America’s faces trade balance deficit with China since a long time ago, in fact since 1985. America’s problem today is caused by our own spending habit financed by huge borrowing. When you take twin deficits theory into account, when current account is facing a deficit, it also means that government spending is higher than tax revenue. Data from usgovernmentspending.com shows that government spending increased since 1995 in an upward sloping graph and it is forecasted to $8142.24 billion in 2015 (See Table 1). Besides, between July 2005 and September 2008, yuan appreciated 22% against the dollar (See Table 2). Yet the US trade balance deficit with China widened from -202,278.1in 2005 to -268,039.8 in 2008 (U.S Census Bureau). This shows that appreciation in yuan did not help the trade balance deficit. Moreover, American is not an export-oriented country, China’s appreciation will not help us as much as we think it would.
Assume that China revalues its currency, Chinese companies would suffer loss of competitiveness, exports will be affected and it raises their production costs. But, all of these would only means that manufacturing would move to other low cost countries such as Vietnam (where per capita income is $2,957), Bangladesh (where per capita income is $1,420) or other African countries, where the per capita income is very low compared with $6,675 in China. (World Bank, 2009). Such a shift would not help close the trade deficit and no new jobs will be added. Inflation would also increase as US consumers would have to pay more for imported goods and US companies would have a bigger challenge to face with now production costs in China will increase.
Even if China appreciates their currency, they can take actions to offset the effect. They could switch to higher-end products and sell them for slightly higher price which would bring the same or more export revenue to China. Also, when yuan revalues, if wages increase and price of capital stays the same, it affects prices and exports. China can substitute labor with capital to put downward pressure on wages and prices, therefore effects on exports is minimal or none. Y=F (K, L)
Moreover, if China revalues its currency, the effect may not be instant. Companies seldom move production in a matter of weeks. It is often cheaper to stick with the same supplier for awhile even if the costs rise, rather than finding a new supplier in another country. Assume that the revaluation does help the trade balance, we have to take into account the J-curve effect, where it takes some time before you could actually see a surplus in your trade balance.
American politicians are pushing the responsibilities of the huge deficits and high unemployment rate to others. How come American politicians never mention anything about China before the 2007 financial crisis but since the crisis, China’s name has been mentioned almost everyday in the press? Americans politicians do not want to blame themselves for the crisis and the best scapegoat available is China.
This problem cannot be solved with just action from one party. I believe that China needs to play their part regarding their currency and holding of dollars reserves and America needs to play their part in reducing consumption and increase savings and growth.
References
Table 1
Table 2
1) Trade in goods (imports, exports and trade balance) with China. (2010, September 09). Retrieved from http://www.census.gov/foreign-trade/balance/c5700.html
2) Gang, F. (2010, March 26). Toying with yuan won’t help US. China Daily.
Retrieved from http://www.chinadaily.com.cn/opinion/2010-03/26/content_9645042.htm
3) Mathur K. V. (2010, September 22). Revaluing Chinese yuan won’t solve trade deficit and indebtedness. Standard-Examiner.
Retrieved from http://www.standard.net/topics/opinion/2010/09/22/revaluing-chinese-yuan-wont-solve-trade-deficit-and-indebtedness
