Tuesday, February 24, 2015

Sherrod Brown doesn't understand trade

In the most recent email I received from Sherrod Brown he makes a startlingly ignorant statement:

This month I joined my colleagues of both political parties to announce the introduction of the Currency Undervaluation Investigation Act, to stand up to Chinese currency manipulation.

This bipartisan plan could create five million jobs, increase our GDP by as much as $720 billion, and provide a shot in the arm to American manufacturing — all at no cost to taxpayers

(My italics and bold print)

No cost to taxpayers? If taxpayers import goods from China (and they do, check your labels) then this act will certainly cost them.

First let me explain what Mr. Brown means by "currency manipulation". Suppose that a Big Mac costs $2 in the U.S. and an identical Big Mac cost 8 yuan in China. For purchasing power parity to hold, $1 would have to equal 4 yuan. This would be the "correct" exchange rate in Mr. Browns view.

But China may want a different exchange rate, perhaps to maintain high levels of employment in China. So in the currency markets China tries to maintain a ratio of $1 = 5 yuan rather than 4 yuan. So what does this mean for the U.S.?

Well it means that the stuff we buy from China is cheaper than it otherwise would be. For example, suppose a tube of toothpaste that is made in China sells for 10 yuan. At a ratio of $1 = 5 yuan I would have to use $2 to buy 10 yuan, which I would then give to the Chinese manufacturer for the toothpaste. So the toothpaste would cost me 2 U.S. dollars. If instead the $1 = 4 yuan was the exchange rate, I would need to trade $2.50 for 10 yuan. So at the $1 = 4 yuan the toothpaste would cost me $2.50 instead of $2. If purchasing power parity held, then the tube of toothpaste would be more expensive.

China prefers the exchange rate of $1 = 5 yuan in this example because it makes the things that China produces relatively cheaper compared to their cost in the U.S. Remember, based on purchasing power parity the toothpaste should have cost $2.50, which is what American made toothpaste would cost int this example. But because China "manipulates" the exchange rate the toothpaste only costs $2 to buy from China while it costs $0.50 more to buy from a U.S. manufacturer. (Like any good, currency prices are based on supply and demand. China can affect the exchange rate i.e. price of dollars in yuan by buying and holding dollars, which reduces supply.)

(Note that the higher exchange rate ($1 = 5 yuan) makes American goods more expensive for the people of China than the $1 = 4 yuan rate. When the Chinese producer of the toothpaste trades his 10 yuan in for $2 he cannot buy the American made toothpaste that is priced at $2.50.)

This is a stylized example but it reveals that Mr. Browns policy does indeed COST U.S. taxpayers by making the things we buy from China more expensive. So if you spend $1000 per year on stuff made in China and prices go up by 2% on average than this policy would cost you $20 per year. If 50 million Americans had their costs of Chinese goods go up by $20, then Mr. Browns "no cost" policy would cost Americans in total $1 billion. I would need to do more research to get a better estimate, but I guarantee that the true cost is a number much greater than $0.

So don't let Mr. Brown fool you. If China is indeed manipulating their currency then they are doing U.S. consumers a big favor. Trade is about producers AND consumers and ignoring one of the groups to paint a better picture of a policy is dishonest. But I don't expect much honesty from politicians such as Mr. Brown anyway.

1 comment:

  1. It's still bad policy for the US economy if China artificially props its currency against ours. This further causes the US current account to decrease, which in turn causes us to borrow from foreign countries (to finance this greater consumption) at an inefficient rate relative to the market outcome.

    On another note, I don't think political rhetoric such as Sherrod's is a function of politicians being ignorant...it's more likely due to the fact that their constituents are ignorant.