By Robert Romano
For the fourth time this year, George Mason University Economics Professor Don Boudreaux submitted a reply to my column. He calls them “letters,” and attaches a mailing address at the bottom of each, although to be honest, I’ve never actually received any of these letters either via email or via the Post Office or fax. I think he just posts them at his popular economics blog, Café Hayek. Boudreaux is foremost in his field, and to get this much attention, still, is an honor, even if it does not find its way to my inbox.
This time, Boudreaux was replying to my recent piece, “China has more to lose in an economic fight with the U.S. than we do,” where I argue that given China’s position as a net exporter to the U.S. (23 percent of China exports go the U.S.), the comparatively fewer exports the U.S. sends to China (7 percent of U.S. exports go to China), and the relatively small amount of U.S. treasuries China actually purchases (5 percent of the overall national debt), that China has a lot more to lose, potentially giving the U.S. more leverage than is conventionally thought in trade talks.
Which, Boudreaux does not really bother to refute my central premise, that China actually has more to lose. Instead he focuses on a single statement of my essay that he takes issue with — this is typical of Boudreaux — like it was a Jenga piece, where I write, “And then there’s the cheap goods we buy from China, but then again, those could be produced here or somewhere else. Doesn’t have to be China.”
Boudreaux replied, “producing such [cheap, low-value-added] goods would be an economic step backward, toward poverty, for wealthy countries such as the United States,” and as for low-priced goods, “these goods could [not] be produced here or somewhere else economically. The goods that we now import from China we import from China for a sound economic reason — namely, the prices that we pay for these Chinese-assembled goods are the lowest prices available. If Trump’s economic policies artificially block Americans’ access to such goods from China, the prices we will pay for similar goods ‘produced here or somewhere else’ will be higher than are the prices we pay now. Americans’ real wages and standards of living will fall.”
So, in short, prices for goods shipped from China are cheaper, and that’s why we buy them — and that serves U.S. interests. And, if tariffs were put on Chinese goods, prices and thus inflation would rise, and that would not serve U.S. interests, in Boudreaux’s eyes. This ignores certain social costs of outsourcing including displacing people out of their jobs, and reduces the analysis to simply that of the costs of production and the rate of return on capital.
But so far, so good. Let’s play along. Nobody disputes that tariffs increase the prices of goods that consumer pay. That’s the point of tariffs. That does not mean that China doesn’t have more to lose in a trade negotiation. Still, Boudreaux offers an interesting analysis and it raises an important question: If it produces relatively cheaper goods for us to consume, does Boudreaux actually support China’s de facto currency tariffs on U.S. goods? A curious position for a supposed free trader.
Because one of the major reasons it’s cheaper to make goods in China is indeed currency, that is, the yuan’s artificially low fixed exchange rate with the U.S. dollar. This is separate from conventional tariffs, which on an average basis, stood at 3.21 percent for China and 1.44 percent for the U.S., according to the World Bank, which have been dropping for years.
On currency, by contrast, since 1994, 1 dollar has equaled on a fixed basis as many as 8.62 yuan, or about 6 yuan in 2014, according to the Bank of China. Today, it equals 6.9 yuan and has been rising since China’s economic bubble popped in 2014. This artificially low price of the yuan to the dollar keeps the price of Chinese exports to the U.S. lower while simultaneously increasing the price of U.S. exports to China.
Although, it should be noted Boudreaux disputes this notion. In April he responded to me that the premise that “Beijing has long kept the prices of Chinese exports artificially low by keeping the value of the Chinese yuan artificially low” is “contrary to fact”.
Here, Boudreaux finds himself not just at odds with myself, but prominent economists like Art Laffer on the right and Paul Krugman on the left, who take the definitive view that currency devaluations do in fact boost exports. Also, the International Monetary Fund. And, even Milton Friedman and Anna Schwartz.
In 2015, Laffer wrote, “Currency manipulation and its impact on free trade,” in which he stated, “currency manipulation is a potent tool of mercantilists, tempting nations to increase their trade balances and export domestic unemployment to the countries that are not devaluing, a ‘beggar-thy-neighbor’ approach to international economics.”
Laffer cited a Peterson Institute for International Economics study of 20 nations that stated “the currencies of the interveners [that are] substantially undervalued [boost] their international competitiveness and trade surpluses,” costing anywhere from 1 to 5 million jobs in the U.S. and contributing $200 billion to $500 billion to our annual trade deficits.
