Yuan Appreciation!

On Wednesday, Chinese President Hu Jintao will meet with President Obama to discuss the relationship between China and the United States, focusing particularly on issues of trade. This has been a hotly contested issue for sometimes now as the US has pressured China to appreciate their currency, claiming that China has held the exchange rate artificially low so that Chinese businesses can enjoy a trade advantage over their US counterparts. In an interview with the Wall Street Journal, Jintao has fired back at the US saying that “the monetary policy of the Untied States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable level.” He also suggested that China will consider making the yuan a global currency, while conceding that it “will be a fairly long process.” This is the setting for what should be an intense bilateral discussion between the leaders of the two biggest economies in the world.

The yuan has tremendous potential as a global currency because of China’s continuing emergence as a global economy. Currently, less than 1% of China’s $2.3 trillion imports are done in yuan. According the the Wall Street Journal article “New Move to Make Yuan a Global Currency,” “some analysts have predicted that it will be only a few years before 20% to 30%” of the imports “will be conducted in yuan rather than dollars.” This suggests that there is already a demand for direct yuan exchange in foreign exchange markets.

Trade between the United States and China constitutes a large portion of the United States’ goods deficit and China’s surplus. Of the United States’ $51 billion monthly goods deficit, $26 billion is attributable to China. The trade between the two countries means that both countries have a stake in each other, present and future. The US has helped China build its economy by buying their goods, and as a result of this capital outflow and wealth, China has accumulated US financial assets.

From an economics perspective, it should be understood that both countries can benefit from a yuan as a global currency, one that is subject to appreciation and convertible for direct trade with other countries. The appreciation of the yuan relative to the dollar can help the US industry and trade in a number of ways. However, it can also help China by reducing its exposure to the US, reducing its transaction costs in trade and making foreign resources less expensive. The decision to make the yuan a global currency should have mutually beneficial consequences.

The US has been clamoring for the Chinese government to appreciate their currency for sometime. Because the yuan has been pegged at a fixed rate, China has enjoyed advantageous trade with several countries, but in particular the United States. We know from our stock and flow model that countries neither want to face a trade deficit (because of the marginal cost of debt) nor accumulate foreign financial assets forever (because of the risk of default). Eventually, the demand for a flow of foreign goods and services must shift, leading to an appreciating yuan. An stronger yuan should help the US trade deficit by making its goods cheaper and China’s goods more expensive.

Devaluing currency often is depicted in a negative light because it is usually caused by inflation. Traditionally, inflation has been the primary cause of a depreciating dollar. Additionally, a strong dollar is important for buying foreign foods and for travel. However, it has been detrimental to domestic industry and labor. First, depreciating the dollar relative to the yuan is not a result of inflation but rather a consequence of the market forces; there is a demand to conduct trade directly in yuan rather than in dollars. Second, a strong dollar has hurt the US by making domestic goods less attractive to foreign countries, influencing the balance of trade. It has also made it more attractive to invest in cheaper foreign labor by outsourcing, since domestic labor has been relatively more expensive. As other currencies appreciate relative to the dollar, companies from those other countries will be more attracted to hiring US labor. Having the dollar depreciate relative to other currencies can have a positive impact on the balance of trade and labor without the worry of inflation.

China has been accumulating US financial assets through the influx of dollars from the imbalance in trade. The combination of accumulating US assets as well as the growth in the US budget deficit has made China increasingly exposed to the US default risk. While US bonds have always had the reputation of being a safe asset to hold, the recent financial crisis has reinforced the important of diversification. China has been concerned that the US will “inflate away its debt” “by printing money.” By making the yuan a global currency and relying less on the dollar as a medium of exchange, China will accumulate less dollars which will not necessitate the purchase of US financial assets. Instead, China will be trading in their own currency and accumulating other foreign currencies and financial assets. This will increase their portfolio’s diversification and help stronger relationships with foreign countries. It will make the countries interdependent on China just as the US has been. Diversification will make China less susceptible to fluctuations in the United States, enabling for a more stable economic environment.

