How is China's decision to lock its currency affecting American
commodity prices and jobs?  Do you think it's possible or viable to
China to make its exchangen rate free floating?

Dear georgemiron:

China's fixed exchange rate versus the United States dollar keeps its
exports extremely competitive in United States markets, even with the
decline in the trade value of the dollar.  To the extent that
importing Chinese goods is cheaper than manufacturing them here,
American jobs are adversely affected.

China's rapid growth has increased its demand for many commodities
also used in United States.  This has increased the price that
Americans have to pay for those commodities.  However, American
producers of commodities in high demand have benefited.

As China's economy matures, a floating exchange-rate appears to be a
likely eventual outcome, although probably not in the near future. 
The United States is placing considerable pressure on China to at
least loosen its currency restrictions, which should result in at
least a modest revaluation of China's currency in the next year or
two.  China's poorly developed financial system and dependence upon
exports for growth to absorb the millions of people leaving
agriculture and inefficient state-owned enterprises naturally makes
the government leery of doing anything drastic that would slow the
economy.  However, the present situation may create excessive foreign
investment in China, which could cause undesirable inflation.

Sincerely,

Wonko

Source material:

"Despite all the hubbub over the China-driven rise in commodity prices..."

"U.S.: Speed Bumps On The Road To More Jobs" By James C. Cooper &
Kathleen Madigan, Business Week, April 5, 2004
http://www.businessweek.com/@@9rHKnWcQ5DthDg0A/premium/content/04_14/b3877036_mz010.htm?from=presignon

"Because the yuan is now pegged to the greenback, investors from Japan
and Europe find Chinese assets more attractive as the dollar falls
against the yen and euro. A weak U.S. currency also makes Chinese
goods more competitive in Europe and Japan, which boosts exports,
corporate earnings, and thus the returns on Chinese investments."

"Chinese Commerce Ministry officials say that if the dollar doesn't
fall, investment into China could still rise by 30% this year. Such a
large inflow of funds would add stress to China's shaky financial
system and raise fears of economic overheating."

"Government officials are committing themselves to making the yuan's
exchange rate more flexible, possibly this year. A revaluation would
effectively cause the yuan to strengthen against the dollar,
automatically lifting the value of Chinese assets already held by
overseas investors."

"Economic Trends" Edited by James Mehring, Business Week, March 15, 2004

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Request for Answer Clarification by georgemiron-ga on 09 Apr 2004 16:00 PDT

Thank you for your prompt answer - but I must ask you this:
According to He Yafei (Foreign Ministry dictor-general of the
Department of North American and Oceanian Affairs), " The Sino-US
trade volume accounts for less than one percent of the US GDP (gross
domestic product), which is too low to influencethe US economy."

What do you think?

---

Clarification of Answer by wonko-ga on 09 Apr 2004 16:23 PDT

I strongly disagree.  China's growth is strongly influencing many
industries in United States and commodity prices worldwide.  Consider
the following examples of pianos and steel, coal, and copper.

Sincerely,

Wonko

"China's rise in the instrument business, as in many others, is
pushing prices down. It's now possible to find a decent piano, for
instance, for less than $2,000 in the U.S. It's no Steinway, but it'll
get your 8-year-old through her Suzuki exercises. "Because of China,
our average retail price in 2003 was 10% lower than in 2002," says
Richard Ash, chief executive of Sam Ash Music Corp., a retailer with
41 outlets in 13 U.S. states. Today, he says, more than a third of the
products he sells come from China. "Anyone who's not there can't
compete," Ash says."

"How China Is Hitting All The Right Notes" By David Rocks in
Guangzhou, China, with Moon Ihlwan in Seoul
Business Week April 12, 2004
http://www.businessweek.com/@@Ue9TwmcQ7DthDg0A/premium/content/04_15/b3878068.htm?se=1

"Manufacturers of all sizes are facing unprecedented price rises on
steel, coal, copper, and a host of other materials. But small- and
mid-sized suppliers are suffering the worst; most are holding the line
only by squeezing out productivity gains where possible.

The reasons are many: In some cases, consolidation has cut supplies,
as in the steel and aluminum sectors. At the same time, the weak
dollar and high energy prices are forcing manufacturers to shell out
more to import and process raw materials. Meanwhile, competition for
industrial resources is rising, particularly because of China.
Industry veterans are used to the ups and down of commodity prices,
but many think this time is different. Says Karlis Kirsis, managing
partner of World Steel Dynamics Inc.: "The days of cheap raw materials
are gone."

