Lawrence Lau comments on China's exchange rate

As U.S. factories continue to lay off workers, lawmakers have found something to blame: a flood of cheap manufactured goods from China. %people1% observes that forcing China to revalue its currency will not solve the U.S.' unemployment problems.

U.S. takes issue with Chinese exchange rate WASHINGTON - As U.S. factories continue to lay off workers, lawmakers have found something to blame: a flood of cheap manufactured goods from China. And, they say, China gives those exports an unfair advantage by making the Chinese currency - the yuan - artificially cheap compared to the U.S. dollar. The result: Chinese-made goods enter world markets at rock-bottom prices. "This policy is unfair," Rep. Mark Green, R-Wis., said at a congressional hearing on the Chinese currency earlier this month. "It is anti-competitive. It is anti-freedom. And it is costing us jobs." President Bush has weighed in, too, asking Chinese President Hu Jintao last weekend in Bangkok to let market forces determine the exchange rate. Hu agreed to study the problem jointly with the United States. Presidents don't often get involved in the abstruse details of how to manage the international financial system, and for good reason. Engineering changes in currency policy is a risky business that can have unintended and harmful consequences. Financial crises resulting from botched currency policies have been a regular feature of the world economy for the entire history of international capitalism. Indeed, that's what happened during the Asian financial crisis of 1997, when China was cast in the role of a hero for holding its currency steady and helping to halt the spread of the crisis. Despite this history, Bush and U.S. lawmakers want China to allow its currency to fluctuate against other currencies, much as the U.S. dollar, the Euro and the Japanese yen do today. Since 1994, China has locked its currency at 8.3 yuan to the dollar. Chinese officials say they want to do just what Bush is asking for, but not right away. They worry that China's banks are too weak to withstand the shock of a sudden liberalization of the currency policy. The banks have huge bad loans on their books, and only a steady inflow of yuan deposits keeps them alive. If the yuan were allowed to fluctuate, and money could flow freely in and out of the country, depositors might shift some of their money out of China. A big enough shift would cause the banks to run short of cash, causing a financial crisis that could sink the economy and send waves of instability around Asia. So Chinese officials want to get the banking system in shape before moving forward, and the truth is that a Chinese banking crisis would hardly help American workers. On the U.S. side, a stronger yuan may do less than advertised for American factory workers. Chinese imports aren't the only reason why manufacturing jobs are in decline. Factories are installing more and more automated equipment that allow production of the same amount of goods with fewer workers. And lower wages - not an undervalued currency - is probably the main reason why Chinese-made goods are cheaper than their American counterparts. Still, Fred Bergsten, who heads the Institute for International Economics in Washington, believes that a 20 percent to 25 percent increase in the value of the Chinese currency - a move to the 6.2 to 6.6 yuan to the dollar range - could translate into 500,000 U.S. jobs, mainly in manufacturing. That's only a part of the 2.8 million manufacturing jobs lost in the last three years, but it's not insignificant. A stronger yuan, at least in theory, helps U.S. factories in two ways. First, it makes U.S. exports cheaper for Chinese buyers. At 6.6 yuan to the dollar, a $10 item would cost 66 yuan instead of 83 yuan. It also makes Chinese imports more expensive for American consumers, who then might opt for American-made goods instead. But the actual impact of a stronger yuan in prices may be less than expected. For one, 80 percent of the parts in Chinese exports - which range from Motorola cell phones to Dell computers - are made in other Asian countries and elsewhere. Changing the value of the yuan won't affect the cost of those parts, at least not directly. As a result, Stanford University economist Lawrence Lau estimates that a 20 percent increase in the value of the yuan would push up the cost of Chinese goods only about 4 percent. Even those costs might not get passed on to consumers in today's highly competitive economy. Companies that export from China - many of them American - may absorb the exchange rate shift, taking a cut in profits instead. "Forcing China to revalue does not really help us solve our job problem fundamentally," Lau told a congressional hearing on China trade last month. Nonetheless, Chinese officials have indicated repeatedly that they eventually want the yuan to fluctuate against other currencies. That would allow the central bank to use interest rates to fight inflation or unemployment, as in the United States, rather than just to maintain the exchange rate. But Bergsten of the Institute for International Economics worries that China won't move fast enough to satisfy America's politicians. Chinese officials have suggested to him that China might change its exchange rate policy around the time of the Beijing Olympics, set for 2008. By then, he fears, U.S. trade policy will have turned protectionist.