Yuan Hits All-Time High; So Too Does U.S. Trade Deficit with China

http://www.reuters.com/article/2011/12/26/us-markets-china-yuan-idUSTRE7BP03220111226

The above-linked Reuters article reports on a 4% increase in the value of the yuan in 2011, now at a record high.  Why is this significant?  Because economists say that a stronger currency makes exports more expensive and imports cheaper, thus leading to a reduction in the U.S. trade deficit with China.  In fact, the article suggests that China is letting the yuan appreciate to accomplish exactly that – a “rebalancing of trade”:

The currency is likely to continue to appreciate next year as China continues to post big trade surpluses despite a slowdown in exports and amid pressure from the United States to let the yuan rise to balance bilateral trade, traders said.

… The yuan has appreciated 4.27 percent so far this year, with most of the gain being recorded in the first 10 months of the year as China tries to rebalance trade and use the currency to help fight high inflation.

Isn’t that nice of the Chinese?  They’re such good citizens of the global community, with nothing but the common good at heart.  That’s what makes the next sentence in the report so amusing:

While the government has recently halted yuan appreciation amid slowing exports, it also seems to be wary of a weaker yuan that may lead to capital outflows.

They’ve halted yuan appreciation because of slowing exports?  Wasn’t that the whole idea – to rebalance trade – which can only happen when exports slow and imports increase?  Maybe China isn’t so interested in rebalancing trade after all.  Maybe they’re just looking out for themselves.

The fact is that none of this matters.  In the same year that the yuan has appreciated by over 4% to a record high against the dollar – and has now appreciated 23% since 2005 – the U.S. trade deficit with China is on track for another record in 2011.  The following chart tracks the decline in the value of the dollar vs. the yuan against the U.S. trade deficit with China, both overall and for manufactured goods. 

$US-Yuan Rate vs Balance of Trade

(Note that the 2011 trade deficit is annualized based on data through October, the latest month for which data has been released.  Data for manufactured products isn’t yet available for 2011, since I haven’t yet gone through the tedious process of sorting it out.) 

The most logical conclusion that one can draw from the data is that the exchange rate has followed the trade deficit, with the dollar declining as the trade imbalance has worsened.

The least logical conclusion is that the falling dollar will reverse the trade imbalance.  That conclusion is defied by the data.  Last year I presented the results of a study of changes in exchange rates vs. change in the balance of trade with the U.S. for sixteen of America’s largest trading partners.  There was no correlation.  A change in exchange rate was as likely to have the opposite effect on balance of trade as it was to have economists’ predicted effect. 

Again, there is no correlation.  Never has been.  Never will be.  How can this be?  How can economists lob this theory out there and get it so wrong?  Because, they would likely respond, there’s no need to spend valuable time doing the donkey-work of gathering data to prove theories that are self-evident and intuitively obvious.  Economists have much better things to do, like constructing sophisticated mathematical growth models, writing paid-for reports and analyses that support political and corporate stances, and so on.  Nevertheless, the data proves them wrong. 

The data also proves that a disparity in population density is a very reliable predictor of balance of trade.  Once you understand that, the debunking of the exchange rate theory isn’t so surprising.  A change in exchange rate can easily be negated by cost-cutting and improvements in efficiency by the nation with the trade surplus.  But it’s impossible to negate the effects of population density without actually resorting to tariffs.

Still, economic ignorance prevails and our politicians follow the lead of their economists, pinning their hopes on exchange rate tinkering to rebalance global trade.  We’re still waiting for the predicted effects.  It hasn’t happened in six years with China, and we’re still waiting for it to happen with other nations, like Japan and Germany, after six decades.  Thirty-six consecutive years of trade deficits that are only getting worse.  Nice call, economists.

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