China Hurts Its Own Citizens with Under-Valued Currency

If you are following the news recently, you will realized that many people and industries are frustrated about the under-valued Chinese currency. These folks are blaming that such action by China is increasing the US current trade-deficit with China and it is weakening the American economy. Some others are citing China as the main reason why American is too slow in recovering from the last financial crisis. Especially, Ben Bernanke, the current chairman of the US Federal Reserve, who claimed that China is growing at the expense of everyone else. However, we should note that a trade-deficit does not necessary mean an unhealthy economy, check my trade deficit article to see why.

Before addressing the topic of China’s under-valued currency, let us step back to see why is Chinese yuan under-valued and what caused it?

In a free-floating exchange rate global economy, if a country offers high interest rates, then international investors will pour their supply of funds into that market and lower the interest rates until they are no longer attractive. The following supply & demand of loanable funds should make it clear:

(source)

Along with this in-pour of investments, if China does not expand its currency reserve, then we should see a rising in exchange rate between China yuan & US dollar. The reason is because if there are more US dollars for the same amount of Chinese yuan, then the dollars become less and less valuable.

However, for the decade of 1995-2005, China has been fixing its RMB to USD exchange rate by printing money and expand its currency reserve to match the 1995’s RMB to USD level. In addition to doing this, China does not allow its citizens to freely invest abroad by putting a tight control on the exchange between RMB and other foreign currencies. In this way, China is devaluing its currency. China took a short break but began to do this again since 2008.

(source)

Now that we confirmed that China is devaluing its currency. But how does this affect the world economy?

Well, for countries that do not print money as fast as China, Chinese products became cheaper for foreigners and many foreign companies shift their productions to China because of lower production costs (including labor costs). This means that the foreign countries, including the US, can use less of their money to produce the same amount of goods. In turn, they can use the extra savings to invest in their more competitive and leading industries such as pharmaceuticals and financial services. As for the foreign citizens, they can use the extra savings for a nice vacation or an extra car.

At the same time, we will see that comparatively less productive industries such as plastic production will be shifted oversea to China – where they can be competitive. This, in turn, will require foreign workers to shift their industries or move to China in order to be productive. The workers who are unwilling to find a new career or migrate will be likely to lose their jobs. This is why we usually see more complaints from worker unions than from the firm managers.

On the opposite end, we also see that foreign products are more expensive to Chinese citizens. Why? Because prices are rising everywhere in the world because governments are on their race to print money in order to close their spending gap. However, since Chinese government is fixing their exchange rates, the Chinese citizens now have to earn more yuan to buy the same the product. As the result, the Chinese citizens can afford less and less things in their daily lives.

In brief, we can see that, by devaluing the yuan, the Chinese government is hurting its own citizens and some incompetent foreign industries & workers. At the same time, this Chinese trade-surplus is enriching foreign citizens and competitive industries by allowing them to invest money in something better.

The lesson for Vietnam?

Vietnamese leaders should recognize the effects of devaluing currency on Vietnamese citizens. A better way to assist the growth of Vietnam is to provide quality job-related trainings and allowing free exchange rates to avoid making Vietnamese lives harder for the reasons mentioned above.

Vietnamese workers should not hang on to one job for life. Every industries has it life-death cycle. Knowing this, the only way to remain competitive is to keep on learning and be creative.