America and China: Converging or Diverging Interests?
With China’s inhabitants representing nearly one-sixth of the world’s population, it’s no wonder their competitive edge has been in their labor workforce. For years American companies have been outsourcing production to countries like China where more affordable manufacturing costs have become profitable investments. Adding to their already competitive advantage, foreign exchange risk has rarely been a deciding factor with China because they have historically pegged the Yuan against the U.S. dollar. The announcement from the People’s Bank of China has now given American companies a reason to rethink about the costs associated with outsourcing to China; but has it given them a reason to take action? There are two lenses one can view this decision through. The optimist would believe the Chinese have loosened their policy to devalue the dollar against the Yuan in favor of both countries’ interests. Conversely, the wary would be apprehensive to jump to such a conclusion noting the diverging interests between the United States and China as they compete for global economic dominance.
To the wary: The Chinese currency is backed by a number or basket of different currencies. The lack of transparency in this basket leaves speculation to determine what quantity of each currency the Yuan is backed by; although, some believe the Chinese have been increasingly moving towards the Euro. Cornell economist, Eswar Prasad, is quoted in the Wall Street Journal as reporting nearly a quarter of China’s trade is in Euros. If the Chinese have indeed moved towards backing their currency with the Euro instead of the dollar, the Euro’s recent downward spiral could quickly dissolve American expectations of Yuan appreciation against the dollar. In other words, politicians who believe the Chinese central bank’s decision was a favorable one for the United States may be sadly mistaken.
For the optimist: There is a simple explanation as to why a devalued dollar against the Chinese Yuan could be advantageous for America – the Chinese would buy our goods and services. This is why politicians such as Treasury Secretary Timothy Geithner have been making visits to China to encourage a loosening of foreign exchange policy. The purchasing power Chinese households would acquire with a strengthened Yuan could potentially reinvigorate the troubled, down-ward sloping world economy. The unemployment rate in the United States, currently steady near 9%, would quickly improve. Without inflation, a sharp increase in jobs would result in growth of America’s Gross Domestic Product (GDP). For these reasons and more, China’s move towards a flexible currency presents enough hope for U.S. interest in their decision.
The world will not see the results of this move by the Chinese for at least the next sixth months to a year. Even then the short-sighted effects may attest to be drastically different than the long-term scope will prove. As for now the politicians, the analysts, and the public can play the role of speculators – all part of the game of politics.
Thanks to Flickr for the photo.
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