Chinese Currency Change

China announced Thursday that it will no longer tie the value of its currency to the U.S. dollar, a step that was urged by the Bush administration and many U.S. manufacturers who argued that the Chinese Yuan was undervalued, putting American products at a disadvantage on the world market. While China is not yet allowing its currency to "float" freely on the world markets, Thursday's decision is a sign that the country is becoming a stronger, more influential player in the world economy.

Marc Miles , director of the Center for International Trade and Economics at The Heritage Foundation, was online Friday, July 22, at 11 a.m. ET to discuss the U.S.-China relationship, from economic to strategic issues.

Read more: China's Currency Change May Ultimately Mean Little.

China Ends Fixed-Rate Currency.

A transcript follows.

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Northern Virginia: How could one tell if the "Yuan" was undervalued? On that matter, how could one tell if the dollar itself is undervalued or not?

Marc Miles: Beats me. There are some things that economists know, and some things they don't. Much of what we don't know revolves around how the value of money (or the relative value of currencies) is determined.

I notice that most people who comment on this do not trade in currencies. If they really think that a currency in under or over valued, they should be putting their money where their mouth is and trading currencies in the world market.

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Arlington, Va.: How does this news affect the average person's everyday life? Does is affect it in any way?

Marc Miles: Unfortunately the pressure from the US to have China unpeg the RMB from the dollar is just a continuation of the "weak dollar" policy that this administration has pursued. I do not know of any positive effects on the average person from such a weak dollar policy. But there certainly are costs.

For example, when the dollar falls in value, the purchasing power of savings a person's savings in a bank, or the purchasing power in one's 401(k) is reduced. This seems at odds with the Administration's stated goal of having people rely more on their private savings for retirement. We will all be working longer.

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Chantilly, Va.: Do you really believe that the floating of the RMB against $ will have any impacts on correcting trade imbalance in favor of China? If you look around, it seems almost everything has a made in China imprint on it. I believe that the net effect will be higher prices for the U.S. consumers without much increase in U.S. exports to China. China will buy what it needs from the U.S. regardless of price. I don't think the Chinese demand is price elastic, unless of course the RMB appreciates 100% against the U.S. $. What are your thoughts? Thanks.

Marc Miles: There are a number of myths in economics which get passed on from father to son, even if they have little if any validity. One of the most tenacious is the belief that letting your currency fall in value leads to the trade balance moving towards surplus.

I have followed this assertion throughout my career, and I remain confounded how this belief persists. In my dissertation many moons ago, I analyzed this very assertion. I looked at something like 18 devaluations of 14 countries during the Bretton Woods period. There was simply no systematic shift in these cases toward a trade surplus.

If you look at the US trade account since say 1997, it systematically moves towards a larger and larger deficit. Over the same period the dollar first rose sharply, then fell sharply. One can only conclude that the value of the dollar had no impact on the direction of the trade account.

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Washington, D.C.: Hello Marc, What effect, if any, will China's decision have on the values of the Euro and the Pound versus the U.S. Dollar? Thank you.

Marc Miles: Economics does not provide a very good guide to this question. As I said, this area of economic theory is not very well developed. I will leave this question to the currency traders. I suspect that they don't really know either, since for every seller of currency, there is another buyer. In other words, whenever there is a transaction, two people are disagreeing about the direction the currency will move.

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Arlington, Va.: With China's ability to utilize it's cheap workforce, does this move do anything to help make Western companies more competitive with Chinese companies? I think right now we are just living in China's world and trying to put a rosy spin on a situation that can't possibly help U.S. companies.

Marc Miles: The current arguments about China have a familiar ring. They sound very similar to the fears in the 1980's that Japan Inc was about to take over the economic world. Well, we now know better.

China does have great potential economically. The question is whether the ruling bodies will allow markets to work and people to use their abilities to create wealth. So far the answer is mixed.