Another advantage of opening the yuan to global trade is reducing transaction costs. By using the dollar as a medium of exchange, China is paying a spread, the difference between the price to buy or sell, of the dollar exchange rate. Essentially, for every transaction that China is conducting in dollars, China is paying a tax. They are paying more and getting less than what they would if they had direct exchange through the yuan. While it may only be a small fraction of the transaction, with the magnitude of trade that China is involved in, its sum adds up. If it makes the yuan a global currency, it can trade directly with other countries rather than using the dollar as an intermediary medium of exchange.

As a developing country, China has become a huge player in the commodities industry. Commodities are very much the life blood of industry and commodity production is integral to industrialization. The mark of an industrialized nation is consuming 300 kilogram per capita of steel. Currently, China is producing 426 kilograms per capita. To produce steel, you need coke, which is a product of coal. Additionally, 68.7% of China’s electricity comes from coal. While China is the leading producer of coal, it imports nearly 3 million tons of coal from the United States. This is only one example of China growing demand for resources, but a stronger yuan would make these resources, these factors of production, cheaper.

The bilateral meetings Wednesday should serve as an opportunity to discuss the possibility of opening up the yuan to the world. As Juntao said, it will be a “long process.” As the world’s two largest economies, China and the United States are the leaders of the global economy. For both sides, it is important for them to come to a resolution that is mutually beneficial. A war of words between two countries so interdependent on each other is not a viable solution. Appreciating the yuan can go a long way to better the relationship by helping trade and industry in the US and making trade less costly and risky for the Chinese.

Political Correctness Fails Again

I hate that people are trying to be overly sensitive on certain issues. This is America. It's a country built on freedom, built on the ability to express oneself. You think the Founding Fathers would be impressed with what the country is becoming right now? We are becoming hypersensitive and incidents such as this are where this movement to be more politically correct is failing. Let it run Guru:

Galli says he and his friends were sitting at a table during brunch break when the vice principal asked two of the boys to remove American flag bandannas that they wearing on their heads and for the others to turn their American flag T-shirts inside out. When they refused, the boys were ordered to go to the principal's office.

Sometimes I just have trouble wrapping my head around events that happen. I cannot believe that this happened. I really can't. This is a colossal face palm. You're telling me kids couldn't wear patriotic clothing?

Now, may be I don't give a shit about this political correctness bullshit because I do understand the situation. I can see how people would think that it is offensive on a Mexican holiday, though the celebration of the holiday isn't even celebrated in all of Mexico. With recent immigration controversy, it could be seen as disrespectful. However, that's saying that patriotic clothing is disrespectful. That's saying the American flag is disrespectful. Does anyone see the problem here? This shit is news for a reason.

Here are some quotes from the kids:

"They said we could wear it on any other day," Daniel Galli said, "but today is sensitive to Mexican-Americans because it's supposed to be their holiday so we were not allowed to wear it today."

They're Mexican-Americans. This is America. You're telling me America cannot be celebrated? And their holiday? Their holiday? Not everyone celebrates their holiday, so I don't understand how this is disrespectful to their holiday. It's not like these kids were wearing swastikas on Rosh Hashanah. This is totally different.

More from the kids:

They said if we tried to go back to class with our shirts not taken off, they said it was defiance and we would get suspended," Dominic Maciel, Galli's friend, said.

Parent:

"I think it's absolutely ridiculous," Julie Fagerstrom, Maciel's mom, said. "All they were doing was displaying their patriotic nature. They're expressing their individuality."

Personally, I would sue the school for breach of the First Amendment. Although I'm sure the school would contend that the First Amendment doesn't apply on Cinco de Mayo.

Live Oak High School, you have failed.

(Special shout out to K-Lamp for this article)

US and Russia sign Nuclear Disarmament Treaty

Assessing the Treaty: