All currencies are not created equal.
Over the last decade the Zimbabwean dollar became utterly worthless because it was issued by a government that had so badly managed its economy that it would be hard to imagine worse. Nobody in the world trusted the Zimbabwean dollar and all currencies are based on trust.
While the Zimbabwean dollar was tanking the Swiss franc was soaring, prompting the country’s central bank to take action to try to weaken it.
Currency Values Fluctuate
The paper on which a $100 bill is printed is worth almost nothing. However, the bill has a value of $100 because people trust they can use it to buy $100 worth of goods or services.
If they take that $100 bill to another country they might be able to buy more or less with it depending on the exchange rate. The relative value of one currency to another depends on how well or badly each nation’s economy is doing.
In January 2002, the Canadian dollar was worth just 61 cents U.S., so someone crossing the border southwards to do some shopping could only get about sixty dollars worth of goods for their Canadian 100 dollar bill. At the time, the American economy was buzzing based on a technology boom while the Canadian economy was sluggish.
Then, the United States got itself entangled in two massively expensive wars at the same time as it cut taxes. The American economy began to tank and then was walloped by the financial crisis of 2008.
Now, the Canadian dollar is worth a little bit more than its U.S. counterpart. This is good news for Canadian cross-border shoppers. However, good times for shoppers mean bad times for Canadian exporters.
Companies selling widgets in the States liked it when the Canadian dollar was worth about 60 cents U.S. That’s because their products were cheaper for Americans; they only had to spend $60 to buy $100 worth of goods. Now, a truckload of Canadian widgets costs 40 percent more in the U.S. than it did nine years ago
But, the global financial system is far more than just the trade between Canada and the U.S.
Integrated Global Markets
Forex Online Learning explains that, “Every day, you probably buy items that were made in one country, assembled in another; market tested in yet another country, and then shipped by a company from one more country.
“Along the way, money changes hands in each step.” This has an effect on how currencies behave relative to one another.
In 2008, James Fallows explained the chain of events following a consumer product sale in the United States in Atlantic Magazine:
“Let’s say you buy an Oral-B electric toothbrush for $30 at a [retailer] in the United States…Most of that $30 stays in America, with [the retailer], the distributors, and Oral-B itself. Eventually $3 or so…makes its way back to southern China,” where the toothbrush was made.
The factory takes its dollars to a local bank and changes them into Chinese yuan (just to baffle us all the official name for the Chinese currency is renminbi) so it can pay its workers.
The local bank sends the dollars to the People’s Bank of China (PBOC), the government-run central bank, which sends the yuan equivalent back the other way. (In most other countries, that local bank would be able to keep those dollars and invest them as it saw fit. But, the Chinese government forces commercial banks to hand over dollars to the central bank as part of its scheme to manipulate its currency).
The PBOC then hands the money over to an outfit called the State Administration for Foreign Exchange that invests those U.S. dollars in one of several ways. It might acquire shares in overseas companies or buy up U.S. government debt in the form of secure Treasury notes.
So the dollars spent on the toothbrush, along with all the other consumer goods purchases, end up finding their way back into the U.S. economy. The Chinese hope that money, which amounts to more than a billion dollars a day, will be used to buy more of their goods. It is in this way that the U.S. has racked up a massive debt, much of which is owned by China.
Currency Value Manipulation
The people of America, Canada, and other countries buy so many Chinese products because they are so darn cheap.
One reason Chinese products are inexpensive is because the country’s government has a deliberate policy of keeping the value of its currency low in relation to other currencies. This causes a lot of friction on the international stage, however all governments tinker with the value of their currencies, although few more so than China.
The Chinese government does this by paying a high price to buy U.S. dollars on the open market. This has the effect of driving up the value of the dollar relative to the yuan, but it can trigger inflation. Another way of weakening your own currency is to print more of it, but this also carries with it the threat of creating inflation and this can lead to some horrible side effects.
By various estimates China has kept its currency undervalued by between 15 percent and 40 percent.
Some argue that if the Chinese currency was traded at its real value, the country would lose its price advantage in selling its goods. Others, such as Alan Schram in the Huffington Post (October 2010), say we should let the Chinese go for it: “America benefits from the policy [which] 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.”
But, all countries are playing the same game of trying to keep their currencies artificially low. This prompted Brazil’s Finance Minister Guido Mantega, in the fall of 2010, to say “We are in the midst of an international currency war.”
Sources
- “Understanding Money and Exchange Rates.” Microsoft in Education.
- “How International Trade Affects Currencies.” Forex Online Learning.
- “The $1.4 trillion Question.” James Fallows, The Atlantic, January/February 2008.
- "Infographic: How China Manipulates its Currency." Derek Thompson, The Atlantic, March 29, 2011.
- “Let China Manipulate its Currency – They Are Doing us a Favor.” Alan Schram, Huffington Post, October 17, 2010.
- “World Gripped by International Currency War.’ ” Tim Webb, The Guardian, September 28, 2010.
Rupert Taylor - Rupert Taylor is the editor of a magazine that provides background to current events.
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