07 October 2010

Currency wars

I hear a lot on the radio and in the news lately about the U.S. and other central banks' grumbling about China's refusal to let its currency rise. I have (what I think is) a pretty good understanding of inflation and deflation and how central banks' policies affect their currency, but I had never really put much thought into why China refusing to let their currency rise was a bad thing. This morning NPR did a story about possible coming currency wars, and finally spoon fed me the information that I was too lazy or apathetic to discover for myself.

The U.S. Federal Reserve wants to inflate the dollar, or in the parlance of the previous paragraph, make it fall. Make sure you really take that in; the Fed wants to devalue the dollar. It wants to do that because when the dollar is weak, then U.S. exports become cheaper overseas. This is because foreign currency, in relation to the dollar, rises. Therefore, that foreign currency can buy more of a given U.S. good than it could have previously. The thinking over at the Fed is that if our exports rise, then businesses will begin producing more which will require them to hire more which will eventually start the economy growing again.

The reason the U.S. is upset at China is that it is doing the exact same thing. By refusing to let its currency rise, China is making its exports cheap for foreign buyers. So, the U.S. is mad at China for doing the very thing that it is trying to do.

This is yet another case of "its okay when we do it but not when they do it", but it's so much worse than that. There's no guarantee that China will play along. There is no guarantee that the Fed will inflate the currency just enough to "goose" the economy but no so much that it creates hyperinflation. There's no guarantee that the Fed will "revalue" the dollar if the economy starts moving again; in fact, it's more likely that that value will be forever lost. Even more basic that that, does it concern anyone that twelve people at the Federal Reserve can take money out of everyone's pockets in the U.S. whenever they want by devaluing the dollar?


  1. No, the reason they want China to allow the yuan to rise to it's *natural* level is because of the trade deficit. The dollar is always going to be weaker than a lot of other currencies, so it's not just about job creation here, despite any politician's attempts to focus on that.
    As long as China keeps the yuan unnaturally deflated, imports will greatly outpace exports and the trade deficit will continue to skyrocket. In addition, China holds quite a bit of our debt, and to raise the value of the dollar against a certain currency would be to actually owe our lenders more (specifically China), which the government certainly does not want to do.

  2. @Jenn: You'll have to explain to me why a trade imbalance is a bad thing.


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