# De-valuation of Chinese currency. How? And to what effect? **URL:** \ **Category:** Factual Questions\ **Created:** [October 23, 2010, 2:58am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068 "2010-10-23T02:58:46Z")\ **Posts on this page:** 9\ **Page:** 1
**Author:** ![Tripler](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/tripler/32/21807_2.png) [@Tripler](https://boards.straightdope.com/u/Tripler)\ **Post date:** [October 23, 2010, 2:58am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/1 "2010-10-23T02:58:46Z")
I was driving at length today, and something on NPR mentioned that the Chinese government has devalued currency (something I knew they’d practiced for awhile). But it reminded me of two questions I’d always had: A.) How would you devalue your own currency? Would you limit its value domestically compared to what the rest of the world is trading it for? What mechanisms would you implement to keep it de-valued? B.) To what purpose would you do this? To make your creditors do something? To influence your debtors? Stave off inflation or something? NPR mentioned this in contrast with the export surplus China has (e.g. they flood the world’s markets with a volume of cheap goods, but don’t import as much), but again, I don’t follow why China (or Mauritius, or SeaLand, the Klingons, or anyone for that matter) wouldn’t want their currency to be as strong as possible. Can anyone teach a non-economist some basic financial principles to this simple engineer? Tripler IIRC, they also discussed the impact to the housing bubble. . . ---
**Author:** ![Tripler](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/tripler/32/21807_2.png) [@Tripler](https://boards.straightdope.com/u/Tripler)\ **Post date:** [October 25, 2010, 12:20am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/2 "2010-10-25T00:20:29Z")
Polite bump (or an artificial inflation on the views). Did I misunderstand the radio then? I found a related [NPR article](http://www.npr.org/templates/story/story.php?storyId=130712612) discussing how the “G20 finance ministers” are pledging to fight currency manipulations. Given this: > [@the lNPR article above](#): > > _Nations in Asia and other regions have been trying to stem strength in their currencies amid sustained weakness in the U.S. dollar out of fear their exports will become less competitive. At the same time, China’s currency, the yuan, has been effectively pegged to the greenback, provoking criticism it is being kept artificially low and giving the country’s exporters an unfair advantage._ Bear with my hypothesis: It is a plan then, to devaluate your own currency and flood the market with cheap-to-make goods (cheaper labor = cheaper production costs), hoping that you’ll undercut the other guy’s price (and thus increase your own sales). Then, when your own government gets its hands on the US dollar, it doesn’t convert it into the undervalued local currency, but trades it on the open currency exchange making a bigger bang for the buck it has? The portion of that profit goes back to the masses (in the undervalued currency) to maintain the production. The other portion goes into your operating budget for whatever. Example: A widget costs you $1.25 to make. That same widget costs me USD $0.50 to make in production costs (thanks to an artificially low currency, wage, and centrally-controlled market prices), maybe $0.50 to ship (I’ve got low-paid labor on a fleet of commercial ships), and a low import duty (of, say another $0.10) because your Super-Stores demand it, and my base cost is $1.10. I sell that for another five cents higher, and make $0.05 profit on each piece. But that’s not _my_ five cents, that’s _your_ five cents, which translates into _my_$3.00 because I have a seriously managed economy making that USD 5¢ go farther? Am I seeing things correctly? Tripler Is there a link between an undervalued currency and an overmanaged market economy? ---
**Author:** ![Darth\_Panda](https://avatars.discourse-cdn.com/v4/letter/d/ee7513/32.png) [@Darth\_Panda](https://boards.straightdope.com/u/Darth_Panda)\ **Post date:** [October 25, 2010, 12:48am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/3 "2010-10-25T00:48:32Z")
A country can control the value of own currency simply by buying and selling its own currency on the open market - therefore creating a source supply or demand. The reason that China has tradiitonal preferred a devalued currency, especially versus the US, is because the altering of the nominal exchange rate changes the natural cross border purchasing power parity of one country versus another - in effect, allowing US consumers to buy goods from the Chinese cheaper than they might if the currency were completely free floating. Of course, it isn’t without downsides - for one, it makes it more expensive for the them to buy stuff from us. More importantly, from a policy point of view, it means