Technical Tuesdays

Is China’s currency manipulation behind the U.S.’ trade deficit?

Is China’s currency manipulation behind the U.S.’ trade deficit?

For 41 years in a row, the United States has bought a lot more from the world than it has sold to it. In 2015, this resulted in a trade deficit of US$750 billion.

President Trump never hesitates to cite this deficit to play the victim. He seems determined to do something about the situation and is targeting China, a country that recorded a surplus of US$347 billion in its trade with the U.S. in 2015.

China produces every kind of consumer good you can imagine. Even companies from the U.S. itself have helped China establish itself as the world’s manufacturing center.

American money means jobs and income for Chinese workers. And with the economy slowing down in the Middle Kingdom, that cash is needed more than ever.

But now, we’re hearing strong words like “trade war” coming from the American side.

President Trump has repeatedly accused China of manipulating its currency and keeping it artificially low in order to boost its exports, and called it unfair competition for U.S. corporations.

Let’s examine if this statement holds water.

The graph below illustrates the relationship between US-China through the trade deficit and the USD/CNY exchange rate.

We can see that the deficit has steadily increased since 1994 and that the Chinese yuan has appreciated against the dollar by 25 percent over the same period.

What happened is that the U.S. greatly contributed to China’s unprecedented economic growth. Importers from the U.S. had to cough up more Chinese yuan for imports from China, which caused the Chinese yuan to appreciate over time.

Still, the U.S. keeps importing from China and even though the Chinese yuan is getting more expensive, the increase of China’s share in the deficit was proportionate.

This effectively renders Trump’s accusation completely baseless. You see, the appreciating Chinese yuan has not resulted in a reduced trade deficit for the U.S.

So no, the Chinese yuan is not the problem. China’s restrictive policies are!

U.S. exports to China are heavily restricted. The trade deficit would vanish in the blink of an eye if only U.S. banks, insurance companies, management consultancies, and IT firms were allowed access to the Chinese market.

Those are the areas where U.S. companies would outshine everyone else.

But China’s protectionist policies heavily safeguard the country’s financial services industry by strictly limiting or even prohibiting foreign investments.

Perhaps China is afraid that allowing U.S. bankers into their market could result in a complete financial takeover of the Chinese economy.

Regardless, letting the trade dispute escalate would be terribly unwise, because both countries stand to lose a whole lot if a full blown “trade war” actually emerges.