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Why Devaluing The Yuan Won't Help China's Economy
Submitted by Frank Shostak via The Mises Institute,
Earlier this month, the Chinese government decided to depreciate its currency on three consecutive occasions. On August 13, the price of the US dollar was trading at 6.413 — an increase of 3.3 percent against July.
The key factor behind the central bank’s lowering of the yuan is a sharp decline in the growth momentum of exports with the yearly rate of growth falling to minus 8.3 percent in July from 2.8 percent in June.
It is held that by means of currency depreciation that it is possible to strengthen the export of goods and services, thereby strengthening the gross domestic product (GDP), which currently displays a visible weakening. The yearly rate of growth of real GDP stood at 7 percent in Q2 against 7.5 percent in Q2 last year and 8.6 percent in Q1 2012.
According to popular thinking, the key to economic growth is demand for goods and services. It is held that increases or decreases in demand for goods and services are behind rises and declines in the economy’s production of goods. Hence in order to keep the economy going economic policies must pay close attention to overall demand.
Why Governments Devalue Currencies to Boost Exports
Now, part of the demand for domestic products emanates from overseas. The accommodation of this demand is labeled “exports.” Likewise, local residents exercise demand for goods and services produced overseas, which are labeled “imports.” Observe that while an increase in exports implies an increase in the demand for domestic output, an increase in imports weakens demand. Hence exports, according to this way of thinking, are a factor that contributes to economic growth while imports are a factor that detracts from the growth of the economy.
From this way of thinking it follows that since overseas demand for a country’s goods and services is an important ingredient in setting the pace of economic growth, it makes a lot of sense to make locally produced goods and services attractive to foreigners. One of the ways to boost foreigners’ demand for domestically produced goods is by making the prices of these goods more attractive.
One of the ways of boosting their competitiveness is for the Chinese to depreciate the yuan against the US dollar. Based on this one can reach the conclusion that as a result of currency depreciation, all other things being equal, the overall demand for domestically produced goods is likely to increase while also lowering Chinese demand for American goods. This in turn will give rise to a better balance of payments and in turn to a stronger economic growth in terms of GDP. What we have here, as far as the Chinese is concerned, is more exports and less imports, which according to mainstream thinking is great news for economic growth.
Why an Exports Boost Fueled by Depreciation Can’t Grow the Economy
When a central bank announces a loosening in its monetary stance this leads to a quick response by participants in the foreign exchange market through selling the domestic currency in favor of other currencies, thereby leading to domestic currency depreciation. In response to this, various producers now find it more attractive to boost their exports. In order to fund the increase in production, producers approach commercial banks which — on account of a rise in central bank monetary pumping — are happy to expand their credit at lower interest rates.
By means of new credit, producers can now secure resources required to expand their production of goods in order to accommodate overseas demand. In other words, by means of newly created credit, producers divert real resources from other activities. As long as domestic prices remain intact, exporters record an increase in profits. (For a given amount of foreign money earned they now get more in terms of domestic money.) The so-called improved competitiveness on account of currency depreciation in fact amounts to economic impoverishment. The improved competitiveness means that the citizens of a country are now getting fewer real imports for a given amount of real exports. While the country is getting rich in terms of foreign currency it is getting poor in terms of real wealth (i.e., in terms of the goods and services required for maintaining people’s life and well being).
As time goes by, the effects of loose monetary policy filters through a broad spectrum of prices of goods and services and ultimately undermines exporters’ profits. A rise in prices puts an end to the illusory attempt to create economic prosperity out of thin air. According to Ludwig von Mises,
The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption.
This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation's welfare. In plain language it is to be described in this way: The British citizen must export more British goods in order to buy that quantity of tea which he received before the devaluation for a smaller quantity of exported British goods.
Contrast the policy of currency depreciation with a conservative policy where money is not expanding. Under these conditions, when the pool of real wealth is expanding, the purchasing power of money will follow suit. This, all other things being equal, leads to currency appreciation. With the expansion in the production of goods and services and consequently falling prices and declining production costs, local producers can improve their profitability and their competitiveness in overseas markets while the currency is actually appreciating.
The economic slowdown in China was set in motion a long time ago when the yearly rate of growth of the money supply fell from 39.3 percent in January 2010 to 1.8 percent by April 2012. The effect of this massive decline in the growth momentum of money puts severe pressure on bubble activities and in turn on various key economic activity data. Any tampering with the currency rate of exchange can only make things much worse as far as the allocation of scarce resources is concerned.
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They had to take the easy way out because the other alternative might hurt a bit and tarnish their reputation for infallibility.....
But does devaluation help allocate surplus dollars?
re: "While the country is getting rich in terms of foreign currency it is getting poor in terms of real wealth (i.e., in terms of the goods and services required for maintaining people’s life and well being)."
and there goes the entire article, if you think real wealth is how the elite Politburo and friends define growth lol
Largarde said it all: "Predictable, predicted, unavoidable..."
why would anyone seemed/sounded/showed surprise?
this is where the Asian ideal of 'face' becomes 'faceplant', followed by 'facepalm'...
Ask the IMF about September delay. ;0
Press Release: IMF Executive Board Approves Extension of ...
Yes, and the Chinese had a tantrum after this. But that is what happens when you ban folks from selling stocks and play those kind of games with you market. You don't get to play the game with the other kids and get a time out.
Excellent article, its why I hang at ZH.
"According to popular thinking, the key to economic growth is demand for goods and services. It is held that increases or decreases in demand for goods and services are behind rises and declines in the economy’s production of goods. Hence in order to keep the economy going economic policies must pay close attention to overall demand."
