for Chinese imports. When the RMB is "weak" it allows our dollar to buy more Chinese-made goods (assuming their prices stay the same). And when the RMB is as strong, it takes more dollars to buy the same amount of Chinese goods, making them more expensive in the United States. A strong Chinese currency also allows the Chinese to purchase our products (soybeans, grain, oil) more easily.

The Chinese currency has strengthened recently, as it appears their economy is not going to slide into a deep recession -- and as money from around the world has sought a place to invest cash. But also behind the strengthening of the RMB is the Chinese government, allowing more upward movement as they are sensitive to criticisms that an "undervalued" currency helps boost their exports to places like America.

Both political parties have been critical of Chinese currency policies, which have facilitated cheap imports into the United States, and which subsidize manufacturing in China. Early in the Obama administration, there were strident calls to "do something" about the weak Chinese currency. And now Mitt Romney has said he would label China as a “currency manipulator” and act to raise tariffs on imports of Chinese goods into America.

It is ironic that these calls would come just as the RMB is growing stronger against the U.S. dollar. But it is even more ironic that both parties seem to be demonizing China in this election. After all, many of the dollars we send to China are used by their central bank to buy U.S. Treasury securities -- helping us to fund America's budget deficits at low-interest rates.

In fact, China now owns roughly $1 trillion of our $16 trillion national debt. If they stopped buying -- or didn't earn the dollars that they use to buy our debt -- the United States might have to attract other buyers of our debt by raising our interest rates.

And higher interest rates would work against our recovery. So while it might be "politically correct" to harangue against China's currency "manipulation," it's important to realize that the Chinese are helping the Fed "manipulate" our interest rates down to artificially low levels. And any currency war, or trade tariffs, could hurt the United States as much as it would impact China.

Because we're in debt, we're in this together.

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