But don't sell the US short. While China is producing more textiles, TVs, etc., many of these products were no longer produced in the US. From this perspective, China has probably had a bigger effect on countries like Korea. Meanwhile the US continues to advance in how to use the components and products that are produced elsewhere. US war planes may use foreign parts, but it is US brain power that knows how to use the parts to create a mighty weapon.

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Poughkeepsie, N.Y.: What measures are the U.S., and other world economic and political officials, taking to ascertain the exact composition of the Chinese Yuan's new "basket?" -interested econ undergrad.

Marc Miles: Like Singapore, China is not disclosing what basket of currencies it is targeting. I don't know that it really matters. I think it is very shrewd of the Chinese to respond to all the global political pressure to unpeg its currency to the dollar by shifting to pegging the RMB to a basket of currencies. This way no one country can complain.

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Wheaton, Md.: Please help me understand something that I've been confused about for a long time. Isn't China a dictatorship? Why would anyone here want anything to do with China business-wise? If you invested in a Chinese company, couldn't the government just take the company from you?

Marc Miles: You raise an important point. The rule of law is sadly missing in the PRC. That means that there is uncertainty about whether profits or investments will be expropriated when one invests. Uncertainty is a cost or tax, and anything that raises the cost of doing business, reduces the amount of business conducted. So the absence of the rule of law is hurting the development of China.

It should be noted, however, that last year the Chinese did incorporate the concept of property rights into their constitution. What we don't know is the extent to which those property rights will actually be enforced. But the fact that a communist country felt the need to recognize property rights is an important development. It probably reflects the growing wealth in the southern provinces where most of the manufacturing is occurring. There is a growing middle class, and the middle class wants to keep what it has earned.

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Dallas, Tex.: Now Americans are putting the numbers into perspective, and start to realize that the appreciation of Yuan actually means Chinese goods that we buy will be more expensive (and we don't like to pay more!), manufacturing jobs are not coming back as a fact despite politicians have passionately argued for, and interests may rise due to less need to hold on to T bills by Chinese government (meaning higher mortgage payments and cooling of property boom, which we don't like either!).

Although these impacts were foreseen by the educated few, the general public does not have a clue. Those Congressmen who aggressively pushed for this to happen did say tell American people that when the Chinese finally bowed to our pressure, we would not get what our politicians promised, and instead pay additional prices.

We are once again shooting our own foot, and elected Congressmen deliberately misled the public. They have immediately lost their credibility, and have to apologize to all Americans.

American policies should be based on facts and intelligent perspectives, not uneducated and biased emotional arguments, or simply lies.

Marc Miles: The bottom line is that this pressure on China to unpeg its currency from the dollar was just one more example of the blatant protectionist sentiment sweeping the country. People are afraid they are losing their jobs to foreigners. But the lost jobs are only part of what is going on. Americans are also gaining jobs.

For example, some of the worst protectionist sentiment (particularly against the Chinese) is in South Carolina. Politicians are bemoaning the loss of textile jobs. It is true that textile jobs have been lost. Yet it is also true that BMW and Mercedes have opened assembly plants in SC, as has China's largest producer of consumer appliances. So, while low paying textile jobs have been lost, higher paying jobs have been gained. The global competition has not hurt the US. We have gained.

If the good people of SC are really worried about textile jobs, they should be out lobbying their Congresspeople and the American people to support CAFTA. Under CAFTA, assembled textile goods from Central America only get preferential tariff treatment if they contain at least a minimum amount of American thread and cloth. If CAFTA were defeated, those Central American producers could well shift to China, which would not use American thread and cloth.

And the as far as losing versus gaining jobs, the US government statistics show the jobs gained in the US from abroad far outweighs those lost.

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Germantown, Md.: It seems to me that majority of economists and business community are very cautious about the move. The most excited people are politicians. What is the business community's take of this?

Marc Miles: I think this adds to the uncertainty of the business community. If they are dealing with China, they no longer can predict what the value of the RMB will be when they attempt to do business with the Chinese.

