In his current New York Times article, economist Paul Krugman is calling for the United States to fire back at China for manipulating its currency.
However, as usual, Krugman has it totally wrong.
Krugman’s argument is that the United States — not China — is in a position of strength. He argues that China has been manipulating its currency lower for years in an attempt to keep trade surpluses with the rest of the world and to gain a competitive advantage.
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Of course, he fails to criticize the United States for a similar policy.
Since the early 2000s, the United States has devalued its currency in an attempt to prop up economic growth. Rates where set near zero after the dot com bubble burst and the United States dollar’s slide during the recovering of the mid 2000s.
All China did was to follow the same pattern and ride the United States’ coattails.
In addition, in a creditor-debtor relationship, the creditor always has the upper hand.
Sure, if China dumped its Treasury holdings, it would hit the dollar, the value of those holdings.
However, the United States at that point could not finance its debt and the U.S. government would fall into a Greek-style financial crisis.
We must remember that in 1956, the United States threatened to dump the debt of the United Kingdom during the Suez Canal crisis if the U.K. did not back down.
The United Kingdom did back down, as the economic Armageddon that would have ensued from such a tactic was much more serious than the battle over the canal.
The nation that is the creditor has the power.
Chinese officials need to let the yuan float and appreciate.
However, this does not mean China won’t still continue to run huge surpluses.
For example, despite having a strong currency, Japan has a trade surplus with China.
I have news for U.S. politicians: If U.S. companies make excellent products and are competitive, people will buy the products no matter what the nation’s currency does.
Efficiency — not devaluation — is the way to prosperity.
In this relationship, it is China — not the United States — that has the power.
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