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Chinese inflation and us

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LARRY DeBOER, Guest Columnist

Economics is called the “dismal science.” I’m not sure it’s really a science, but lately it sure has been dismal. Most of the economic news over the past three years has been bad. Even a dismal economist gets worn out, so sometimes I go looking for good news. This week I found some, in a headline that said “In China, Inflation Raises Concern.”

Here’s why that’s good news for us. Our main complaint about China’s economic policy has to do with the exchange rate between the dollar and China’s currency, the yuan (also called the renminbi). We think China holds the exchange value of the yuan too low so that the value of the dollar is too high.

We buy lots of manufactured goods from China. Chinese exporters want to be paid in their own currency, so U.S. importers have to buy yuan with dollars. We offer to trade lots of dollars for yuan. China, though, doesn’t buy that much from us. They’re not offering many yuan in exchange for dollars. So, lots of dollars chase just a few yuan. That should make the value of the yuan rise and the value of the dollar fall.

If that happened, China’s exports to the U.S. would become more expensive, and U.S. exports to China would become cheaper. They’d buy more from us; we’d buy less from them. That would help bring trade into balance, and it would increase employment in the U.S. It’s one of those self-correcting processes that economists just love.

But China hasn’t let the value of the yuan increase by much. The low value of the yuan gives Chinese goods an extra price advantage over products produced in the U.S. U.S. importers buy yuan, and then use the yuan to buy Chinese goods. If the yuan are cheap then Chinese goods are cheap in terms of dollars. American consumers buy more from China and less from factories at home. Likewise, a low value of the yuan makes dollars expensive in China, which makes U.S. products expensive, too. So, the Chinese buy even less from us.

China stopped the yuan from rising starting in July 2008. They held its value at just over 6.8 yuan per dollar. They worried that a more expensive yuan would cause China’s exports to grow more slowly. Jobs in their export industry would grow slowly, too. Millions of people migrate to China’s coastal cities each year looking to work in factories. China’s leaders fear the unrest that might result if those factories can’t employ those migrants.
We know why China has kept the value of the yuan from rising. But how do they do it?

The answer is they create new yuan to buy up all those extra dollars. With more yuan for dollars to chase, the value of the yuan doesn’t rise.

They lend those dollars back to us. That helps keep our interest rates low, which is fine, except that those dollars helped inflate the housing bubble that led to the Great Recession.

Who’s getting those newly printed yuan? It’s the people who are offering dollars for yuan to buy Chinese products. More and more yuan are chasing Chinese goods, and that’s a recipe for inflation.

Now inflation has China’s leaders concerned. Maybe unrest will arise because of higher prices, instead of unemployment.

The inflation threat may encourage China to stop creating all those extra yuan. Fewer yuan chasing China’s products would restrain inflation. The yuan’s exchange value would rise, which would make U.S. goods cheaper for China’s consumers. That’s another check on inflation. And if U.S. exports to China increase, U.S. employment will, too.

China has begun to allow the value of the dollar to fall. It’s been falling in fits and starts since September. The exchange rate is under 6.7 yuan per dollar - not a big change, yet, but in the right direction. U.S. officials are pressing for more.

So, inflation could encourage China to adopt a currency policy that will help U.S. employment. That would be good news. But then what would make economics dismal? How about the rising prices of goods imported from China? Exchange rate changes always have two sides.

DeBoer is a professor of agricultural economics at Purdue University.