This gets to the heart of the issue. The major roles of government are to maintain the rule of law, and maintain stable money. Allowing your currency to "float" reduces the stability or dependability of its purchasing power. It escapes me why a country's leaders would want to subject their inhabitants to increased instability.

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Arlington, Va.: Correct me if I'm wrong, but I thought Foreign Direct Investment in China has been increasing since around 2000/2001...even with the PRC still in control and it appears to not be letting up, despite U.S. concerns about dealing with a communist nation?

Marc Miles: You are correct. I did not say that FDI would stop, only that it would be less than otherwise. While uncertainty raises the cost of doing business, the potential benefits may outweigh those increased costs for some investors. Clearly there are a lot of potential consumers in China, and many businesses want to be there on the ground floor.

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The Woodlands, Tex. : You assert that your scholarship demonstrates that devaluation of one nation's currency against the world does not assist in improving the trade balance.

1. Why did the League of Nations spend so much time in combating "competitive depreciation" and decrying this effort to be a "Beggar thy Neighbor " policy, i.e. one which exported unemployment?

Marc Miles: "Competitive depreciation" means that countries are trying to make their currencies fall more and more relative to each other. It is in a sense a "race to the bottom." The problem there was not diverting trade flows as much as destroying confidence in currency, and make it an extremely hard environment in which to do business. If you agree to supply goods to someone, but don't know what a currency (domestic or foreign) will be worth in real terms when the goods are delivered, then you are reluctant to go down that road. Hence the level of business activity falls.

Contrast that to the Bretton Woods era (1947-early 1970's) where the dollar was fixed to gold, and all other currencies were fixed to the dollar. Countries had low inflation rates, low interest rates, and strong growth rates. Dependability is a strong enabler to an economy.

This also points out that we have had periods where competing countries pegged their currencies to the dollar, but it was not a problem at all for the US. The US did very well during this period. So simply keeping a currency stable in terms of the dollar does not mean the US is at a disadvantage.

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Washington, D.C.: If globalization is good, then why are the equities markets flat since 2000 and why is the U.S. trade deficit skyrocketing while the dollar falls?

Marc Miles: why do you worry about the trade deficit. What has it ever done to you?

Seriously, a trade deficit may reduce GDP from an accounting perspective (when you add up all the accounts, the trade account has a negative sign). But that does not mean it has a negative economic effect. In fact empirically, it is the countries which are growing the fastest that typically find their trade accounts shifting towards deficit. So a growing trade deficit is often a sign of a strong economy. Watch out when the trade deficit of the US starts to shrink!!!

Another way to see this is to realize that the trade account and the capital account must some to zero. So a wider trade deficit means a bigger capital surplus. More capital is coming into the US. People around the world obviously have a lot of faith in our economy. Why would we want that to change? But those who are transfixed on the trade deficit and want it to shrink are essentially saying they want foreigners to invest less in the US.

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Tennessee: Will this tiny change give our political types enough cover so they will not have to do anything about trade balance, Yuan values, etc? Seems like China just gave them a free pass for them to remain silent and stoic! But as politico's now will claim bragging rights of how "We made China revalue etc", declaring "we got actions etc", then go to lunch and later release some sort of press release!

Marc Miles: I think you are right. This is not about economics, but about politics, the politics of fear and protectionism. The Chinese were smart and have reduced the level of future "China bashing". I hope we can now get on to more important things like making sure that the free trade agreement with Central America (CAFTA) passes!!!!

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Rockville, Md.: According to China's central bank, it will continuing its "managed float" policy and let Yuan float 0.3 percent above or below the previous day's closing price. Do you think Beijing will just let free exchange rate go in the future?

Marc Miles: Not if they are smart. Countries with a freely floating (highly volatile) exchange rate usually experience slow growth. Just look what happened in the 1970's when the Bretton Woods system broke down and all currencies were allowed to float freely. We had unprecedented inflation and slow or negative growth.

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washingtonpost.com: Thank you all for joining us today.

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