And when the demand is clearly not there (for a variety of public policy and economic reasons) the "popular statist-Keynesian thinking" is...to keep prices inflated above where they actually should be, thus impovershing the masses making them run toward the state for relief from what the state actually caused.
Am-I-Getting-Through?
Is this mic on? ;-)
wha???!!! I guess I'm just too mutha fucking stoopid to think that lower costs win
Demand=growth
A turd will always be a turd...
Perhaps the key to economic growth is low debt to profit in any demand condition? Who would have thought that companies tend to fail when they have too much debt, and not enough business to pay their bills, especially when they seem to have maxed-out their short term credit card in a last ditch gambling spree to make it good.
Indeed, anyone who thinks about economics properly - about all the economic effects and not just the superficially obvious ones (an ability that distinguishes good from bad economists, as Bastiat once remarked) should be able to recognize the quality of this article. But people are generally very confused when it comes to trade, exchange rates and monetary pumping and how it all hangs together. It is an area that requires one to look beyond a huge pile of bad economics that has been with us since the age of Mercantilism. Let us just say there is neither a theoretical, nor an empirical case of devaluation magically producing prosperity.
Wall Street Urinal counterdicts the IMF statement. Watch
http://www.wsj.com/articles/imf-signals-yuan-wont-be-considered-a-reserve-unit-for-at-least-a-year-1440000935
Hopefully WSJ subscribers aren't reading the paper and pissing on another public works metal pole soon to drop.
Constant money velocity is a bitch to maintain.
Bullet velocity on the other hand...
Print and give it to me. I'll spend it and everything will be good again.
"why writing this paper wont make you any smarter"
you dummfuck
Anyone in the music business. Give this kid a shot. I have no affiliation. Saw him on Iowntheworld (fuck me, oldtimer). Yes, the handle has been changed. Old habits never change. This kid is brillant.
In his latest video he takes on the sound of strings.
Keep up the good work,
Mr. Pinko Says…
Well I've been dikin around with linux distros all weekend.
Trying to completely abscond Windows.
I've learned how to make larger than 4g persistent files on USB sticks.
So you clowns can actually test the distros before you actually place them on your SSD drives.
Preety much flat, and keeping the powder dry. It's boring watching all the last minute[ Fiscal year end] corporate buybacks.
...this massive decline in the growth momentum of money...
Can we please, within my sweet, short time on this mortal coil, dispense with this central bank fiat currency bullshit so we no longer see nonsense like that in print.
Gold is money...JPM. Makes sense to me.
Not really, there's a global energy glut at low prices and steadily falling AUD, even as commodity production is still rising, so buffers the drop in Yuan. I think you'll find the NET result is not much change to industrial inputs. Maybe if the PBOC does direct injections ... to Western bank accounts?
But if your economy is based on 8% annual growth in the sales of cheap disreputable plastic crap, then all else being equal, you are going to run into a bit of trouble sustaining that.
A: Because china's problem is lack of payable demand and as USA consumer goes under water the local chinese consumer should step up but with devaluation of wages it will not be able to
... However, once fizzical gold is revalued the world will de facto again be on a gold standard in that all governmental debt will be covered again by gold. all of the stacking chinese middle class will be indeed very wealthy... That will prove to boost local demand for goods and services by quite a bit. as for the US, well, that will be a different story.
Nope, nope, nope. This is where the thread of thought bursts. "As time goes by, the effects of loose monetary policy filters through a broad spectrum of prices of goods and services and ultimately undermines exporters’ profits. A rise in prices puts an end to the illusory attempt to create economic prosperity out of thin air." Also Misses assumes some fairly theoretical concepts like efficent markets and oversimplifies some others. First of all, when it comes to accumulation of capital during the devaluation profits are skimmed on top by exporters while decreasing the life quality of all others. But this effect is very real within that time window and it does not disappear. In addition through wages the citizens themselves obtain a steady cash flow that they can chose to use as they wish to spend ot invest which can further lead to inovation. However a much more important part is how much money is actualy neccessery for life as all excesses but that can be masked. Let's take USA for example, you get Walmart cheap instead of sturdy made in America. This actively masks inflation which has happened among the lower classes. And maybe the most important part Misses is missing, immigration keeps the cost of wages depressed causing the quoted sentence to lose meaning. The best way to understand that something about this piece of Misses thinking is not correct is Italy and Italy's economic miracle. Either if we are talking about pre Nixon or post Nixon, Italy was able to raise it's economy through a series of devaluations to a European powerhouse. It happened in tandem with Germany, it required massive immigration and stimuluses, but the wealth is there. And it was before debt which occured primarily during Euro. Whenever times got hard in Italy, Italy would devalue currency. This would cause a drop in German imports and growth in exports. It would also cause Italy to actualy produce something. A simple thing as a detergent can be produced by both, but the value can be added by one or the other. Even though Germans add that extra value for less, Italians were able to circumvent that through frequent devaluatuions and still be the European economic powerhouse with 100 000 lira equal to 50 euro.
of course devalutation helps China! China needs to keep its status as the most competitive manufacturer/exporter and keep fullest employement possible. No other choice. Japan will have to follow but they will not succeed or be able to compete.
So the Chinese sold their labor and environment under cost. They depressed labor price for the whole world. Wealthy moved their money abroad before devaluation of yuan. And the poor and middle class were not only underpaid and financially repressed (through interest rates below inflation rate), they also face diminished savings through devaluation now. Great.