The NYT Never Heard of Floating Exchange Rates

Print
Sunday, 17 April 2011 20:13

The NYT warned readers that inflation in China "poses big threat to global trade." The article is not very coherent, but it seems that the main potential threat to global trade would be that inflation in China could raise the price of its exports, making them less competitive. From the standpoint of the United States, this would mean that we might buy fewer goods from China, replacing them either with good purchased elsewhere or domestically produced goods.

While replacing imported goods with domestically produced goods reduces global trade, it also increases net exports in the United States (net exports are equal to exports minus imports), thereby increasing GDP and creating jobs. It would have been worth pointing this fact out. Most readers would probably consider increased employment and growth to be more important than increased trade.

It would have been worth mentioning that China's problems with inflation could be largely prevented if it just let its currency rise instead of spending trillions of dollars to keep down the yuan against the dollar and other currencies. A higher valued yuan would reduce inflationary pressures through two channels. First it would make imports cheaper, thereby putting downward pressure on the price of a wide range of products.

The other effect that a higher valued dollar would have is that it would slow China's economy by reducing its exports. This is exactly what China's central bank has been attempting to accomplish by raising interest rates and reserve requirements.

The natural tool for combating inflation in an economy with floating exchange rates is a rise in the value of its currency. It would have been appropriate to discuss currency values in the context of this article.

This article also includes the assertion that China had a $4 trillion stimulus package. Most accounts put its stimulus package in the range of $600-$800 billion, less than one fifth this size.