By James H. Nolt
Last week, I discussed how the economic crisis in China is creating a dilemma regarding the direction to take in economic policy. I concluded that instead of making a transition to consumer-led growth as many outside of China advocate, China is “muddling through” using a set of policies that look a lot like those that yielded so much success in recent decades, but which have now run out of steam−namely, export- and investment-led growth. China is succumbing to forces of political inertia rather than reform.
On the other hand, the consequences of China’s increasingly desperate pursuit of a failing economic strategy are worldwide. This week, I will consider why inertia in China’s political economy is provoking a “political revolution,” as Bernie Sanders would call it, in the U.S.
The political revolution in the U.S. has two wings: the mobilization of a Democratic left behind Sanders and of an anti-establishment Republican right behind Donald Trump. Both candidates’ appeal is enhanced because of strains that China’s crisis exports to the U.S.
In order to understand how crises are exported from one country to another, we must understand the post-1971 world of floating exchange rates. Before that year, most currencies most of the time exchanged with each other at fixed rates that were changed only under unusual circumstances, such as the impact of major financial crises caused by wars.
For example, the Japanese yen was worth half a U.S. dollar from the late 19th century until after World War I, when it devalued some because of higher Japanese wartime inflation. Japan briefly restored the prewar parity at two yen equaling one dollar in 1930, just as the Great Depression hit; in 1932, Japan greatly devalued the yen against the dollar, so that it took six to eight to buy one dollar. At the end of World War II, the yen devalued drastically to 360 to the dollar, where it stayed until 1970, after which it was mostly revalued upward during the floating rate period to become worth roughly around 100 to a dollar, or even more.
Currency values are so important because changing them changes the price of everything denominated in that currency relative to foreign currencies. When a currency depreciates, it is like all the goods and services in that country are now sold at a discount relative to foreign products, especially when the domestic prices of those things do not go up as fast as the currency value falls. So, if the yen prices of cars are going up 5 percent a year but the value of the yen is dropping 10 percent a year, those cars are actually becoming cheaper abroad. (This assumes free competitive prices, however, when in fact the actual prices goods are sold at in various markets are often determined by cartels, whose relative power might vary from country to country−which is another reason for price differences.) Conversely, if the yen depreciates by 10 percent, then imports become that much more expensive, leading more consumers to prefer domestic over foreign goods.
Thus economists often emphasize that changes in currency values affect the flow of trade. When a nation’s currency depreciates, its exports sell more easily because their prices are lower, whereas the country tends to import less since foreign goods increase in cost. This is the balance of trade effect.
Even more important for wealth and investors, however, is the effect of currencies on the value of assets. If the yen goes down, all stocks, bonds, and real estate denominated in yen become cheaper for foreigners to buy using their now more valuable currencies. Foreign assets, on the other hand, become more expensive for the Japanese to buy, but more valuable in yen terms if they already own them before the currency devaluation occurs. Changes in relative currency values are thus one of the most powerful and rapid ways of redistributing wealth globally.
One policy common to both Trump and Sanders is the charge that China is a “currency manipulator” that is thereby stealing American jobs. This charge distinguishes both from the “mainstream” of their respective parties. What is at stake here?
Both insurgent candidates argue that the specific manipulation China is practicing is keeping its currency, the yuan or the RMB, artificially low. The alleged low value of the RMB allows China to sell its goods at low prices that undercut American-produced goods and thus “steal” American jobs. Both candidates want to pressure China to raise the value of the RMB or they will retaliate by increasing tariffs on Chinese imports, thereby increasing their cost by another means.
I agree with the analysis of many economists (a surprise since I am more often contrarian) that the RMB was undervalued during the early years of the 21st century, but no longer is. In fact, today the RMB is more likely overvalued. That is, if the Chinese government did nothing and let free market forces prevail, the RMB would more likely fall in value rather than rise. However, if China were to reform to a more consumer-led economy, that could tend lower the value of the RMB even more.
Now this is a tricky argument to make because governments are always intervening in the economy in a wide variety of ways that may affect the currency value other than by the more direct means of buying or selling the currencies specifically in order to manipulate them. By the way, the central banks of all countries do exactly that, so “currency manipulation” is not a crime but in fact a standard duty of central banks in every country. What Trump and Sanders protest is not the fact that the Chinese government’s activities affect currency values, but the direction of the effect. Both would prefer the RMB to rise and therefore the dollar to fall in relative value as a way to promote job growth in the U.S.
Put a different way, it sounds less one-sidedly attractive: Trump and Sanders want everything made in China and all assets denominated in RMB to be worth more, which means they want everything made in the U.S. and priced in dollars to be worth less. If you understand this fact alone, you will more readily grasp why both candidates are an anathema to the “establishment” interests of both parties, who happen to be billionaires with a large portion of their assets denominated in dollars, not RMB. Devaluing the dollar relative to the RMB would make American billionaires poorer and Chinese billionaires richer. American owners of dollar-denominated financial wealth would suffer a massive relative loss even as American industries might produce and sell more abroad, thus bringing industrial jobs back to the U.S.
It is no wonder Trump and Sanders appeal to some of the same disgruntled working people. It is not irrational for people who work for a living to favor jobs over financial wealth interests. This also explains why the Republican Party’s efforts to spank Trump have only enhanced his appeal among a voter base that does grasp that the issues are broader than just who has a ruder vocabulary. Most of the media seem clueless by comparison.
James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.
[Photo courtesy of Gage Skidmore]