The summit between U.S. and Chinese economic officials in Beijing last week has been widely declared a disappointment, if not an outright failure. U.S. Treasury Secretary Henry Paulson and other senior officials were under pressure to deliver a dramatic breakthrough, especially on the value of China’s currency against the U.S. dollar, and they didn’t. The lack of visible progress, however, may not be such bad news after all.
Policy-makers in Washington believe a stronger yuan and a weaker dollar are just the tonic we need to spur manufacturing and job growth. In the past year, many U.S. manufacturers and trade watchers have cheered as the dollar has depreciated 7 percent against a basket of major foreign currencies, and a whopping 27 percent since March 2002.
But a weaker dollar comes at the expense of millions of American consumers and a broad swath of U.S. industry. For consumers, a weaker dollar means higher prices than they would otherwise pay for imported food, shoes and clothing, toys, sporting goods, consumer electronics, medicines and cars. For Americans traveling abroad, a weaker dollar means more expensive vacations and business trips.
American producers and their workers will also feel the pinch of a depreciated dollar. Half of the goods we import each year are raw materials, capital machinery and parts, industrial supplies and other intermediate inputs purchased by U.S. companies. (Think crude oil, sugar, steel, computers, memory chips, power generators and auto parts.) Rising import prices for those goods mean higher costs for American producers, lower profits, and fewer jobs created in those sectors. For exporters, higher import costs can partially offset competitiveness gains from a weaker dollar.
In fact, a falling dollar is one of the chief culprits behind rising crude oil prices. As the dollar loses its value against other currencies, foreign oil producers can demand more dollars for a barrel of crude. This explains why a sharply depreciating dollar has preceded every major spike in oil prices since the early 1970s.
U.S. exporters obviously love a weaker dollar because it makes their goods more affordable in global markets. Customers abroad can more cheaply acquire the dollars they need to buy U.S. machinery, soybeans, aircraft, semiconductors, chemicals, pharmaceuticals and other U.S. exports, boosting orders, production and employment in those sectors.
Policy-makers may consider the downside of a weaker dollar a small price to pay if it would only reduce our pesky trade deficit with China and most of the rest of the world. By making exports cheaper and imports dearer, a declining dollar puts downward pressure on the trade deficit, but the adjustment can take time. Consumers can be slow to change their spending patterns, and foreign producers can dampen price increases to maintain domestic market share.
Consider the meager results of the recent slide in the dollar. Even though the dollar has depreciated sharply since 2002 against the euro and the Canadian dollar, our bilateral trade deficits with both the countries that have adopted the euro as their currency and Canada, as well as our overall deficit, have continued to rise. For all the same reasons, a weaker dollar against the yuan will not be a magic bullet for the $200 billion bilateral deficit with China.
The impact of the trade deficit with China on the U.S. economy has been greatly exaggerated. Since 1994, when China first fixed its currency to the dollar, U.S. GDP growth has been strong, millions of net new jobs have been created, and domestic manufacturing output has risen a healthy 50 percent. U.S. exports to China are up 158 percent since 2000, including exports from thousands of small- and medium-sized U.S. companies. California producers account for nearly 20 percent of our exports to China, with computers, electronics and farm goods leading the way. Countries do not make themselves rich by artificially depreciating their currencies. We are not better off when we pay more for what we buy in global markets and receive less for what we sell.
America’s economic leaders should reject any efforts to engineer a certain value for the U.S. dollar against the Chinese yuan or any other currency. The dollar’s value should be determined freely by supply and demand in the robust, $2 trillion-a-day global currency market. The best dollar policy is arguably the one that Treasury Secretary Paulson and his recent predecessors have all tacitly pursued: talking up a strong dollar while letting markets determine its real value.