US-China Trade Relations

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    Professor Herbener,

    How, specifically, does China devalue the RMB? By quantitative easing?

    What effect does this have on interest rates here in the U.S.?

    How does this lead to an advantage for them in exports?

    Aside from Americans having to pay higher prices, what would be the effects of a Trump Tariff designed to stop them from manipulating their currency?

    How much sense does it make to say, “yes, Americans will pay higher prices, but there will be more money spent in the economy due to Americans having more jobs, so that offsets the higher prices”?

    How true is this claim that China needs us to be friendly with them in order to prosper, and that because of that it would be in their self interest to continue lending to us?

    Will our interest rates go up if they stop lending to us, or is there another creditor with an emerging market that would take their place?

    I know this is a lot to answer. But I’ve been trying to study free trade and trade relations and haven’t been able to answer these questions. And I know a lot of conservatives who are otherwise all for free markets, but who are voting for Trump just because “China is ripping us off”, and I don’t know what to make of this.

    Thank you


    Like other countries, China supports pegs of its currency to other important currencies. China devalues the RMB by moving the peg. It did this last summer:

    The effect of devaluation depends on whether it is an adjustment toward or away from the currency’s underlying purchasing power. If the devaluation is moving the currency in line with its purchasing power, then it improves the efficiency of the international division of labor. If the devaluation is moving the currency below its purchasing power, then it leads to a less-efficient international division of labor.

    A devaluation means that a given amount of foreign currency will buy more of the devalued Chinese currency and therefore, the foreign currency price of Chinese exports is reduced (because the price of the exported products in the Chinese currency remains unchanged). But, again, whether is is beneficial or harmful to the international economy depends on whether the devaluation brings the currency in line with its purchasing power or pushes it below its purchasing power.

    If the devaluation brings the Chinese currency in line with its purchasing power, then efficiency is improved and worldwide standards of living rise. (The Chinese products were over-priced to Americans and under-priced to the Chinese before the devaluation.) If America then places a tariff on goods imported from China after the devaluation corrects the inefficiency, the international division of labor is less efficient.

    If the devaluation pushes the Chinese currency below its purchasing power, then the international division of labor is made less efficient and standards of living are lower than otherwise. If America then places a tariff on goods imported from China, the American government receives tax revenue paid from the lowered income of Chinese producers. Therefore, these two policies, the Chinese devaluation and the American tariffs, do not cancel out and render the efficient result of the free market.

    China’s prosperity depends on it continuing to move toward a free market economy. Unilateral rollback of government intervention on all fronts and unilateral strengthening of the legal sanction of private property and contract is called for.

    As long as the Chinese continue to save, the world’s credit markets will not change and therefore interest rates across the world will not change. Capital markets across the world are integrated. Only is the Chinese quit saving and start consuming will interest rates rise and then not only in America, but everywhere.

    Here’s is something to read on international trade theory:


    I’m reading Hazlitt’s book Economics in One Lesson, and I’ve come across the concept that our imports provide foreigners with dollars to use to buy our exports, and that there’s almost an equilibrium there when you have free trade policies. But couldn’t foreigners just exchange their native currency for dollars? How is it that our imports are the only thing that makes our exports possible?

    Is that still true in the age of central banks, where money is created out of thin air?

    Perhaps I’m missing something fundamental.


    There are two ways to interpret the claim that imports are necessary for exports.

    (1) When you include money as a good, then it must be true in any trade that the goods “exported” (i.e., given up) are the basis for the goods “imported” (i.e., acquired). This is even true of an exchange of one money for another. So if the Chinese sell their money to buy our money there is still a one-to-one correspondence between exports and imports.

    (1) If one divides things into categories (namely: goods & services; money; and capital funding) then the exports of goods and services do not have to equal the imports of goods and services even though the overall movement of everything in all three categories must still balance.

    In a market economy, the composition of the balance of trade is determined by people’s preferences. If Americans prefer Chinese goods over Chinese money or Chinese investments and Chinese prefer American money and investments over American goods, then American will have a merchandise trade deficit with the Chinese which is balanced by a capital account surplus. We buy more Chinese goods than they buy American goods and they buy more American money, assets and claims to assets than we buy Chinese money, assets, and claims to assets.


