A Pegged Currency

I know this isn't marketing focused, but in my Financial Case Analysis class we are examining the benefits and disadvantages of the Yuan being pegged to the dollar. Below are some thoughts and analysis on the current situation, and how China is benefiting.

The current Chinese policy of pegging the Yuan currency to the US Dollar at artificially low rates is beneficial to the Chinese economy as a whole. Lower exchange rates with trade partners lower the demand for imported goods as they become more expensive to Chinese consumers. In addition this makes Chinese exports cheaper than they would be if the Yuan was traded freely without government manipulation of their currency. This benefits Chinese industry at the expense of Chinese consumers in the short run, but long term growth of domestic industry is seen as having many benefits to Chinese society.

By distorting their currency China has become the world’s supplier of cheap unskilled labor and a place that investors can get value for their investments. American companies cannot compete with a Chinese company who has equal capitalization, technology advancement, and human capital of labor due to the current conditions. However, China is currently undercapitalized as a county. They lack the incorporation of technology into their production methods and they lack human capital in many types of industries. To remedy this issue, China has created the opportunity for foreign investors to look towards China as a great investment. Also, investing outside of China is more expensive for domestic investors, thus forcing China to infuse industries with capital to incorporate more technology. To marginalize the effect a lack of initial human capital would have on enterprise, China can compete with overall lower wages offered in labor. Training costs may exceed their foreign competitors, but training costs can be marginalized with low turn-over within a company and can only occur once per employee while a lower wage is always going to benefit the company in terms of lowering costs.

While a simplistic economic model, a Production Possibilities Curve graph can easily depict the reason China has adopted this currency policy to address the issues described above. To infuse capital into their economy they have decided to make it more enticing for investors to invest in China. This is why outsourcing to China at the expense of our other trade partners has occurred over the past two decades. In order to speed up this process of increasing the capacity of production within China, a devalued currency would help foster domestic industries that in the long run will be able to compete against foreign companies which are currently more productive and profitable due to proper capitalization and human capital.

If China were to change their policy and let the Yuan float against other currencies in a free market it is likely that the Yuan would appreciate in relation to these foreign currencies. This can have societal effects that could lead to a dangerous internal political climate. It would be expected that as the Yuan increased in value exports would be reduced. This reduction in exports from an export based economy like China would render it with high unemployment as their labor intensive export based businesses like the garment industry would be rendered uncompetitive against foreign competitors.

While China’s currency policy has hurt American companies attempting to compete directly with artificially cheap Chinese exports it has benefited the American consumer and all companies that do not directly compete with Chinese exports. Every time an American buys a Chinese good that is cheaper than alternatives due to currency “manipulation” it increases the buying power of that American consumer. This increased purchasing power allows American consumers the chance to purchase other goods and services they normally would not have been able to afford. A perfect American company that is an example of this would be Walmart. Walmart has benefited greatly by being a large buyer of Chinese exports and providing American consumers the opportunity to purchase these goods at lower prices than domestic providers can produce them at.

Although one could make the argument that with greater purchasing power we are hurting in terms of reducing the ability to export goods. The question then becomes: Is the benefit greater than the cost? In this case the answer is an emphatic yes. Most of our economy is not subject to Chinese competition. China does not sell us a house in Orange County, a meal in New York or health care in Chicago. On top of that we do not purchase any of their cars or airplanes. Therefore, only a small segment (i.e. clothing and furniture) is harmed, but at the same time this segment becomes more efficient as a result. China has given itself a competitive advantage and competition is good for capitalism.

Being able to purchase Chinese and other foreign products at the lowest possible price makes American companies more competitive. It allows them to sell more products and hire more American workers. Therefore, as some of us would like to render the devaluation of the Yuan as “manipulation” of Chinese currency, we have made the argument that it actually saves and create jobs here in the United States.