that their central bank isn’t able to exert control over their own country’s rate of inflation. (The US fed buys and sells treasury notes from our banks in order to set interest rates, and therefore target inflation rates). That’s the real simple version (take with a grain of salt or two, I’ve got nearly a 12 pack in me…) Here’s some more info: > **[Fixed exchange rate system](https://en.wikipedia.org/wiki/Fixed_exchange_rate#cite_note-0)** > > A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold. > There are benefits and risks to using a fixed exchange rate system. A fixed exchange rate is typically used to stabilize the exchange rate of a currency by directly fixing its value in a predetermined ratio to a different, ... > **[Pitfalls\_Sep\_Oct1990.pdf](https://files.stlouisfed.org/files/htdocs/publications/review/90/09/Pitfalls_Sep_Oct1990.pdf)** > > 1527.18 KB > **[China Ends Fixed-Rate Currency](https://www.washingtonpost.com/wp-dyn/content/article/2005/07/21/AR2005072100351.html)** > > China on Thursday took an important step forward in its move toward a market economy, announcing it would increase the value of its currency, the yuan, and abandon its decade-old fixed exchange rate to the U.S. dollar in favor of a link to a basket... ---
**Author:** ![China\_Guy](https://avatars.discourse-cdn.com/v4/letter/c/779978/32.png) [@China\_Guy](https://boards.straightdope.com/u/China_Guy)\ **Post date:** [October 25, 2010, 2:51am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/4 "2010-10-25T02:51:13Z")
Tipler, your semantics are incorrect. The Chinese are being pressured to appreciate their currency. This is effectively a way for the US to depreciate the greenback. competitive devaluations are very painful. Look to the experience of the 1997 Asian crisis. This is what the G20 is trying to avoid. Devaluation only helps one economy if no one else follows suit - and maybe not even then. to rephrase there has never been a serious economic guggernaught that devalued their currency. ---
**Author:** ![Hellestal](https://avatars.discourse-cdn.com/v4/letter/h/3ab097/32.png) [@Hellestal](https://boards.straightdope.com/u/Hellestal)\ **Post date:** [October 25, 2010, 12:23pm UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/5 "2010-10-25T12:23:44Z")
**Tripler** , let’s start with the idea of trade. There are ships. We load stuff like big industrial equipment onto the ships and send them sailing over the ocean. At the other end, China unloads the industrial equipment and loads up plastic toys for Happy Meals. The ships come back. Assuming the value of the industrial equipment is the same as the value of the plastic gewgaws, we’re gravy. There’s a trade balance. You can say that China sends us cash, and we send the same amount of cash back. Ah, but what if the total value of the toys is greater? What if there’s a trade deficit (as is the case now) and China sends us more stuff than we send them? Then the Chinese have _extra dollars_ hanging around. They didn’t buy enough of our stuff to close the trade balance, which left them with more greenbacks, which is what we have to offer them. Well, they don’t want dollars. They want RMBs, the people’s currency, to buy stuff back home. For most world currencies, the next step is simple. They take their dollars to the foreign exchange market and get their native currency. But now it’s a supply and demand situation: there’s an extra supply of dollars, trying to buy up the native currency. The value of the dollar would drop against that currency. And that should, in ideal situations, lead to a new balance. For the next round of trade, as the ships go and come back, the dollar wouldn’t be as strong. That means people in the US couldn’t afford to buy as much foreign stuff, while those folks abroad could afford even more US stuff since the dollar is so weak. In this case, we would expect to see the trade balance shrink automatically. A new equilibrium is reached, as it were. Every time there are extra dollars sloshing around, those dollars should depress the US currency and thus make US exports more competitive for the next round. But China does something different. They have strict money controls. Their currency isn’t freely exchanged like the other major currencies. What the Chinese government does, essentially, is take all those extra dollars and stick them in a sock drawer. A _very big_ sock drawer. So instead of having the US currency lose value to the RMB on the open market, the relative exchange rate between the countries is kept within relatively well-defined boundaries determined by the Chinese government. The RMB does not appreciate. It stays “undervalued”. Understand here: To keep the RMB fixed at a relatively stable value against the dollar, the value “pegged”, the Chinese government must be willing to buy up all those extra dollars sloshing around. And that’s what they’ve done. Chinese