    Are we making China rich, or are we taking advantage of them by borrowing all this money we’ll never pay back so that they can subsidize our imports?

    Is Peter Schiff right that it’s a vendor financing scheme?

    If so, should we worry that China would retaliate against tarriffs and crackdowns on their currency manipulation by discontinuing the purchase of our treasuries?


    Freer trade allows people to extend the division of labor which raises productivity and standards of living overall. Tremendous wealth has been created by market reforms in China.

    The Chinese have been buying American assets and claims to assets. Like any investment, if they earn a rate of return, they will be better off. If they buy physical assets in the U.S. or hold bonds and stocks of private companies, then they will be paid back. Of course, the Federal government may default on Chinese held Treasuries, in which case expect the Chinese government to retaliate in some manner.

    Here is a list of foreign holders of U.S. Treasuries:

    Here’s a list of foreign holdings of U.S. assets:

    Here’s a list of Chinese holdings:’s%20FX%20Reserves%20and%20Treasury%20Holdings.pdf


    With respect to your response to my question about China’s devaluation and it’s purchases of our treasuries and the effects on interest rates, I feel like you’re talking over my head a little to be honest. I keep going back and studying your response and getting bits and pieces, but I still really struggle with that one. Can you break it down a little more fundamentally? Or suggest an incremental study plan that covers the fundamentals so I can get a better grip?
    I know that’s a huge thing to ask, and that an economics class at my college may be a better way to understand these things, but I don’t trust the government schools to teach me correct theory, and since I can’t afford a private school, I feel like that’s what makes the Liberty Classroom so valuable.

    Also, I understand the idea that when manufacturing is shifted to China, it’s nothing to fear because the division of labor will make it so that employment here is just shifted to different sectors. But in concrete terms, what would that look like? What are our manufacturing jobs replaced with? What opportunities for good jobs are opened up for Americans? I understand the theory, and I work in a law office, so my job isn’t threatened, but it seems to me like good paying manufacturing jobs for people who don’t have white collar skills are being sent to China, and all my friends now have to work at Lowe’s or some other crappy job because there aren’t enough good paying jobs available. How does the division of labor replace good paying blue collar jobs with something equivalent?

    Also, I understand that the money sent overseas through our imports sometimes comes back into our economy when foreigners buy assets here. But how is that neutral or beneficial to Americans? How is it that we wouldn’t benefit more if those private assets were purchased by Americans, rather than by foreigners?


    One simple way to think about the issues is to contemplate your questions with respect to changes in the division of labor among the states in the U.S. Are Pennsylvanians really worse off because manufacturing jobs have moved to Georgia, South Carolina, and Alabama and been replaced by jobs in healthcare. Pittsburgh was filthy and depressing in the 1970s during the heyday of manufacturing. Now it’s largely a service economy, clean with burgeoning culture. If Pittsburgh would have put up tariffs against manufacturing imports from the South isn’t it obvious how this would make Pittsburghers worse off, including those in manufacturing since they would be selling to customers who were poorer because they couldn’t sell as much to outsiders (and, of course, outsiders will not buy Pittsburgh manufactured goods since Pittsburgh manufacturers are inefficient and so ask higher prices.) Isn’t it obvious, that the others who were being harmed by the tariffs would simply move out of Pittsburgh or invest outside of Pittsburgh further lowering the standards of living of those remaining in Pittsburgh, including the workers in manufacturing.

    The recent dip in manufacturing jobs in the U.S. is the result of the liquidation of malinvestments during the boom which ended in 2007. Here are the numbers:

    After hitting a trough in 2010, the number of manufacturing jobs has been steadily increasing.

    If you look at manufacturing jobs post WWII, you can see that they have risen from around 12 million right after the war to an average of around 17.5 million from the late 1960s to 2000 then they fell until 2010 and have since risen back to around 12 million.

    Finally, in the same way that you assert the superiority of manufacturing jobs over service jobs, some once asserted the superiority of agricultural jobs over manufacturing jobs. Two hundred years ago, more than 90 percent of Americans worked in agriculture, now fewer than 2 percent do so. How has this made America weak or inferior? Isn’t is a sign of strength when workers become more productive, i.e., each worker produces more output.


