China’s Currency Manipulation Harms China — Not Its Trading Partners

Americans are being told that China’s currency manipulations are causing harm to its trading partners, America being the main victim. Nothing could be further from the truth. China’s currency manipulations certainly cause harm, but to China itself!

No country can cause harm to another by adopting any economic intervention. All economic interventions cause harm only to the country that adopts them. This applies to subsidies of home industries, quotas restricting import volumes, tariffs imposed on imports, and currency manipulations.

A nation typically manipulates its currency by giving more of its own currency in exchange for the currency of other countries. Thus foreign importers can buy more goods per unit of currency exchanged. In other words, if the free market exchange rate between the dollar and the yuan is six yuan per dollar, an importer would be able to buy goods costing six yuan by tendering one dollar. If the Bank of China arbitrarily decides to boost imports, it can give eight or ten yuan for each dollar presented. Chinese goods drop in price on the American market.

Protectionists such as President Trump view this as harm, but where exactly is the harm? A Chinese good that previously cost a dollar now may be purchased for sixty or eighty cents. Our American standard of living goes up at China’s expense! The extra money in Americans’ pockets may be used to consume or invest more. This is a very strange definition of harm.

The real harm occurs in China. The Bank of China sets off price inflation in its own country. It may try to mitigate this inflation by raising the interest rate on its own debt in order to withdraw the extra yuan from circulation. This is known as “sterilization”. It then appears as if China has achieved greater exports with no price inflation. However, China’s debt rises. Eventually holders of Chinese debt will desire to draw down their yuan-denominated debt. Demand for yuan for spending purposes will increase. At that point China will be faced with a dilemma. Either it can raise the interest rate high enough to entice enough marginal holders of debt to roll over their holdings or it can print yuan. The former causes a recession and the latter causes price inflation.

There is no such thing as a free lunch or an economic intervention that causes harm to others and not one’s own country.