Exposing Myths About China and the Yuan

"Money is nothing but a medium of exchange..." - Ludwig Von Mises, The Theory of Money and Credit, p. 31

By John Tamny

President Obama's arrival in China has predictably generated all manner of commentary about the economic relationship between it and the United States. Not surprisingly, the majority of the commentary has been economically untrue, misguided, or both.

First up is the notion that China artificially keeps the value of the yuan lower than it would naturally be. What this commentary misses is that currencies aren't commodities, rather they are concepts. Nothing else.

In that sense, China is one of many countries that pegs its currency to the dollar in order achieve for it a measure of credibility due to the dollar being the world's currency. Much as trade among the fifty states in the U.S. is made more frequent thanks to there being a common currency, the yuan's stable relationship with the dollar is what has fostered a great deal of trade between individuals in the U.S. and China. Trade is the reason we produce, and currency stability facilitates trade.

Many commentators seek an absence of policy whereby the yuan and dollar would float against each other as "fundamentals" warrent, but as Von Mises so clearly saw, floating currencies "complicate the technique of exchange" given the basic truth that uncertain currency values make it more difficult for producers to confidently use money in order to transact. Money is merely a medium of exchange, and the less uncertainty we have, the better off all parties to trade are.

Looking at the yuan, it's "settled logic" among the commentariat that currencies must reflect an economy's fundamentals, but not only is this untrue, it perverts the reason for currencies altogether. Indeed, when individuals trade, they're not trading money, instead they're using money in order to measure the value of goods so that goods can be exchanged. That is why currencies are meant to be stable value concepts, rather than floating paper values lacking any definition.

As to the absurd suggestion that currencies are supposed to reflect economic fundamentals, this might surprise those who watched Japan's yen triple in value versus gold during its near two decade recession. This might also surprise Americans who witnessed a much more vibrant U.S. economy vis-à-vis England's in the aftermath of World War II; all this occurring despite the pound being stronger than the dollar. It would be more realistic to say that excessive currency strength or weakness is an economic retardant, as opposed to the result of economic strength or weakness.

Currencies once again aren't supposed to move in value, because when they do the changes in value distort the money prices of all investments and transactions. The whole point of the Bretton Woods gold standard wasn't for currencies to float, but for them to be tied to the dollar so that peaceful trade could reliably occur among individuals around the world. Stable currencies not only enhance wealth-enhancing trade, but they free up those engaged in mere economic facilitation (think currency traders, hedge funds) to actually produce economic goods thanks to floating money values no longer being an economic variable.

Lastly, implicit in the jawboning of China for its yuan policy is the assumption that somehow its citizens don't suffer from the same currency weakness that now weighs down the U.S. economy. More realistically, inflation is death by a thousand cuts anywhere it exists, which means the unseen is how much China's economy would be growing if U.S. monetary policy weren't transferring an to inflation it. China is not aided by our inflationary policies as evidenced by its need to import all sorts of goods to create finished products, so it's naïve for anyone to assume that China is enjoying the decline of its currency thanks to our irresponsible Treasury.

Next up is the myth offered up by the Daily Telegraph's Ambrose Evans-Pritchard (among others) which suggests that with its artificially cheap currency, China is exporting deflation. Comments like this merely prove that many who write on economics don't have a clue what deflation is.

Indeed, by virtue of the yuan being in freefall thanks to its dollar definition, the cost of imports necessary to manufacture goods in China must be rising. This means inflation is stealing any alleged benefits that might result from a cheap currency.

Secondly, the import of cheap Chinese goods is in no way deflationary. That is so because if cheap Chinese shoes allow individuals to spend $50 on loafers when they used to spend $100, that merely gives them $50 of new demand for a wider range of goods, thus driving up the costs of other goods previously demanded less. The broad price level by definition cannot be changed by imports; instead it can only move up or down based on changes in the value of money. In that case, all signs point to inflation worldwide, the U.S. Treasury the main miscreant in this regard.

The third impoverishing myth possessing many adherents is the one that says China is pursuing an "export strategy." If we ignore the certain truth that countries don't trade, to suggest a country is pursuing an export strategy is as idiotic as the suggestion that a country could pursue an "import strategy."  Good luck importing unless you're exporting. 

What's forgotten is that exports and imports are but two sides of the same coin, and unless the supposed "experts" in our midst believe that Chinese producers are exporting in order to remain impoverished, there's no such thing as an export strategy. In truth, the dollars taken in by Chinese producers are either used to buy U.S. products, equities, land and debt, or they're traded to others with designs on what we have in the United States. Individuals export so that they can import, which means that to the extent U.S. citizens are complimented by a great deal of imports, that means they're also exporting something of value in order to have the means to buy imports.

Von Mises once observed that "Economic history is the story of the gradual extension of the economic community beyond its original limits of the single household to embrace the nation and then the world." That's exactly what's happening right now, and stable currency relationships are bringing the producers of the world closer and closer on a daily basis.

So rather than nonsensical commentary that perverts the purpose of currencies, we should embrace any measures taken that enable more, not less in the way of cross-border trade. In that sense, we should hope that more countries follow China's responsible lead in pegging the yuan to the dollar, all the while hoping that monetary authorities in the U.S. wake up to the economy retarding inflation they're foisting on the world, which threatens the wonderful process whereby individuals the world over are becoming more, rather than less economically interconnected.