Smith Faculty Opinion Article
November 16, 2009
China's Yuan, Not the Dollar, Is Too Cheap
From Berlin to Bangkok, governments are screaming about the falling dollar,
because they can no longer rely on reckless American consumers to power their
From the late 1980s to 2007, the global economy enjoyed The Great
Moderation-low inflation and sustained growth interrupted by brief recessions.
Driving global growth was an eight fold increase in the U.S. trade deficit,
facilitated by a doubling of the value of the dollar against other currencies
from 1989 to 2002.
Deregulation and new technologies powered U.S. growth, and Americans flush
with success bought whatever the world had to sell. However, when imports
substantially exceed exports, Americans must consume more than they earn
producing good and services, or demand for what they make is inadequate,
inventories pile up, and layoffs and recession follow.
From 2003 to 2007, the U.S. trade deficit averaged $665 billion, and
Americans massively borrowed from abroad to keep the U.S. economy going. They
posted as collateral overvalued homes financed on shaky mortgages. When
mortgages failed, banks failed, home prices dropped, and retail sales tanked.
The U.S. economy was thrust into the worst recession in 70 years and pulled the
rest of the world into crisis.
Imports of oil and consumer goods from China account for the lion share of
the U.S. trade deficit. Americans drive big cars powered by thirsty engines.
They sit on vast untapped deposits of natural gas but burn too much heating oil
in the winter. Simply, conservatives in Congress are unwilling to submit to
genuine energy conservation, and liberals teach developing domestic fossil fuels
resources is evil.
For nearly two decades, China has maintained an undervalued currency. The
Chinese government tightly regulates private trading in the yuan, and each year,
purchases more than 400 billion U.S. dollars with newly printed currency to keep
the yuan artificially cheap against the dollar. That is 10 percent of China's
GDP and 20 percent of exports to make Chinese goods artificially inexpensive on
U.S. store shelves and juice Chinese exports.
China amasses huge trade surpluses that power its impressive growth, and the
rest of the world suffers slower growth to compensate. An economic miracle sold
to the world as policy genius but really built on currency mercantilism and
Japan has propped up its economy by purchasing dollars and permitting private
investors to borrow yen at near zero interest rates and trade those for
dollars-denominated Treasury securities. Now, Tokyo signals it will not let the
yen drop much below 90 per dollar when a market equilibrium value would be
closer to 80.
Other Asian export powerhouses have practiced variants of the Chinese and
Japanese currency model too. It is no wonder the dollar was so strong for so
In recent years, private investors have grown wary of massive American
borrowing. They have turned to the best substitutes available for the dollar-the
euro, yen and gold-and driven up their values and pushed the dollar down against
every major currency but the Beijing regulated yuan.
Now, with Americans no longer able to borrow madly to prop up global growth,
protests are shouted around the world about a "cheap U.S. dollar."
The hard facts are the dollar became overvalued earlier in this decade, in no
small measure thanks to the currency policies of China and other Asian
governments. Now, as private traders flee the dollar, its average value has
fallen near the middle of its trading range for the 1990s.
The dollar has fallen too much against the euro and some other currencies,
because China, Japan and other Asian exporters have been unwilling, in varying
measures, to abandon currency mercantilism and let their currencies rise in
value as free markets would require.
If China and others ceased subverting currency markets, the yuan would rise
at least 40 percent, other Asian currencies would appreciate too, the U.S. trade
deficit would shrink dramatically, and the new demand for American goods would
rocket the U.S. economy.
With higher incomes, Americans would need to borrow less, and the global
economy could go forward, embracing free trade in goods and currency.
Peter Morici is a professor at the University
of Maryland School of Business and former Chief Economist at the U.S. International