What Exactly Would a Stronger Yuan Do for the US Economy?

Obama’s trip to China was mostly photo-ops and talk about the importance of trade. The one topic on which Obama spoke sharply was the need for China to allow the Yuan (officially called the Renmimbi) to strengthen against the dollar. Many analysts are criticizing the Chinese government for ‘manipulating’ the Yuan, keeping it too low relative to other Asian currencies. Paul Krugman, perhaps the best-known economist in the US, calls it ‘outrageous’, and accuses China of making its export-oriented neighbors poorer through unfair currency manipulation. Leaving aside the obvious point that all currencies are manipulated—in a world of fiat currencies, no item of intrinsic value stands behind the dollar or the Yuan—let’s explore the question of how the US might benefit from an strengthening of the Yuan.


Back in 2005, the World Bank estimated the Yuan to be undervalued by 10%, based on purchasing power parity. Other economic analyses have concluded an undervaluation of 20 to 25%. Let’s take the upper end of the these estimates and assume the Yuan is undervalued by 25%, and that China, acting for the good of the world, allows the Yuan to appreciate 25% against the dollar. What would that do for the US economy?


The most obvious and immediate effect would be an increase in prices. Consumer price theory tells us that that increases in exogenous costs such as tariffs are not fully reflected in final prices, but the cost is shared by producer and consumer depending on the elasticity of demand. The increase in prices directly translates into increased prices for consumer goods, for apparel, electronic goods, raw materials, food items, etc. It’s hard to see how that rise in prices would benefit American households, who are feeling the effects of 10.2% unemployment and falling home prices. It’s more likely that increased consumer prices would bring significant hardship.


In theory, an appreciation of the Yuan should narrow the trade deficit between the US and China. But it’s likely that the trade deficit won’t fall much (if at all), because consumers driven by low prices are likely to select goods from other low cost producers (Thailand, South Korea, the Phillipines, or India, for example).


Would an appreciation of the Yuan cause an increase in American employment? It’s hard to see how. There aren’t many US industries that are in direct price competition with Chinese exporters. Overall, the US economy is in a process of shifting back toward productive activity (including manufacturing), but such a shift is the product of many structural economic forces, not simply the relative value of the Yuan and the dollar.


As Obama urged China to allow the Yuan appreciate, Zhou Xiaochuan, the head of China’s central bank, fired back that the US needs to get its fiscal deficits under control and raise interest rates. Zhou is clearly correct that currency manipulation (in whatever direction) cannot help the US economy out of its malaise. Only fundamental economic changes can do that. But cutting the deficit in this economy will require massive spending cuts, while raising interest rates will cut off the monetary stimulus, no doubt deepening the recession.

If only it were as easy as blaming China.