Big Mac Index And The Furor Over China's Yuan

Here is an update of the Economist's Big Mac Index which shows how McDonald's Big Mac are priced around the world.

In other words, the relative purchasing power of a currency measured in terms of Big Mac prices.
According to the Economist, (bold highlights mine)

``RECENT renewed American calls for China to revalue its currency have so far fallen on deaf ears. China has rejected accusations that America's huge trade deficit with it is caused largely by an artificially weak yuan, which has been pegged to the dollar since July 2008. Economists point out that a depreciation of the yen did little to help reduce America's trade deficit with Japan in the 1980s. But the yuan is unquestionably undervalued. Our Big Mac index, based on the theory of purchasing-power parity, in which exchange rates should equalise the price of a basket of goods across countries, suggests that the yuan is 49% below its fair-value benchmark with the dollar. "

While it may be true that the Chinese yuan may be "artificially weak", it is inaccurate to entirely blame the yuan for the America's deficits.

Chart from Google

As you can see, US trade deficit is largely a world phenomenon, except that China takes up most of the load (see below)

From US Census Bureau

In addition, outside of the oil exporters and China, the US has substantial deficits with Canada, Ireland and Japan even when the currencies of the 'developing economy' group are mostly "dearer" [or 'at par' with the US as with Japan].

Several additional observations:

-It is a fallacy to assume that weak currencies automatically extrapolate to strong exports or increased jobs.

As the Economist rightly points out, the strength of the Japanese Yen over the past decades didn't automatically transform Japan into a "consuming" class. To this day Japan is known as an "exporter".

-All furor over the Yuan, ignores the role played by the US dollar as the world's de facto currency reserve.

In short, the US has to produce dollars, required not only at home, but to fund global transactions and thus contributing to deficits. [see the Triffin Dilemma as previously discussed in The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency]

-If the Chinese have indeed been subsidizing their export sector, it does so to keep Americans buying their product.

In a subsidy one group is favored over another, which means redistribution of resources from other sectors to the favored sector.

chart from Google

China's exports account for 35% of the GDP, alternatively this means the rest of her economy is shouldering the burden of the subsidies.

In addition, if China is subsidizing her exports then it also means that by keeping the yuan "artificially cheap", her subsidies extend to the American consumers. So how bad can it be for Americans?

And such dynamic is seemingly being reflected on the growing clout of US discount behemoth Walmart to influence the production methods of her Chinese suppliers,

This from the Washington Post,

``Wal-Mart has more than 10,000 suppliers in China. In addition, about a million farmers supply produce to the company's 281 stores in China. If Wal-Mart were a sovereign nation, it would be China's fifth- or sixth-largest export market. So the company hopes that small measures taken by all suppliers start to add up. Its 200 biggest suppliers in China have already trimmed 5 percent of their energy use.

``In the past, environmental concerns have taken a back seat to growth in China and to costs for Wal-Mart. And China and Wal-Mart have come under sharp criticism for conditions in factories. Yet pollution now threatens China's growth; as a result, awareness of climate change and energy security has spread in China. Likewise, as consumers grow more environmentally aware, Wal-Mart's executives have responded. On Thursday, the company pledged to reduce its greenhouse gas emissions by 2015."

In short, politicos when caviling over currencies are looking only looking at superficial and not on structural issues.

-The problem of US joblessness isn't an issue of China stealing jobs but instead of domestic bubble policies as earlier explained in Why Americans Are Jobless

-Lastly, it is simply foolish and highly pretentious to believe that foreign policies based on antagonism or belligerency will alleviate US economic woes.

Even if we assume that China yields to Americans, as shown above, this won't solve their problems. So failure to do so would only prompt blood lusting politicians to ask for more interventionism that may lead not only to a trade war but to a risks of military confrontation.

Importantly, it would seem that egotism has overwhelmed rationality such that by threats to slap protectionism aggravates and not helps the US predicament. Remember the Smoot-Hawley Tariff Act?

It is such hypocrisy for these dunces to proclaim that they are working for the common good when they are, in fact, agitating for a great depression.

As the UNCTAD recently wrote, (all bold highlights mine)

``Amidst continued financial crisis, the question of the global trade imbalances is back high on the international agenda. A procession of prominent economists, editorialists and politicians have taken it upon themselves to “remind” the surplus countries, and in particular the country with the biggest surplus, China, of their responsibility for a sound and balanced global recovery. The generally shared view is that this means permitting the value of the renminbi to be set freely by the “markets”, so that the country will export less and import and consume more, hence allowing the rest of the world to do the opposite. But is it reasonable to put the burden of rebalancing the global economy on a single country and its currency? This policy brief contends that the decision to leave currencies to the vagaries of the market will not help rebalance the global economy....

``It is time to break with a sterile polemic that ignores the increasing evidence from a range of experiences showing that both absolutely fixed/pegged and fully flexible/floating exchange rate systems are suboptimal. These so-called “corner solutions” have added to volatility and uncertainty and aggravated the global imbalances . With this as a starting point, the debate can move forward to explore new common formulas for exchange rate management that increase consistency between trade and financial flows in a globalized economy.

``In order to address global imbalances coherently, governments need to act in the same spirit of multilateralism that characterized the international fiscal response to the crisis at its most critical moments in 2008. A coherent approach to restoring balanced trade calls for policies that address and prevent currency speculation at the global level. Even those who criticize governments for stabilizing exchange rates and intervening in financial markets generally recognize that a viable long-term solution to the problem of massive trade distortions and global imbalances cannot be expected from individual central banks trying to find a unilateral solution to a multilateral problem like the exchange rate."