Wednesday, January 20, 2016

Chinese Currency Manipulation and Price Controls

The curious claim made against the Chinese about "Currency Manipulation" is gaining momentum. Many believe that the United States are "losers" in trade relations with China.  Somehow these modern day mercantilists believe that this impacts the trade deficit with China. In reality, the United States benefits from China's "currency manipulation", at the expense of the Chinese citizens. To have a deeper understanding why this is true, "currency" must be analyzed as a good, and the Chinese government, in effect, is placing price controls on its currency. When analyzed under this light, the outcome is pretty clear: the Tax Payer class in China pays the economic cost of this action.

Economic Theoretical Considerations of Price Controls

In economics, there are two types of price controls. The first type is where the Government places a price maximum on a particular good or service. When this happens, the price maximum is above the equilibrium price. Based on the law of demand, the stock of the goods will increase, thus creating a surplus of that particular good. An example of this is the "ghost" cities in China. There are many buildings that are empty because the prices of those buildings are above the equilibrium price. The second type of price control is where the Government places a price minimum on a particular good. In the event of having the Government implements a price control that is below the equilibrium price, a shortage occurs. An example of this situation is the long gas lines that occurred during the 1970s when the Government implemented price controls.

Currency Manipulation is a form of Price Control

To move forward in this analysis, one must look the currency as a "good". Looking back at the claim that China is manipulating its currency, let us look at the ways that this falls under the two forms of price controls, as mentioned previously. When the Central Bank decides to increase the money supply, based on the Central Bank's estimates, and not what the market demands, it is placing a price maximum on the currency. This creates a surplus of currency in circulation. On the other hand, if the Central Bank decides to remove currency out of the circulation, but not based on what the market demands, it is creating a price minimum on the currency.

The Case with China 

The Chinese currency, relative to the US dollar, in this exchange, is a victim of price controls. There is an exchange ratio between the US Dollar and the Chinese Yuan. That ratio is "fixed"(sort of). When the Chinese central bank increases the Yuan supply, it creates a surplus of Yuan in circulation. Since there is an increase of Yuan in circulation, this devalues the Yuan, in terms of the US Dollar. Since the US Dollar is not commonly used by the vast majority of the Chinese citizens, and those citizens use Yuan to purchase goods and services, the Chinese citizens pay the price for the increase in the money supply. This is inflation. The Chinese citizens will see the prices, as expressed in Yuan, increase. This also usurps their savings, and it impacts citizens that are on fixed incomes. The goods they normally purchase take more Yuan to purchase, yet the dollar becomes stronger, relative to the Yuan.

Who Benefits from Chinese Currency Manipulation? 

It is obvious that the Chinese citizens are not benefiting from currency price fixing. The savers lose out, and the folks on fixed income also lose too. But, the folks who can hold US Dollars are "winners" in this scenario. Why is this true? Since the Yuan is being held to a price maximum, and a surplus is created, this drives down the value of the currency. Yet, assuming the US Dollar stays constant, this raises the value of the Dollar, relative to the Yuan.  The holders of the US Dollar, who live in China, they all benefit greater than the other residents who use Yuan.


This dynamic is simply an expression of Gresham's Law. The higher valued currency, drives out the lower valued currency, albeit in a "black market".  In this case, the US Dollar and Gold are held by a minority of individuals, political class and the tax consumer class--and the Chinese Tax Payer is using the devalued Yuan to use to purchase goods and services. This entire scheme is all set up by the Chinese central bank and Chinese government.

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