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Home Publications Blogs Beat the Press The U.S. Can Unilaterally Lower the Value of the Dollar

The U.S. Can Unilaterally Lower the Value of the Dollar

Saturday, 18 September 2010 22:43

The NYT had a useful piece on the exchange rate between the Chinese yuan and the U.S. dollar, however it ignored the fact that the United States does not have to ask China to raise the value of its currency. The United States could unilaterally set a lower value for the dollar against the yuan.

For example, it could announce that it would exchange dollars at the rate of 5 yuan to a dollar beginning at some date in the future. While it is illegal for Chinese firms and individuals to take large amounts of currency out of the country, it is likely that many would be able to evade the law for this sort of profit.

If the U.S. were to offer this exchange rate, it is likely that it would quickly become the effective exchange rate. More importantly, if the United States made clear to China that it was prepared to go this route, then it is likely that China would negotiate a path toward a lower valued dollar.

Comments (9)Add Comment
written by rayllove, September 19, 2010 6:59
This could be a good tactic for a reason that is not mentioned: If US officials were to say this:"More importantly, if the United States made clear to China that it was prepared to go this route, then it is likely that China would negotiate a path toward a lower valued dollar".

By threatening that the US "was" considering the tactic described... the Chinese might become confused by implication. If the US 'was' prepared to do something in the past that could only be effective in the present or in the future, the Chinese might think that the Americans have eliminated the need for the subjunctive mood. This might lead the Chinese to suspect that the US has developed a time-travel machine. In their confusion about how to contend with such a disadvantage they may become confused about how to react and perhaps they will simply recognize our superiority. This should finally convince them that we know what is best for them.
written by izzatzo, September 19, 2010 7:49
Under the Chinese game theory of Feng Sui, the larger country becomes better off by consuming more of the smaller country's output and less of its own output, while at the same time, the smaller country becomes better off by convincing the larger country that that's really what's happening.
written by jm, September 19, 2010 12:03
Alas, Chinese restrictions on movements of yuan in and out of the country would probably make this impossible to implement at the scale needed to move the exchange rate. The movements would have to be done as electronic bank-to-bank transfers.

It wouldn't be feasible to move that much yuan as banknotes, and if we suppose as a thought experiment that someone were able to do it, the Chinese government would be able to stymie by announcing a conversion to a new paper currency, giving as its justification the fact that a foreign government in league with smugglers had been foully subverting its currency controls, and requiring everyone to exchange all their old notes for new by a certain date. As the US government would be the holder of the banknotes, the only way it would be able to get out of its holdings of the soon-to-be-worthless old banknotes would be to sell them back to Chinese having the daring and ability to smuggle them back into China before the banknote exchange deadline -- but to give the smugglers sufficient incentive to take the risks, the US would have to sell the yuan very cheap, negating its goal for buying them in the first place.

Also, this would make some Chinese arbitrageurs incredible profits, as they would be able to buy seven yuan per dollar from the Chinese government, sell them to the US government for $1.40, take the $1.40 back to China to buy 9.8 yuan, smuggle that back to the US for $1.96, and so on, doubling their money with every round trip.

Since the Chinese in the best position to do something like that would be those very well connected, and the main reason for the Chinese exchange rate peg is to benefit the well-connected, I could imagine segments of the power elite there being very happy to play this game with us for a short while before playing the banknote exchange card.

Let's just go with good old-fashioned tariffs.
written by fuller schmidt, September 19, 2010 12:47
This all just seems like urination in the wind. I can't understand how capitalism can complain if the Chinese want to buy our treasuries. The real issue is crony capitalism using slave-ish labor instead of fairly competing. I'm convinced that (absolutely) pure capitalism would lead to all boats actually being lifted.
written by diesel, September 19, 2010 5:54
Nice going, rayllove, tipping our hand to the Chicoms about our time-travel machine. Rush will have a field day with this.
The US has been devaluing for ten years
written by wellbasically, September 19, 2010 6:42
The trick is that the US has been trying to devalue for 10 years, and the chinese have pegged to the dollar, so they are devaluing right along with us. Nobody could ever come out and say "we want to devalue the dollar", I'm sorry no politician who wants to save his job would do that, because it would mean, "we want to destroy your savings, your negotiated salary and wage level, in the service of some export manufacturing bosses, who will just take the money out of the hides of their workers and turn this country into Guatemala." No politician could say that, so they are trying to get China to engage in monetary deflation to cover their asses.
written by vorpal, September 19, 2010 9:19
Dean, I would like to point out that you are doing exactly what you accuse others of doing: cowing to the conventional wisdom, no matter what the numbers say.

The trade deficit with China is perfectly reasonable given the population and GDP of the country. China is the most populous nation in the world, if we are going to run deficits with the world, then China _should_ have the largest share. Or do you suggest we compare China with Fiji in absolute terms?

The deficit with China is not bad at all when corrected for nation size. In the same way, the per capita trade deficit with Canada is massive. I don't see you whining about the Canadian exchange rate.... because it isn't fashionable.

You are contributing to the "pick on China" movement because it conveniently fits into your world view of how trade deficits are "corrected" (i.e. currency exchange rates), _not_ because the numbers merit your attitude.

On a happier note , maybe you can come up with a strategy to correct the trade deficit that treats all nations equally, rather than only with the bete noir du jour.
written by scott, September 20, 2010 7:46
Or, we can give the banks money at 1/2% and let them buy commodities, driving up inflation for all Americans, while experts such as yourself declare you don't detect any inflation. Of course, you wear blinders you put on your own head, and they decry others for tilting at windmills you can't detect.

Look at gold, oil, cotton, corn, all these are driven up not by supply and demand but by rank speculation and silly policies like corn ethanol. We have contango in our oil markets again, yet, no economist sees this.

Not even you Dr. Baker, who missed the oil bubble, which caused the housing bubble to pop.
actually, no it wouldn't
written by ts, September 20, 2010 2:07
Foreign exchange operations by central banks and actual trade based on foreign exchange are a small minority of the trading. Over 95% of currency trading is done by speculators, either direct speculation, indirect speculation versus other instruments (e.g. the carry), or hedging.

It is never a wise decision to tempt fate by baiting this $1 trillion a day speculating community. Sure, the US could just "decide" to support a 5:1 exchange rate, but if speculators suspected that the U.S. would or could not permanently support this exchange rate, they would pile on the other side of the trade until it failed.

This is why "managing" the exchange rate works better than outright pegs. If the central bank is "creditable", meaning they can balance speculation on either side of the trade at a given exchange rate, they can successfully keep the currency in the desired band.

However, the central bank is also committed to buying or selling whatever amount of assets is necessary to keep the currency in the band. This is how China and Japan amass $1 trillion reserve accounts at the Fed (and also why they're accused of "currency manipulation").

An unrealistic peg would necessitate the Fed sell dollars in increasing amounts, should the speculative community feel this policy was not permanent. As it becomes more troublesome to do so, speculation would actually become worse, and upon the policy being abandoned it will impart a massive shock on the real economy. In Argentina, for example, this was an inflationary shock. In our case it would be a deflationary shock. Not exactly what we need right now.

*This is not to mention that China's central bank would probably fight our unilateral policy as well - perhaps financing the speculation indirectly.

(I agree with you on 95% of stuff - just not this.)

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.