Carte Blanche: The Nationalist Fear Of Chinese Currency Manipulation

In the midst of President Trump’s trade wars, the debates between free-trade advocates and economic nationalists have been extremely disconnected. Supporters of free-trade are still trying to explain Ricardian models of comparative advantage from economics 101 when the nationalists are not even close to denying that argument as their justifications for tariffs and trade wars. Those arguments in favor of laissez-faire are correct, but modern cases for trade barriers have moved on to different reasons to push their agenda, so opposing them by relaying the common explanations of mutually beneficial free-trade is not productive to the discussion. The rhetoric now cites supposedly illicit and unfair trade practices from China, such as intellectual property theft and the ambiguous accusation of “currency manipulation.” This boogyman term “currency manipulation” sounds so scary and complicated, that nobody cares to question it, conceding to the nationalists to allow them to raise trade restrictions, grow government, and make the country poor. 

The practice of so-called currency manipulation means that a nation’s central bank engages in the devaluation and weakening of its own currency, followed by the purchasing of large amounts of foreign currency at inflated prices. This policy changes the exchange rate with the foreign currency purchased, increasing the ratio of the central bank’s currency per unit of foreign currency. For example, if 1 USD is worth 5 Chinese Yuan, after the process of currency manipulation from the Peoples’ Bank of China, 1 USD could be worth 10 Yuan. The effect is that China is able to increase its exports to this foreign economy, and this is supposedly a benefit at the expense of the U.S. China accumulates a trade surplus and the U.S. a trade deficit. According to economic nationalists, China engages in currency manipulation and is clearly taking advantage of the United States. President Trump has called the practice “competitive devaluation”, using it as one of the justifications for massive rounds of tariffs on Chinese goods. 

Under the narrative of the currency manipulators and those who want the government to intervene to retaliate against it, exports are a necessary economic gain while imports are a necessary loss. If China is clearly winning with this practice, the U.S. must clearly lay down tariffs and trade restrictions and weaken our own currency to stimulate exports, as Trump has called for. The problem with this narrative is wrong premises and a wrong conclusion. In reality, the menacing currency manipulation actually hurts the practicing country at the benefit of the supposed victims and falls for the same rhetoric of the old economic doctrine of mercantilism. 

An analysis of the practice begins with the simple devaluation of the Chinese Yuan. The Peoples’ Bank of China has artificially expanded credit and engaged in massive quantitative easing, increasing the M2 money supply of the Yuan by more than 200%. The central bank has a larger balance sheet than both the European Central Bank and the Federal Reserve. When a central bank inflates the money supply, the money is used to purchase government bonds and expand credit, diverting purchasing power to the first spenders of the new money at the expense of people that hold the currency. Purchasing power and real wealth flows from the last receivers of new money, the poor and middle class, to the first receivers, the financial sector and the government. Since monetary inflation enters the economy at a specific point, price inflation does not happen uniformly, but over time in different stages. It often begins in the stock market, propping up share prices and creating the illusion of a booming economy. An increase in the money supply relative to the real wealth of an economy distorts resources, diverts wealth, depreciates the savings of individuals, and diminishes purchasing power. 

It should be clear that the first step of Chinese currency manipulation, devaluation of the Yuan, hurts the Chinese saver and consumer, but the main focus of currency devaluation is the effect on international trade. Trade across borders is the same as trade between individuals as a mutually beneficial exchange of value. The addition of money only makes the exchange indirect. If we imagine international trade as barter, it is easy to imagine how a trade deficit or surplus is impossible because goods are traded for goods. When the barter is made indirect, the same principle must apply. However, with the economic intervention of currency devaluation and manipulation, the importing country can now buy increased foreign goods for the same price. Depreciation of the Yuan against USD allows importers to buy more Chinese goods per USD, making the goods more attractive. 

The final step that defines “currency manipulation” is the Peoples’ Bank of China widening the exchange rate against USD yet again by purchasing large amounts of the foreign currency. This essentially increases the effects on trade of devaluing the Yuan in the first place, except by decreasing the circulation of USD. This does indeed favor Chinese exports, but a closer look at the flow of real wealth tells whether this helps or hurts the economy. When China manipulates their currency, Americans increase the amount of Yuan they receive per dollar, and can therefore buy more Chinese imports for this same amount in USD. The Chinese exporters sell the same goods to American importers and receive the same amount in Yuan as before, except the money carries less value in China because it is depreciating. The Americans, by purchasing Chinese imports at a lower price in USD increase their real wealth, as they now have more purchasing power. The Chinese, by exporting goods for the same price in Yuan, which is losing value, decrease their real wealth, as they are producing the same amount but losing purchasing power. 

The economic nationalists believe that China is subsidizing its exports at the expense of the United States when in reality it is subsidizing American importers at the expense of its own economy. To recap, the People’s Bank of China inflates the currency, draining purchasing power from the people and redirecting it to itself. The new money is spent on USD, creating an exchange rate with a strong dollar and weak Yuan. The real wealth that has been absorbed from the people of China is then used to subsidize American importers so they can purchase more Chinese goods to which the exporters receive less purchasing power in return. Real wealth flows out of China and into the United States. Just like any intervention in the economy, the Chinese central planners are robbing the people of China and driving their economy into the ground. 

The fallacy that China is gaining at the expense of the United States with this practice is nothing but a modern-day version of mercantilism. This way of thinking tends to identify money with wealth, rather than goods and services that create our material well being. Mercantilists focus on price level and the flow of currency rather than the flow of real wealth, ignoring what improves the life of the individual. Original European mercantilists believed that the wealth of a nation was composed of how much gold was contained it its borders. They favored protectionism and central banking that devalued the currency to artificially prop up exports. 

Mercantilism pops up in many different forms put into complicated terms. The economic nationalists in the United States believe currency manipulation it is genuinely helping China at their expense and support mercantilist interventions of their own to push back. They have also successfully made “currency manipulation” the frightening term among average Americans that must necessitate government action. Regardless, the best policies for the United States are the opposite of the populist suggestions. Our central bank should refrain from devaluing the dollar and return to a gold standard, allowing free exchange rates with foreign countries. Furthermore, all trade restrictions and tariffs should be abolished, leaving a free-market for international trade. China can continue to print money and subsidize American importers all they want and continue to transfer wealth to the U.S., while also inflating a giant stock market bubble, completely masking their failed state-run economy.