dollar holdings are huge. Their sock drawer is the size of Rhode Island. They have gobs and gobs and gobs of dollars (or really, dollar-denominated assets). This means their currency stays cheap, and their factories can continue to churn out those gewgaws at low prices that we like so well in the US. Meanwhile, US goods are more expensive than they would otherwise be, which makes it hard to sell them in China. This is an unbalanced situation, and US officials would like them to kindly knock it the fuck off. I am, of course, oversimplifying. But the main thing to keep in mind is that the Chinese sock drawer is a form of government-mandated _savings_. And if the Chinese government ended its currency manipulations, but each and every Chinese citizen kept private savings in their own tiny sock drawers, that collectively added up to the size of Rhode Island, then nothing much would change. By saving money instead of trading it on the international exchange–whether it’s government mandated reserves or voluntary private savings–the dollar wouldn’t decrease in value. But eventually, we know they’re going to spend their cash. A trillion bucks isn’t doing anybody any good if it stays in the drawer. Eventually it has to come out and play. That’s the basic story. The US wants China to stop storing so damn many dollars so that the RMB appreciates in value more quickly, but for now, the Chinese want to maintain a friendly money situation for their factory sales. There are other wrinkles, like that their capital controls allow them to increase domestic interest rates even while their currency is undervalued, but let’s stick with this for now. > [@China Guy](#): > > competitive devaluations are very painful. Look to the experience of the 1997 Asian crisis. This is what the G20 is trying to avoid. Devaluation only helps one economy if no one else follows suit - and maybe not even then. to rephrase there has never been a serious economic guggernaught that devalued their currency. This is assuming no deflationary pressure. That’s the norm, but it is not always the case. If you look at a different situation, like the Great Depression, there was a series of devaluations as the major economic powers dropped their gold pegs. But this was very beneficial, and that was true even when other countries followed suit. The faster the countries devalued, the quicker they recovered from the Depression. And the current world situation is quite comparable to the Depression in many ways. The Fed, ECB, and BoJ could all stand some collective (not necessarily “competitive”) monetary loosening. ---
**Author:** ![Tripler](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/tripler/32/21807_2.png) [@Tripler](https://boards.straightdope.com/u/Tripler)\ **Post date:** [October 30, 2010, 3:15am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/6 "2010-10-30T03:15:27Z")
**Hellestal** , that makes _perfect_ sense. If I understand it, in a nutshell, the values of currencies (and through abstraction, economies) are pretty dependent on liquidity. And when one is holding back, it pisses the other off–especially when engineered by trade imbalances. Am I on the mark? Tripler Much obliged for the explanation! ---
**Author:** ![Throatwarbler\_Mangrove](https://avatars.discourse-cdn.com/v4/letter/t/8c91f0/32.png) [@Throatwarbler\_Mangrove](https://boards.straightdope.com/u/Throatwarbler_Mangrove)\ **Post date:** [October 31, 2010, 11:59am UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/7 "2010-10-31T11:59:15Z")
> [@Tripler](#): > > **Hellestal** , that makes _perfect_ sense. If I understand it, in a nutshell, the values of currencies (and through abstraction, economies) are pretty dependent on liquidity. And when one is holding back, it pisses the other off–especially when engineered by trade imbalances. Am I on the mark? > > Tripler > Much obliged for the explanation! Read the following blog posts, in order. You should also read the comments, as the blogger goes through and gives detailed replies to each comment. > **[NameBright - Coming Soon](http://mpettis.com/2010/02/what-the-pboc-cannot-do-with-its-reserves/)** > **[NameBright - Coming Soon](http://mpettis.com/2010/09/the-politics-of-chinese-adjustment/)** > **[NameBright - Coming Soon](http://mpettis.com/2010/10/what-happens-if-the-rmb-is-forced-to-revalue/)** I am not an economist and it was pretty hard slogging at times. ---
