|
The recent buzz from the Fed and the US manufacturing industry has been pinning the blame for the US trade deficit on China's undervalued currency, accusing them of stealing jobs and dumping goods. Although some of the claims are true to a certain extent, a yuan revaluation would certainly not be the rescue package that saves the dollar from its recent troubles. Inarguably, the fundamental effect of the revaluation will be dollar depreciation against the yuan and a slightly smaller depreciation against a basket of currencies as the central bank releases their dollar reserves. That brings us to the economic effects that this nominal exchange rate change implies.
The dollar's recent stumble is largely due to its record-breaking current account deficit. Although in the short run, a yuan revaluation might cause an improvement of the trade situation with China, it's not likely that this will last. Because of sticky wages and prices, Chinese consumers will buy more American products after a revaluation because their income will be worth more in terms of the dollars that they pay. This will cause a small and temporary decline in the US trade deficit, which will mean good news for dollar bulls. However, as prices and consequently, foreign demand adjust in the medium term, the negative effects on China's export industry will be felt in the economy as a whole. Chinese wages should decline and consumption of both foreign and domestic goods will slow during a period of adjustment causing a downward deviation from the current inflationary trend. |
|
Lower prices combined with an elevated currency value means that, in real exchange rate terms, China's price competitiveness would move towards pre-revaluation levels
- ADVERTISEMENT -
again. This being said, keep in mind that, as shown in US trade data for the first half of 2004, China is the destination for only a little over 4% of US exports and it's the origin of less than 13% of US imports. All in all, the short term price effect of the revaluation will be muted by the income effect in the longer run, which leaves the dollar worse off and facing the same depreciation pressures as before. |
|
