Tracing consequences both seen and unseen.
Lee SharpeCurrency Devaluation
Posted at 3:34 pm on March 25, 2010, by Lee Sharpe

A recent NPR podcast discussed how Paul Krugman and other economists are criticizing the Chinese bank for increasing the supply of its own currency, thereby deflating it relative to the dollar and other currencies.

As the podcast correctly evaluates, the result of this is that Chinese exports are cheaper to consumers in other countries, and goods China imports are more expensive for consumers there. Chinese exporters understand this phenomenon all too well, and realize they are going to increase their market share and profit if the currency is devalued, and probably lobbied the Chinese government to make it happen in the first place.  Chinese politicians and the general Chinese public can feel great about this wonderful plan to increase Chinese industry and provide jobs!

Naturally, some in the United States are upset because American producers of the same goods are now at a competitive disadvantage with Chinese producers, costing the American producers money and costing them jobs. Sounds like the United States government needs to do something about this, right?  You’d certainly get that impression from listening to the NPR podcast.

Alas, this evaluation is exactly what Henry Hazlitt warns about in the lesson from which this blog derives its name.  It ignores the other results of China’s actions. Chinese currency devaluation means that Chinese goods are cheaper in the United States.  This is wonderful news for American consumers!  (And, for that matter, everyone else in the world except China, but I’ll focus on the United States.)  Meanwhile, Chinese consumers are forced to deal with more expensive imported goods into China.  American consumers are now helping the U.S. economy more, since they can buy more goods with the same amount American money, creating employment to meet the new demand.  Conversely, Chinese consumers will be buying fewer goods with the same amount of Chinese money, meaning that domestic industries in China (Chinese producers selling to Chinese consumers) will be hurt, which is worse for both parties. This is because devaluing currency is really inflation, and this is what inflation does: makes goods more expensive than they otherwise would be, slowing economic growth.

Why is the Chinese government devaluing its currency, then, if this is so bad for them?  Because those to whom the currency devaluation benefits (Chinese exporters) favor it because they stand to profit substantially from it.  Therefore, if they believe the government will go along with them, they have every incentive to lobby the government to help them.  The politicians, meanwhile, even if they understand the economic realities of the situation (which is unlikely), have on the one hand a small number of lobbying exporters who are helped a great deal, and many consumers who in the aggregate are hurt a great deal but individually are hurt comparatively little, and therefore have no real incentive to counter-lobby.  This means that the politicians have the incentive to not anger the only group with substantial individual stakes, while taking the economically correct action likely won’t anger anyone.

The United States taking a “retaliatory” measure (by deflating the dollar) to balance out the Chinese action is a road to disaster for the exact same reason that it’s a bad idea for China to do it for itself. If China wants to devalue its currency, the United States should be happy it has access to cheaper goods allowing it to more easily grow its economy, and not damage its own economy by doing the same.


Filed under: Economic Theory
Comments: 6 Comments
 

6 Comments »

  1. A slight correction. You say “American consumers are now helping the U.S. economy more, since they can buy more goods with the same amount American money, creating employment to meet the new demand.”. The demand is for the cheap chinese goods and hence the employment generated is in China. As a result jobs are lost in US and the domestic industry looses market to the chinese goods.

    Comment by Gautam Shahi — June 21, 2010 @ 12:10 am

  2. So, Gautam, the importers who bring the goods into the US, the distributors and wholesalers who receive these goods, and the retailers who sell these goods to the public, along with countless support staff such as the Americans working at the docks to take the goods in and the cashiers at Meijer, aren’t working “jobs”? Although cushy jobs in manufacturing are indeed “lost”, the sad fact is that those jobs typically paid higher than they were worth anyway. We see this in $20 an hour jobs at the Big Three Auto Makers becoming $2 an hour jobs in Mexico or China. Analysis suggests, however, that the jobs lost in this way are gained back in jobs described above; therefore, no one actually “loses” jobs in this process.

    Comment by Stephen Sarow — August 14, 2010 @ 1:14 am

  3. Hi Lee,
    Great article. I had the same doubt about the fact that increasing demand for China’s exports by the U.S would actually increase jobs in the U.S I tend to disagree, but the argument that there is no actual lob “losses” is valid.
    I am doing a research on the negative impacts for China of the devaluation of the Yuan.
    I have found these arguments:
    -Devaluated Yuan= Inlfation in China, which means more expansive products for the domestic consumers.
    – While they are investing their surplus on buying huge amounts of dollars, to make sure their currency is undervalued, the Chinese standard of living is still really low. They could invest a lot more on their population.
    -Therefore, the ones who are actually benefiting are exporters.
    (However, increasing demand for China’s products increase jobs in China and boost their industry, which causes the population income to increase)

    Do you believe that the positive sides of the devaluation for China out stand so much that it would not be worth to do research on the negative impacts?
    Would you be able to point more reasons why this could be harmful to China? Or to provide a good source with good arguments over the topic?

    If you have some time to answer, I would really appreciate it.

    Great job with the article!

    Comment by Bernardo Feitosa — December 2, 2010 @ 8:28 pm

  4. Buy american! it’s that simple.

    Comment by Jon — January 18, 2011 @ 10:53 am

  5. “So, Gautam, the importers who bring the goods into the US, the distributors and wholesalers who receive these goods, and the retailers who sell these goods to the public, along with countless support staff such as the Americans working at the docks to take the goods in”

    These jobs are a pittance in number compared to the number of American manufacturing jobs that were lost. Plus all of these jobs you mentioned would still exist if we were exporting goods instead of importing them, which means that there were no jobs gained back by sending American jobs to China.

    China has the problem of jobs versus high domestic prices. America has the problem of people out of work, earning nothing at all – how do you pay for cheap $100 Chinese TVs if you are earning zero? Let me guess… monopoly money? Five finger discount? Help me out here.

    Plus the trade deficit with China is devaluing the dollar and increasing the national debt as well. I leave it up to you to see where that road leads.

    Comment by Jacquelope — September 10, 2011 @ 6:33 pm

  6. Great Post Lee.

    Question: Do you foresee the Chinese yuan seeing the same fate as the Japanese yen in 1977-8? That is, as a result of the Japanese government artificially devaluing the yen, the price of the yen (in terms of dollars) shot up by 50% in 1977-8.

    Comment by Brendan — May 17, 2013 @ 4:10 am

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Henry Hazlitt"[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt, Economics in One Lesson
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