Thursday, February 4, 2010

Obama and China Spar

The US and China are again at each others' throats, at least figuratively. Yesterday President Obama declared his intent to put pressure on China to be more reasonable with its exchange rate policy. China obliged today with a suitably defiant response.

What he meant was he hoped China would loosen its strict policy on its exchange rate. China operates a fixed exchange rate with the US dollar, and where necessary intervenes to protect this rate.

It's long been argued the Chinese exchange rate is too low. China's motive to keep it low is clear: A low exchange rate means us Brits, Europeans and Americans find Chinese goods cheaper, and hence buy more of them. However, Americans have long cried foul over this - not that they can buy cheaper goods, but that the exchange rate is artificially low, meaning that American consumers prefer Chinese goods to US goods.

If the Chinese exchange rate appreciated, as the theory of the determination of a currency's value, that we went through in week 3, suggests it should (there's loads of demand for Chinese currency so we can buy their goods and the supply isn't increasing much), then Chinese goods would become more expensive, and the theory suggests, we would buy less and get more domestically produced goods.

So China's exchange rate policy makes trade deficits in the UK and US much worse, potentially costing jobs here, and hence why the US often cries foul at this market intervention that adversely affects their industries.

Of course such arguments and efforts being placed in lobbying in Washington and Beijing are efforts not being made to make US (and UK) industry more productive and hence more competitive. It's a little like the schoolkid who stops and says "that's not fair" but doesn't try and do anything about it.

Furthermore, it's likely a little short sighted. We're relying on all these cheap Chinese goods to keep our prices down here in the West. If the exchange rate changed, all the goods we import would cost a lot more, and we'd be poorer as a whole. It's somewhat optimistic to think that suddenly UK (or US) industry will suddenly step in to fill this breach.

But maybe we are happy accepting a little more inflation if it means more jobs eventually return to our shores? But will they? Won't some other country start producing at a cheaper price than we can produce? Why shouldn't we try and develop new jobs in new industries, and accept the industries of old are just that?

We have to accept the negative consequences of the world order we established: We get cheaper, vastly higher-tech goods, but we must move with the times and get on with producing the next thing the world wants, instead of subsidising or protecting the things the world doesn't want any more (at the price we can produce them at).

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