Indeed, after decades of falling commodities prices, demand from China
seems to be changing the rules of the game. R. Wayne Atwell, a metals
analyst at Morgan Stanley, compares China's industrialization with the
long post-World War II economic boom, when the U.S., Japan, and Europe
were all being built anew. China is about to hit $1,000 in gross
domestic product per capita, a level when countries start making
massive metal-intensive investments in roads, rail, and buildings, he
adds. Meanwhile, demand from India is following a similar path, just
as industrial output in the U.S., Europe, Japan, and Russia is picking
up.

GROWING APPETITE. Consider the effects of this growing appetite on
steel and its constituents. Prices for hot-rolled steel coils -- huge
multi-ton spools of metal that are processed into more useful forms --
have soared by 79% in the past year. Because it's easier to reprocess
old steel than to make it from scratch, steel scrap torn from old car
bodies and other waste sources, has doubled in price to nearly $300
per ton. Nickel and tin have risen 75% and 41%, respectively. Indeed,
of the nearly 40-plus industrial commodities tracked by the Institute
for Supply Management, just one -- caustic soda -- fell in price in
last month."

"Suppliers In A Squeeze" By David Welch in Detroit and Adam Aston in
New York Business Week, April 19, 2004
http://www.businessweek.com/@@yHR76mcQ6zthDg0A/premium/content/04_16/b3879153.htm?se=1

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Request for Answer Clarification by georgemiron-ga on 09 Apr 2004 16:32 PDT

I'm glad you disagree with him - I hope I'm not pushing my boundaries
here with the multiple follow-ups, but do you agree with Bush's
statement that China's currency value is not a reflection of supply
and demand, and the U.S. expects free trade, which is not the case
here?  Sorry my wording is a little off, but I think you understand
what I mean.

Thank you again

---

Clarification of Answer by wonko-ga on 09 Apr 2004 16:50 PDT

Dear georgemiron:

Given your list price of only five dollars, I feel we are drifting
excessively far from your original question.  I would be happy to
answer your follow-up question, and any similar questions relating to
economics, provided that you post them as new questions to my
attention.

Sincerely,

Wonko

I must severly disagree with some of Wonko's arguments:

"To the extent that importing Chinese goods is cheaper than
manufacturing them here, American jobs are adversely affected."

The simple law of comparative advantage (see here
(http://www.wto.org/english/res_e/reser_e/cadv_e.htm) or here
(http://en.wikipedia.org/wiki/Comparative_advantage)) shows importing
goods freely at lower costs benefits incomes of both countries.  A
practical (and relevent from a US perspectve) example would be
importing steel from China is cheaper than producing it in the US, so
US companies and consumers benefit from lower prices of goods and can
go on to consumer more goods/services and US workers are freed up to
produce these rather than lower value goods.

China is has an exchange rate fixed to the US dollar, however it is
impossible to fix both the exchange rate and the interest rate.  China
has a massive investment boom - although inflation is positive it is
solely caused by food prices (ineffciency of supply but a demand side
pressure), all other components of inflation are negative symbolic of
massive overinvestment and a cause of future deflation and hardship
for the economy.  To prevent long term deflation China has to take the
short term measure of restricting capital growth - increasing the
interest rate (the cost of capital) is a way to do this but is
impossible without breaking the identity interest rate differentials
and exchange rates possess.  So far the effort has been to squeeze the
monetary transfer mechanism by placing minimum deposit-lending ratio
requirements, but these have little effect when the country is flush
with deposits the average Chinese owns more US dollars than the
average American because the average American is in debt to China via
mortgages and the government).  China financing the US in this way has
the effect of deflating the dollar relative to commodity prices as
much as raising commodity prices - if the prices of commodities were
looked a in Yen or Euros, they have increased little.  Much of the
recent increase in commodity prices (Q1 04) has been caused by
speculation (nothing like jumping on the bandwagon) and making the
most of investment in China before tax laws changed towards the end of
Q1.

In summary, American commodity prices have been a funcion of the value
of the currency which has been driven my China's financing of the US
deficit.  Comparative advantage clearly demonstrates the benefit to
jobs (the point of a job is for income, so each job provides more
goods).  Short term effects of jobs can be negative - the best
discussion of this is in Fujita/Krugman/Venables 'The Spatial Economy'
chapters 3 and 4 - in short, a depression of receipts with a high
proportion of overseas income flow in a local area can have a decisive
multiplier effect, in a negative way for the town that has their
income source depleted, but in a positive way for everyone else (lower
general costs), in particular port cities (more ships, higher
prices-for-docking, more receipts, more income, simple).

Give and take, that's the essence of economics - all circular
arguments.  I hope this broadens your perspective on China's financing
of US consumption over the past 3 years.