**Author:** ![Hellestal](https://avatars.discourse-cdn.com/v4/letter/h/3ab097/32.png) [@Hellestal](https://boards.straightdope.com/u/Hellestal)\ **Post date:** [October 31, 2010, 12:46pm UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/8 "2010-10-31T12:46:08Z")
> [@Tripler](#): > > If I understand it, in a nutshell, the values of currencies (and through abstraction, economies) are pretty dependent on liquidity. The value of currencies (or practically anything else in the world) is dependent on supply and demand. That’s all this is. We give China dollars. If China dumped its dollars, the value of the USD would drop compared to the RMB, which would help balance the trade deficit in the future. But they don’t dump. _They save_. Their dollar savings at the present time is due to strict government capital controls, but if their private citizens chose to save the same amount, the outcome would be pretty much the same. They save, so instead of the USD getting weaker (equivalent to the RMB getting stronger), the dollar stays strong, and the trade deficit doesn’t decline. > [@Tripler](#): > > And when one is holding back, it pisses the other off–especially when engineered by trade imbalances. Am I on the mark? Just keep in mind that it is the extra savings (the giant sock drawer stuffed with dollars) that actually maintains the trade imbalance. We give them so freakin many dollars that greenbacks should be absolutely flooding the foreign exchange markets. All that supply should lower the price, weaken the dollar. But the Chinese government has hoovered up all of that supply and stuffed the cash out of sight, thereby keeping those dollars from sloshing around in the markets–thus their currency remains “undervalued”, and ours “overvalued”. We are pissed off because the government is _mandating_ that they save with strict enforcement (in order to keep the RMB weak/USD strong, in order to favor their exports). We want that mandate to end. We want them to stop saving so damn many dollars. But that could, of course, make for a potentially difficult currency situation in China. Faster RMB appreciation could cause a nasty shock to their economy. They’re going to take some major losses on their dollar reserve holdings. Little mice are loose in the sock drawer. The question is when they face up to that fact, and how they handle it. > [@Throatwarbler\_Mangrove](#): > > Read the following blog posts, in order. You should also read the comments, as the blogger goes through and gives detailed replies to each comment. > > [NameBright - Coming Soon](http://mpettis.com/2010/02/what-the-pboc-cannot-do-with-its-reserves/) > > [NameBright - Coming Soon](http://mpettis.com/2010/09/the-politics-of-chinese-adjustment/) > > [NameBright - Coming Soon](http://mpettis.com/2010/10/what-happens-if-the-rmb-is-forced-to-revalue/) > > I am not an economist and it was pretty hard slogging at times. Those are some very good links. On a first reading, my only major point of disagreement is this selection: “We are certainly in a global beggar-thy-neighbor process, in which the first round, just like in the 1930s, takes place as currency intervention, and the second round will take place as tariffs.” As I said before, the devaluations during the Great Depression (in the form of countries dropping their gold pegs) were the single most important factor in the speed of their economic recovery. Devaluation needn’t be a beggar-thy-neighbor proposition in a time of insufficient aggregate demand, if it’s done collectively and cooperatively. The Fed, ECB, and BoJ can all work together on that one. That still doesn’t help China, though. They’re already undervalued. The RMB can only get stronger. The question is how fast, and how they’ll handle it. ---
**Author:** ![Throatwarbler\_Mangrove](https://avatars.discourse-cdn.com/v4/letter/t/8c91f0/32.png) [@Throatwarbler\_Mangrove](https://boards.straightdope.com/u/Throatwarbler_Mangrove)\ **Post date:** [October 31, 2010, 1:27pm UTC](https://boards.straightdope.com/t/de-valuation-of-chinese-currency-how-and-to-what-effect/558068/9 "2010-10-31T13:27:38Z")
> [@Hellestal](#): > > On a first reading, my only major point of disagreement is this selection: “We are certainly in a global beggar-thy-neighbor process, in which the first round, just like in the 1930s, takes place as currency intervention, and the second round will take place as tariffs.” As I said before, the devaluations during the Great Depression (in the form of countries dropping their gold pegs) were the single most important factor in the speed of their economic recovery. Devaluation needn’t be a beggar-thy-neighbor proposition in a time of insufficient aggregate demand, if it’s done collectively and cooperatively. The Fed, ECB, and BoJ can all work together on that one. > > That still doesn’t help China, though. They’re already undervalued. The RMB can only get stronger. The question is how fast, and how they’ll handle it. I’m not sure if dropping the gold standard is exactly analogous to what is being described as “beggar-thy-neighbor devaluation”. My understanding of how the gold standard works vis-a-vis exchange rates is probably incomplete. Incidentally, China suffered relatively little during the Great Depression because it was never on the gold standard - Chinese currency since the Ming dynasty had been on the silver standard, up until the Republican period.