January 22, 2011

Obama Must Push for a Higher Yuan

President Obama is now meeting with China's President Hu Jintao over a number of tough issues, among them the value of China's currency. A view has grown up among some analysts that the yuan isn't our problem. According to this view, a significantly revalued yuan would neither reduce America's imports (China's cheap exports would be replaced by Vietnam or Mexico) nor materially increase U.S. exports to China (price is not a big factor driving China's demand for our jet engines or nuclear reactors). It then follows that we should not pressure China on this matter and instead push for greater market access and human rights reforms.

This is a backward-looking view of our interests. Today's Chinese exports to the U.S. — what you buy at Wal-Mart — mostly do not compete with American factories. A forward look sees China's new export mix to its developing market trading partners in Southeast Asia and Africa: fast rail systems, wind turbines, and wireless telecom equipment. U.S. and European factories selling the same big-ticket capital goods are currently underpriced 20%-35% by Chinese competitors on the strength of the undervalued yuan, and the Chinese are rapidly gaining market share. If President Obama really wants to save our best manufacturing jobs and double exports, he must push for a much higher yuan. Developing markets are together a bigger capital goods market today than developed markets.

Chinese fast rail system competitors are now preparing bids for several U.S. projects on the drawing board. The President should impose reciprocity on the Chinese — either your barriers to our capital goods sold into Chinese projects come down or you will get the same treatment here. The danger is that he will stop there and not further insist that the yuan revalue materially and fast. Last year's 3½% increase was too small to make a difference. Economists who claim that the real exchange rate rose much more because of China's higher inflation rate ignore the fact that it is capital goods inflation, not consumer inflation that drives this calculation. There is little capital goods inflation in China as there is huge excess capacity. China's prices have not materially changed. They must.

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