Chinese currency appreciation: You “yuan” it, you got it!


Earlier this week, China did something totally out of character: it allowed its currency – the renminbi, or “yuan” as its sometimes called – to rise against the dollar.  While this may not set off alarm bells in your head, its actually pretty amazing, and will have some far-reaching consequences for your ability to get a job, and/or get a raise any time soon.

First, a little background.  Each country has a currency, though the particulars vary from place to place.  When someone within a country talks about the amount of money it takes to buy something changing – say, an air conditioner – they say that the price is inflating (or in some rare instances, deflating).  However, companies that do business overseas have to figure out how many dollars they have to spend to buy things from foreign markets – how much will Wal-mart have to pay a Chinese company that makes air conditioners?  Well, the more dollars it takes to buy things that are priced in a foreign currency, the weaker the dollar is, and the stronger the other currency is.  If it goes the other way, and we need fewer dollars to buy those air conditioners, the dollar is getting stronger.

We currently have a strong dollar.  This is very good if our nation wants to borrow money (which we have done a lot of in the past two years) because other countries see a rising dollar in much the same way as we’d see a rising stock market – as an opportunity to make some money.  However, a strong dollar can be a very bad if we want to sell things to other countries (because our stuff is really expensive).  And the US has things to sell, from airplanes to wheat, the U.S. export market is huge.  In 2008, total us exports equaled $1.8 trillion dollars, or 18% of our GDP.  Most of the rest of our economy is driven by consumption, and as you may be aware, our domestic economy isn’t all that great right now – unemployment continues to hover just below 10%, just as it has for a while now, and the housing market continues to falter, leading to ever more foreclosures, displaced families, and overall economic uncertainty.

Enter China.  China’s economy has been booming along like a rocket for a while now – check out the graph here to get a sense of how fast its been growing for the past few decades, versus the U.S. or the world as a whole.  Part of why it’s been doing so well is that it’s kept its yuan artificially low – so low, that most of the rest of the world can’t resist buying Chinese-made stuff, since it’s all so cheap to buy.  That means that those products are not being bought from the U.S., which has been a source of frustration to a variety of U.S. administrations since Clinton.

What will the currency shifts do to the price of pig’s blood cakes?

However, for a variety of reasons, China has had a change of heart, and allowed its currency to rise, which means, in effect, our dollar is going to get weaker.  What does this mean?  It seems likely that a variety of our export industries are going to get a boost soon, as international orders for things that would have been coming from China shift to the newly cheaper U.S. export market.  As these industries get more orders for products, they’ll likely expand production, hire more workers, and act as a stimulant to the U.S. economy… provided that the Chinese don’t decide to change their mind, or their economy starts to falter.

This is all good news, but with this new change comes new problems.  First off, as our economy begins to take off again, and the unemployment rate starts to go down, we’ll likely start seeing some inflation.  A little inflation is ok, but a lot of inflation will start making waves: The Chinese, who hold a lot of U.S. Treasury Bills (remember the borrowing we did?  We did it by selling U.S. T-Bills to the Chinese!), won’t want to see inflation eat away at their investments, and rampant U.S. inflation will likely cause them to change their mind on their new currency policy.  Similarly, high inflation in the U.S. is bad for people who are living off savings or defined-benefit pension plans… i.e., the most vulnerable people in our country.  

For this good news to keep going, Ben Bernanke, Tim Geithner and the Obama administration are going to have to do some fairly sophisticated policy adjustments – all during an election year.  Can they pull it off?  What do you think?