Browsing the blog archives for September, 2015.

Economics & China

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I just returned from a trip to China. While there I spoke with students considering coming to the US to study, one of which asked me a great question: The economic systems of the US and China are different, so if I study economics in the US will what I learn be useful when I return to China?

I gave her a truthful answer: Economic principles are universal, economies are global, and there are similarities and differences between the US and Chinese economies. What you learn in the US would be very useful when you return to China.

But a complete answer is much more complex. Yes, there are economic differences between the two nations, but they aren’t as great as some think. Granted, the US and Chinese economies are officially “capitalist” and “communist,” the US has two centuries of economic growth China cannot match, and the US dollar—unlike the RMB—is openly traded and respected on world markets. These differences aside, the similarities are growing.

Both nations manipulate their currencies. The literal and figurative printing presses in Congress and the Fed have been expanding and inflating the money supply in the US. Central planners in China do pretty much the same, pegging the value of the RMB in part to the market value of the US dollar.

Politicians in both nations routinely call for economic growth while beating down the source of that growth, the private sector. The US and China are moving in different directions, but toward the same middle ground. The Chinese government just introduced a “reform package” for its state-owned enterprises (SOEs) that allows them to make more of their own decisions and offer better compensation packages to top executives, most of whom have left the SOEs for private firms. However, the government will retain tight control over capital and key strategic decisions will always be vetted by government officials.

Meanwhile, Washington has ramped up regulations for virtually every sector in the economy. From Obamacare to Dodd-Frank to “anti-trust” persecution of successful companies to calls for a national $15 minimum wage, the US government is implementing ever-expansive controls on US industry. Like Beijing, Washington attempts to find the “balance” between economic freedom that produces growth and jobs, and state control that legitimizes the political claim that business cannot be trusted. In this respect, both nations are off course. Of course, there’s no thing as a balance between liberty and statism. The US is moving in the wrong direction, away from a successful free enterprise tradition. The Chinese are moving in the right direction, but still want the control. Both the US and China could use a heavy does of Hayek.

There is one key distinction between the US and China—political freedom. Reform in China depends on the wisdom of the current socialist regime, but citizens in the US have the opportunity to replace its socialist political leadership by means of the voting booth. Statism is well grounded in the US; our government schools, a bloated social security system, and massive deficit spending connected to an entitlement mentality won’t change overnight, even with the right leadership. But we have the power to recall our representatives and begin moving in the right direction. Many of the candidates in the Republican presidential primary offer potential for doing just that.

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Is Trump Correct on China?

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Donald Trump is talking a lot about China. His central claim is that that the Chinese government continues to manipulate the value of its currency, keeping it low and enabling Chinese companies to export their products at lower costs than competitors in the US or other parts of the world. Is he correct?

When Trump made this claim as a presidential candidate several months ago, “fact checkers” rebuked him, citing economic reports that the Chinese currency (RMB) is now fairly valued relative to the US dollar. But the Chinese government pegs the value of the RMB in great part to that of the US dollar and reserves the right to inflate or deflate this value on a daily basis. If—as these economists claim—it is obvious that the RMB is not undervalued, and if the Chinese government is really committed to a market-based exchange rate, it would simply allow the value of the currency to float with the market. It’s like someone from the US Postal Service claiming that the private sector couldn’t deliver a letter for less than 49 cents. If so, then why maintain laws prohibiting the private sector from giving it a try?

There’s an interesting irony here. If the Trump critics were correct at the time when they claimed that the RMB was valued accurately, then the currency is now undervalued due to two significant devaluations made by the government during the Chinese market meltdown last week. I believe the Chinese currency is still undervalued but I am guessing. The truth is that we can’t know for sure without letting the market decide. The beauty of a market system is that prices will set automatically and will accurately reflect market value. An exchange rate is nothing more than a price for a currency. This debate would resolve itself if the Chinese government allows the RMB to trade freely on global markets.

So when it comes to currency valuation, Donald Trump is entirely correct. But he also refers to a need to “decouple” economically from the Chinese. Here I believe he is right again, but only to a point.

History, economics, and market logic tell us that free global trade benefits all partners. Artificially reducing trade between the US and China would have economic costs. If this is what Trump means by decoupling, then he’s incorrect.

But it is clear, however, that the US has mismanaged both its own economy and the US-Sino relationship. The Fed’s overbearing influence on interest rates and financial markets makes it difficult for US negotiators to argue with straight face that the Chinese government should leave its markets alone. US government subsidies also pick winners and losers, and our massive debt has given the Chinese an opportunity to invest heavily in the US dollar. US negotiators should have been clear about the currency manipulation issue years ago, but they bought the argument that a weak RMB was necessary and appropriate for Chinese development. In this respect, the relationship with China is skewed. We need to clean up our own house fiscally and then—from a position of strength—insist that the Chinese do likewise. To the extent that Trump is suggesting this type of reboot, he is correct.

For the record, I am not endorsing Donald Trump or any candidate for President at this point. Many of you know that I like Rand Paul a lot, but he has struggled to package his ideas effectively. Trump has clearly changed the rules of the game and I’m glad that he is running, however. His candor is a breath of fresh air, but there’s still a long way to go.

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