China becoming more reliable economic player in world markets

Either by design or neces­sity, it seems China is finally becom­ing a more viable eco­nomic part­ner for the U.S. and other nations. Over the week­end, China’s cen­tral bank announced they would allow their cur­rency, the yuan, to trade freely in a wider range of val­ues than pre­vi­ously per­mit­ted. It is impor­tant to note that this devel­op­ment is quite dis­tinct from allow­ing the yuan to move com­pletely freely rel­a­tive to other currencies.

While this is only a small step, it is one that should, over time, work to the advan­tage of America’s exporters. With the yuan allowed to appre­ci­ate (rise) in value rel­a­tive to the dol­lar (and the euro, yen, peso, etc.), the goods and ser­vices pro­duced in the U.S. (and else­where) can be offered up to Chi­nese con­sumers and busi­nesses more rea­son­ably priced. As a result, U.S. busi­nesses should sell more of their products/services in China and thereby increase U.S. output/employment.

Of course, there is a down­side to China that comes with this more market-friendly approach to the yuan’s value. If the Chi­nese import more from the U.S., their pro­duc­tion needs will taper off and the pace of eco­nomic growth may sub­side. First quar­ter growth in China’s GDP sug­gests this may already be hap­pen­ing, with a “mod­est” eco­nomic growth rate of 8.1 per­cent. But even as their domes­tic production/employment grows less briskly, the buy­ing power of Chi­nese cit­i­zens advances — because they can afford more for­eign prod­ucts, includ­ing those from the U.S. — and infla­tion­ary prob­lems are bet­ter con­trolled. After all, Amer­i­cans have seen the ben­e­fits of low-priced Chi­nese prod­ucts for years. Now, the tide can turn and Chi­nese cit­i­zens can ben­e­fit from more reasonably-priced U.S. goods and services.

As time pro­gresses, the huge trade sur­pluses expe­ri­enced by China in the past will begin to dis­si­pate, as will their super-sized eco­nomic growth rates. But then that is part of the attrac­tive­ness of market-based solu­tions among nations; under a free trade sys­tem, as time pro­gresses, the growth rates among coun­tries will tend to con­verge and every­one has the oppor­tu­nity to see mate­r­ial stan­dards of liv­ing advance.

To be sure, this change from China’s past currency-manipulation efforts is not with­out pain for the U.S. As the value of the yuan appre­ci­ates, the value of the dol­lar (rel­a­tive to the yuan) must nec­es­sar­ily depre­ci­ate. Over time Amer­i­can prices for Chinese-produced goods/services will rise and tend to ignite infla­tion­ary pres­sures here in the United States. With higher infla­tion­ary pres­sures the Fed­eral Reserve may be forced to remove the exces­sively accom­moda­tive mon­e­tary poli­cies of the past sev­eral years and thereby drive up U.S. inter­est rates.

Even beyond what may hap­pen with regard to mon­e­tary pol­icy actions by the Fed­eral Reserve, inter­est rates may be forced to rise (pos­si­bly sig­nif­i­cantly) due to the fed­eral government’s inabil­ity — or will­ing­ness — to con­trol the deficit/debt sit­u­a­tion. Since the U.S. gov­ern­ment is pro­jected to have annual bor­row­ing needs of one tril­lion dollars-plus almost indef­i­nitely into the future, the gov­ern­ment must bor­row those funds from who­ever is will­ing to buy U.S. Trea­sury secu­ri­ties. In the past, China has been a major purchaser.

But with the U.S. dol­lar depre­ci­at­ing under China’s more market-oriented approach, the attrac­tive­ness of buy­ing U.S. Trea­sury secu­ri­ties (which accu­mu­late inter­est income in dollar-denominated terms) is reduced. With this low­ered demand for U.S. Trea­suries, the price of Trea­suries would fall, or stated dif­fer­ently, the inter­est rates that the U.S. gov­ern­ment must pay to attract funds would rise. So, whether orig­i­nat­ing with this need to offer higher returns on Trea­suries or the Fed­eral Reserve dri­ving up rates to con­trol infla­tion, both con­sumers and busi­nesses would face higher bor­row­ing costs and pos­si­bly lower U.S. growth prospects.

But then again, savers would finally get a reprieve from the Fed’s pun­ish­ingly low inter­est rates. So, pre­cisely how eco­nomic activ­ity in the U.S., Chi­nese, and world economies would set­tle is hard to deter­mine, but in a net sense a more market-based approach to cur­rency val­u­a­tions should be favor­able to almost every­one involved.

It should also be noted this yuan-policy is just a first step for China in becom­ing a more respon­si­ble player on the world eco­nomic stage. They are still accused of engag­ing in acts of indus­trial espi­onage and fail­ing to honor the patents orig­i­nat­ing in other coun­tries. But as time pro­gresses, Chi­nese eco­nomic devel­op­ments may well force the coun­try to become freer. And for Chi­nese cit­i­zens, that free­dom may well be the most valu­able import of all.

Dr. James New­ton serves as chief eco­nomic advi­sor to Com­merce National Bank and is an aux­il­iary fac­ulty mem­ber in eco­nom­ics and sta­tis­tics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not nec­es­sar­ily reflect those of Com­merce National Bank or OSU-Marion/Newark.

Posted by Jim Newton on Apr 17 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.