Krugman, for his part, although he has moved away from the idea that the yuan is currently undervalued, his writings on the yuan’s devaluation in the 2000s was clear. In 2010, he wrote, “This is the most distortionary exchange rate policy any major nation has ever followed. And it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.”
There is also the Oct. 2015 World Economic Outlook from the International Monetary Fund (IMF) study of 60 economies including China found that “A depreciation in an economy’s currency is typically associated with lower export prices paid by foreigners and higher domestic import prices, and these price changes, in turn, lead to a rise in exports and a decline in imports. Reflecting these channels, a 10 percent real effective exchange rate depreciation implies, on average, a 1.5 percent of GDP increase in real net exports,” with much of the increase happening in the first year.
Or Milton Friedman, if you prefer? Citing research by Matthew Simon in “A Monetary History of the United States,” with Anna Schwartz, Friedman wrote of U.S. monetary policy in the Civil War that “the depreciation of the exchange rate manifested in the rise in the greenback price of gold contributed to resolving the North’s balance of payment difficulties… by affecting the ‘real’ terms of trade and so fostering exports and discouraging imports…”
So, currency devaluations lower the prices of exports and increases the prices of imports. It’s a simple math equation that you could calculate on a napkin. Say, the dollar and yuan have a 1 to 1 exchange rate, and widgets sell for $4 in the U.S., whether produced domestically or imported from China. But then China artificially changes the exchange rate to 1 dollar equals 3 yuan. The price of Chinese widgets drops to $1.33 in the U.S., while the U.S. widget still costs $4. Meanwhile, in China, the cost of U.S. made widgets jumps to 12 yuan while the Chinese made widgets remain 4 yuan there. That’s a huge tax on U.S. goods — a de facto tariff.
So, it is somewhat puzzling that a free trader like Boudreaux would not support President-elect Donald Trump’s call for China to lower its de facto tariffs on U.S. goods via its current exchange rate machinations. We thought free traders were in favor of lowering tariffs. But in his most recent response, Boudreaux indicates that it’s actually in U.S. interests that it remain cheaper to produce goods in China. Does he then support keeping China’s de facto currency tariffs on U.S. goods?
Trump’s policy is that China ought to lower its tariffs, including its use of currency. He uses the threat of tariffs to get there, but so what? Boudreaux can disagree with that tactic and he would not be alone. But what about the overall goal of lowering tariffs on U.S. producers, including currency? Isn’t that worth pursuing?
What if Trump’s negotiations on currency actually succeed and one day soon China announces it is going to float the yuan on global currency markets and end its de facto tariffs? Maybe Trump never even needs to use his tariff. Which goes back to my original point, that China, having more to lose in a trade fight, might actually be willing to deal with Trump. Wouldn’t that be a good thing? It would result in freer trade, right? That is, reciprocal tariff reductions on a bilateral basis.
Of course if that happened, the yuan might appreciate in value, and so would the price of exports from China, which if that happens, per Boudreaux then prices “will be higher than are the prices we pay now.” Meaning, inflation and “Americans’ real wages and standards of living will fall.” And that would be bad, right? Prices of goods produced in the U.S. would also be relatively cheaper if China let the yuan float, and if that happened too much, production might shift back here, and that could mean, per Boudreaux, “producing such goods would be an economic step backward, toward poverty, for wealthy countries such as the United States.” How could a situation arise with fewer tariffs? We thought free trade was supposed to make everyone richer.
Boudreaux consistently portrays himself as an opponent of tariffs but has not single a word of criticism for China’s use of currency to boost exports and discourage imports, because he does not even believe devaluing currency even affects the prices of exports, but even if it did, wrote Boudreaux in April in his first response to me, “we Americans should feel pity not for ourselves (for we are artificially enriched by such policies) but, instead, for the Chinese people. It is they, if your premise is correct, who are losing. The Beijing government (again, assuming your premise to be correct) is waging war, not against us, but against its own subjects.”
If anything, Boudreaux appears to definitively place more of a premium on relatively cheaper imports than on free trade. Perhaps we should infer then that Boudreaux actually prefers China’s taxation of U.S. goods through currency while making its exports to the U.S. cheaper. After all, they’re only punishing themselves, right? Free trade, indeed.
Robert Romano is the senior editor of Americans for Limited Government.