The Bogus Alarmism About “Currency Manipulation”

Politicians need to stop panicking that China’s doing it.

Chinese workers making shoes at a factory
Chinese workers making shoes at a factory in Jinjiang, southeast China’s Fujian province

Photo by STR/AFP/Getty Images.

I asked Slate’s readers what economic pseudo-problem they wanted me to explain, and in overwhelming numbers you said: currency manipulation.

To hear America’s politicians tell it, currency manipulation is a severe and alarming problem—especially when the Chinese do it. Campaigning in 2008, Barack Obama promised to get tough on Chinese currency manipulation. Campaigning in 2012, Mitt Romney promised to get tough on it, too. Toughness, you see, is good. But the truth is that there’s absolutely no need for Americans to worry about Chinese currency policy—or anyone else’s. We just need to mind our own shop appropriately and this alleged crisis will melt away.

The beginning of wisdom here is to try to understand what modern-day currency is. It’s not little circles of valuable metal. It’s not even backed by metal. It’s what we call “fiat money”—worth something because the government says it’s worth something.

Why should anyone care about that? Well, the Canadian government happens to employ various armed individuals. Some are police officers, some are soldiers, and some are prison guards. These folks will throw residents of Canada or those who operate business there in jail unless they pay their taxes. And they expect those taxes to be paid in Canadian dollars. Conveniently, this very same Canadian government issues Canadian dollars to its employees, to beneficiaries of pension schemes, to doctors who treat Canadian patients, and to others to whom it owes favors. People everywhere need to use some medium of exchange (prisoners traditionally used cigarettes, but smoking bans have led to a surge in the use of canned mackerel for this purpose) and since Canadian dollars are both in circulation and occasionally in demand, it’s convenient for Canadians to use them.

Of course if you’re not in Canada this isn’t particularly convenient. In the far-northern U.S. you can find some stores that will accept payment in Canadian dollars, but ordinarily to do business in America you need American currency.

So the world has a bunch of currencies, all created by governments. And since the currencies are created by governments, their value is subject to influence from public policy. But what does the value of a currency even mean?

There are two ways of thinking about it. One is in terms of the exchange rate and the other is in terms of the domestic price level. The exchange rate is a simple concept. How many American dollars do you need to fork over to a bank if you want 100 euros? But the domestic price level is more important. It would be naive to look at the fact that $1 will buy you about 80 yen and conclude that a visit to Japan would be very cheap. It turns out that purchasing Japanese goods and services requires a lot of yen. Whether a place is cheap or expensive depends on prices and not just exchange rates.

When central banks conduct monetary policy to control inflation, they’re thinking about the domestic price level. Most central banks want to keep prices on a path of slow but steady increases. In the United States we aim for a bit less than 2 percent inflation a year. This is “currency manipulation”—an effort to control what dollars are worth—but nobody thinks it’s pernicious and nobody calls it that. They just call it “monetary policy.”

But governments also can influence the price of their currency relative to other currencies. When American stores stock up on Chinese-made goods, they need to buy Chinese currency in order to buy the goods. That should push up the price of the renminbi relative to the dollar and make Chinese goods more expensive for Americans to purchase. The allegation of “currency manipulation” is that the Chinese government turns around and buys American government bonds in order to prevent Chinese money from getting more expensive. This, we’re supposed to worry, costs American jobs, because it theoretically keeps Chinese goods underpriced relative to American-made goods.

If you think about that for a minute, however, you’ll see that this is a non-problem. China is subsidizing its manufacturing exporters by giving the American government a very cheap loan. The sensible response would be to say, “thank you” to Beijing, not to complain. And then the government should take that cheap Chinese loan and spend to boost domestic employment—in other words increase the budget deficit. If you’re someone who thinks there are lots of useful public projects we could be undertaking, then use the Chinese windfall to build them. If you’re skeptical about big government, then use the windfall to hold a big payroll tax holiday. Either way, seize the day. The only reason concern about currency manipulation started getting traction in serious circles in the United States was despair about the prospects of Congress enacting any sensible fiscal stimulus measures. But if you want to worry about something, worry about the fact that our legislature is so dysfunctional it can’t even handle receiving a massive subsidy correctly.

But the really calming news is that in the medium-term this doesn’t matter at all. When the Chinese government tries to keep Chinese currency cheap, that keeps the RMB-denominated price of internationally traded goods high, meaning it’s expensive to buy foreign goods in China. Then Chinese workers demand higher wages. The result is inflation. Unless, that is, the central bank steps in to slow inflation by increasing the value of the currency. The exchange rate and the domestic price level are two sides of the same coin. Domestic prices don’t adjust immediately to exchange rate shifts, so exchange rates can matter. But ultimately “currency manipulation” and monetary policy are the same thing. And that’s exactly what happened in China. Trying to keep the exchange rate low led to high inflation, so in inflation-adjusted terms, the exchange rate was rising anyway. That’s probably why China has basically given up on “manipulation” and decided that stabilizing domestic inflation is the most important priority.

The moral of the story is that everyone needs to calm down and mind their own business. Countries that feel they’re victims of “manipulation” are probably just in need of a temporary tax cut to take advantage of the good fortune of getting the gift of cheap loans from foreigners. Countries that engage in manipulation will swiftly feel the bite of inflation. Cross-border hectoring doesn’t offer much of a solution to anything and just tends to distract people from domestic solutions to domestic problems. The next time you hear a politician complaining about Chinese currency manipulation, ask him why not extend the payroll tax holiday instead of whining about foreigners?