Exchange rates dominated the agenda at the IMF's annual meeting recently. Officials blamed exchange rate imbalances on everything from China's undervaluation of the Yuan to unilateral currency intervention by Japan. Currencies will likely dominate the agenda again when G-20 leaders meet in November.
But the key question has been ignored by policy makers: Why should Americans be upset if the Chinese government keeps the Yuan undervalued?
The standard explanation is that China's cost advantage, the product of government policy, is artificial. And that is true. Indeed, Chinese citizens should resent this wasteful abuse of their resources. But America benefits from the policy errors of Beijing: this policy is effectively a Chinese subsidy given to American consumers.
This manipulation of the currency by China is in our benefit, because a weak Yuan makes Chinese goods cheaper for American consumers, making us wealthier and China poorer. Conversely, a weak Dollar enables others to buy our goods and services at low prices, subsidized by American taxpayers.
By buying clothing from China, to use one example, American labor and capital are freed to be employed in other, more productive fields. If we prevent this Chinese subsidy being gifted to us and reject cheap Chinese goods, American consumers will pay higher prices. There may be more jobs here, but we will all be poorer.
If a weak currency is somehow advantageous, we could devalue the dollar by 50% and immediately become so much more competitive. Ofcourse we will also be giving away valuable goods and services for less than what they are worth.
Letting free markets set the exchange rate is the best policy for both countries. But in its absence, a strong dollar is in the best interests of the United States, even if the Chinese fail to grasp this. Artificially stimulating the country's exports by devaluing the dollar is not a good way to achieve prosperity or create jobs.
Moreover, the purpose of trade is to serve consumers, not create jobs. The ultimate goal is the productive use of equipment, not the manufacturing of that equipment. So what if the Chinese are taking over manufacturing? Specializing in the production of other goods and services in which we are more efficient than the Chinese, we Americans will be much better off.
As Professor Donald Boudreaux from George Mason University Economics department notes, devaluation creates more trade, but not better trade. It doesn't matter how many dollars exchange hands, but what they buy, because voluntary exchange is not sum-zero. It is positive for both sides, and this concept, although not always intuitive, is crucial to understanding economics.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at email@example.com.