Currency Manipulation, continued

I still haven’t bothered to solve my currency manipulation model, but I’m pretty confident in what it would show: in a world without market failure, attacking your own currency hurts your own country more than it helps your trading partners. And there was never any question that the manipulating country is the loser, and the trading partner is the winner. But when we look at the US and China, it’s quite clear that most of the support for currency manipulation is coming from the “loser”, China, while most of the opposition is coming from the “winner”, the US. Why?

Part of the answer is undoubtedly political. On both sides of the Pacific, there are both winners and losers within the population, and it happens that both the Chinese winners and the American losers are very important politically. For anyone who remembers the 2004 Presidential election (or anyone who studied the state-by-state results of the previous 10 Presidential elections), I can make this point about the US in just one word: Ohio. Although I know less about Chinese politics, I get the impression that marginal workers in the manufacturing sector are thought to be a potentially dangerous group.

But I really don’t think that’s the whole story. The fact is, we don’t live in a world without market failure. Human irrationality, sticky prices and wages, time to build, path-dependence, monopoly and monopsony power, pre-existing government distortions, externalities, missing markets, not to mention all the examples of market failure that I’ve forgotten – these things are not only present but, in my opinion, potentially important in understanding the US economic relationship with China. Moreover, the distribution issue discussed in the last paragraph is not just a political one: the US population, in aggregate, may benefit from China’s currency manipulation, but that doesn’t mean that the typical American benefits; if the benefit is sufficiently concentrated within the population, then the typical American can end up making a sacrifice for the benefit of the average American. (If you take a look at recent income distribution statistics, you may notice that the average American has been doing very well over the past few years, but the typical American – that is, the median American – has been losing ground.)

Trying to blog about the Yuan issue, I feel like Hercules battling the hydra. Every time I try to simplify the issue, it grows two more heads. I’ll have to deal with the latest heads in future posts.



Update: Another point regarding the “average American”: What conclusion you reach may depend on what quantity you are averaging. If you take average income, then, in the absence of market failure, the weak yuan policy clearly helps the US. But if the benefits go disproportionately to the rich while the costs fall disproportionately on the poor, then average welfare might be reduced. Because of diminishing marginal utility, a given amount of additional income is worth more to the poor than to the rich.