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We are well into a political season as the U.S. presidential campaign heats up. We are also in the midst of deflationary pressures evident in the unprecedentedly low cost of oil and other commodities, and the falling dollar value of the yuan. Many Republican candidates, led by Donald Trump, are keen to blame America’s economic troubles on President Obama and, of course, on the Chinese.|
“Currency manipulator” is the typical charge against China. But what does it mean and why is being thrown around now?
In the broadest sense, every country with a functioning central bank—including the U.S. with its Federal Reserve System—is a currency manipulator. The duty of a central bank is to manage or, one could say, manipulate, the value of its nation’s currency by expanding or contracting the money supply, as appropriate for national policy.
So the fact that China also uses its central bank, the People’s Bank of China, to manage the yuan comes as no surprise. China would be lax if it did not do this. What Republicans like Trump protest is not that China manages or “manipulates” the yuan, but that it allegedly tries to keep it cheap in dollar terms. Critics of China’s currency policy claim that it promoted a consistently undervalued currency to keep its goods cheap in relation to the goods of other countries, especially those of the U.S., its number one overseas market.
The evidence for a deliberately “weak” yuan is itself weak. For many years after China emerged from self-imposed economic isolation of the 1960s and 1970s, it aimed at stabilizing the value of the yuan at RMB 8 per dollar. Like dozens of other countries around the world, it tried to stabilize its currency by pegging it to the currency of its leading trading partner, the U.S.
By 2005, China was amassing huge trade surpluses relative to the U.S. as its exports flourished while its imports—at least, those from the U.S.—lagged. Consequently its dollar reserves grew fast. It became increasingly difficult for the Chinese government to maintain the peg to the dollar, so the government began allowing the yuan to appreciate relative to the dollar until 2014. So for nine years the value of the yuan was moving in the direction that critics like Trump say it should.
Despite the fact that the yuan grew in value, from 8 yuan to the dollar to almost 6, the drumbeat of “currency manipulation” accusations continued. Why? Mostly because the claims were based on the textbook economics argument that in free markets the value of currencies ought to reach an equilibrium that balances trade. Since China maintained a persistent surplus in its trade with the U.S., its currency, though rising in value, must have not been rising fast enough.
This is another case where, when reality does not accord with the economic textbook, people blame reality rather than the faulty textbook. In fact, the textbook is wrong in this case for two reasons.
First, as I have argued in my book and in earlier pieces, very little of world trade occurs in free markets. Thus market prices and exchange rates may not adjust as freely and swiftly as the textbook theory assumes they will, regardless of government intervention.
Second, the main influence on currency values today is not trade flows, but investment flows, so-called “hot money”—that is, investments into and out of a country. When a country is attractive as a destination for investment, its currency tends to rise. That rise does not necessarily reduce its exports, as the China case shows. When a country is no longer as attractive for investments, as has been the case for China since 2014, capital flows reverse and the currency tends to decline in value, as indeed the yuan is now doing. These flows are driven, for the most part, not by government policy, but by the interests and expectations of private investors. To respond as critics now demand, the Chinese government would have to intervene massively against the current market tendency to depress the value of its currency. In other words, to satisfy the critics charging it with “currency manipulation,” China would have to become a massive currency manipulator.
I suspect there are two real reasons that Trump and others are so adamant about China’s alleged currency manipulation. First of all, China is a convenient foreign scapegoat. Second, the real agenda is not to strengthen the yuan, but the flip side of that: to weaken the dollar. But China-bashing may be more popular than campaigning for a weaker dollar.
Taken as a whole, Trump’s economic policies represent a reversal of long-standing Republican Party priorities. In effect, regarding monetary and currency policy, the Democratic and Republican Parties have switched places in 2016. This is a historic change, but it has largely escaped notice.
Throughout much of American history, the Republican Party has been the party of big manufacturers and the “Eastern Establishment,” meaning large financial interests concentrated in New York, Philadelphia, and Boston. On the other hand, the Democratic Party has been the party of southern planters and northern urban real estate and development interests. The way this translates into monetary policy is that the Republican Party has generally favored tight money, better described as tight credit policies, of the big banks and bearish blue-chip corporations, which also correlate with a strong dollar. The Democrats favored looser credit since real estate and landed interests, like the southern planters, have assets such as land that hold their value during inflation, but whose debts become devalued with inflation. The bond holders and banks that lend the money want the dollar to hold its value, but debtors like farmers and real estate developers love nothing better than for inflation to erode the burden of their debts.
Along comes Trump, real estate developer and former Democrat, who now leads in the polls for the Republican Party nomination. He wants to deport millions of immigrants who comprise the industrial labor force for many American corporations, which would certainly increase inflation. He wants higher tariffs on imports, which is inflationary. He wants China to raise the value of its currency, meaning the dollar falls in value, which is inflationary too, because it makes imports more expensive. He wants a huge increase in government spending on infrastructure, which is good for real estate interests and is also inflationary. In terms of the monetary impact of his policies, he still sounds like a Democrat.
Maybe that is because the great financial interests have increased their influence within the Democratic Party so much since President Clinton that they now deliver policies favoring a strong dollar, which used to be a more typically Republican position. Pro-inflation interests like real estate developers and other large debtors have discovered that there is no more room at the table in the increasingly tight credit, pro-Wall Street Democratic Party (Bernie Sanders notwithstanding), so they’re rushing to the Republican Party to steal that cause away from its traditional big business establishment. The established GOP elite is perplexed that standard-bearers like Jeb Bush are losing to monetary debasers like Trump.