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.