A recent NPR podcast discussed how Paul Krugman and other economists are criticizing the Chinese bank for increasing the supply of its own currency, thereby deflating it relative to the dollar and other currencies.
As the podcast correctly evaluates, the result of this is that Chinese exports are cheaper to consumers in other countries, and goods China imports are more expensive for consumers there. Chinese exporters understand this phenomenon all too well, and realize they are going to increase their market share and profit if the currency is devalued, and probably lobbied the Chinese government to make it happen in the first place. Chinese politicians and the general Chinese public can feel great about this wonderful plan to increase Chinese industry and provide jobs!
Naturally, some in the United States are upset because American producers of the same goods are now at a competitive disadvantage with Chinese producers, costing the American producers money and costing them jobs. Sounds like the United States government needs to do something about this, right? You’d certainly get that impression from listening to the NPR podcast.
Alas, this evaluation is exactly what Henry Hazlitt warns about in the lesson from which this blog derives its name. It ignores the other results of China’s actions. Chinese currency devaluation means that Chinese goods are cheaper in the United States. This is wonderful news for American consumers! (And, for that matter, everyone else in the world except China, but I’ll focus on the United States.) Meanwhile, Chinese consumers are forced to deal with more expensive imported goods into China. American consumers are now helping the U.S. economy more, since they can buy more goods with the same amount American money, creating employment to meet the new demand. Conversely, Chinese consumers will be buying fewer goods with the same amount of Chinese money, meaning that domestic industries in China (Chinese producers selling to Chinese consumers) will be hurt, which is worse for both parties. This is because devaluing currency is really inflation, and this is what inflation does: makes goods more expensive than they otherwise would be, slowing economic growth.
Why is the Chinese government devaluing its currency, then, if this is so bad for them? Because those to whom the currency devaluation benefits (Chinese exporters) favor it because they stand to profit substantially from it. Therefore, if they believe the government will go along with them, they have every incentive to lobby the government to help them. The politicians, meanwhile, even if they understand the economic realities of the situation (which is unlikely), have on the one hand a small number of lobbying exporters who are helped a great deal, and many consumers who in the aggregate are hurt a great deal but individually are hurt comparatively little, and therefore have no real incentive to counter-lobby. This means that the politicians have the incentive to not anger the only group with substantial individual stakes, while taking the economically correct action likely won’t anger anyone.
The United States taking a “retaliatory” measure (by deflating the dollar) to balance out the Chinese action is a road to disaster for the exact same reason that it’s a bad idea for China to do it for itself. If China wants to devalue its currency, the United States should be happy it has access to cheaper goods allowing it to more easily grow its economy, and not damage its own economy by doing the same.
Filed under: Economic Theory
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