    Was it outsourcing that was responsible for the decrease in manufacturing jobs from the early 80’s-2010? Or is it true that the decline in manufacturing jobs is due more to automation?

    What sorts of jobs have replaced them in that time?

    Also, is manufacturing more sensitive to the business cycle than other sectors? If so, why? Because of the malinvestment resulting from misjudgments of consumers’ time preferences?


    Is this narrative correct despite the fact that that China manipulates it’s exchange rates?

    “the exchange rate system ensures that the money that leaves our country makes its way back into the US. For example, say that the Chinese are stockpiling dollar reserves, rather than reinvesting them. If people are offering more dollars for yuan(intending to either buy Chinese products or invest in Chinese assets) than others are willing to trade yuan for dollars( to invest in American goods or assets), then currency dealers will see that there is a shortage of yuan and a glut of dollars, and will raise the dollar price of yuan. This depreciation of the dollar will make Chinese products and assets relatively more expensive, and American products and assets relatively cheaper. The exchange rate will adjust until there is equilibrium.”

    This comes from Bob Murphy’s book, except that the country he was talking about was Japan, not China.

    Are the Forex traders able to overcome the peg?


    Of course, Dr. Murphy is correct. The price of anything adjusts to clear the market. Governments can “manipulate” the price of anything by participating in the market for it either as a buyer or seller. The quantitative effect of a government’s manipulation depends on its relative size as a participant compared to the overall market. If a government wants to increase the price of something, it can buy more of it and if it wants to decrease the price of something it can sell more of it. Of course, the effect on price from a one-time purchase or sale of something will be temporary. To have an ongoing effect of keeping price up or holding it down, the government must have an ongoing larger demand or an ongoing larger supply.

    To determine whether or not a government is manipulating its currency, then, one would have to know the world volume of trade in its currency for the foreign currency and the government’s volume of trade in its currency for the foreign currency. As you might suspect, unlike the former the latter is not public information.

    Lacking knowledge of the Chinese government’s actual participation in foreign exchange markets, we as outsiders are left to speculate among the logical possibilities. Maybe the Chinese government is massively (see below for how massive it would need to be) intervening in the foreign exchange markets for its currency. But maybe, the merchandise trade deficit America runs with the Chinese and its matching capital account surplus are merely reflections of preferences Americans and Chinese have. And maybe the exchange rate is being driven by some combination of government manipulation and market forces.

    Here is a chart of China’s currency exchange rate against the USD:

    If you click on the “5 year” button, you can see that the Chinese currency has traded in a rather narrow band of 6.6 to 6.0 USD.

    Here are China’s Foreign exchange holdings:’s%20FX%20Reserves%20and%20Treasury%20Holdings.pdf

    For the last five years, the Chinese holdings of assets for conducting foreign exchange trade have steadily increased.

    Here is foreign exchange trading worldwide:

    As you can see, foreign exchange trade is huge. The average volume of trade each day in April 2013 was $5.3 trillion. The USD-CNY volume of trade was 2.1 percent of the total or $111 billion per day.

    If the Chinese government is selling its foreign exchange reserves (which are around $3.7 trillion) to support pegging its currency to the USD at 10 percent of the market (i.e., $11 billion a day), it would exhaust its entire holdings in just one year. If the Chinese government is hoarding up its foreign exchange holdings to support pegging its currency to the USD at 10 percent of the market, it would double its entire holdings in just one year. As noted above, however, Chinese foreign exchange holdings have slowly increased over the last 5 years.

    There is one other point to note. Under certain conditions, a government could manipulate other participants in the foreign exchange markets to increase their demands or supplies and thereby, avoid doing its own buying and selling. As a superpower country, The U.S. government did this to other countries under Bretton-Woods. Some commentators claim that the Chinese can scare foreign currency traders into inaction by threatening to counter their trades using its own huge foreign reserve holdings. If the Chinese government is doing this, however, there is no way for an outsider to know it. We must speculate from the evidence we have, which is always open to different interpretations.


    Thank you so much for all the time you put into answering questions and explaining things.


    I still have a hard time understanding how this works if it’s not a true floating exchange rate system. It seems to me that Trump is right by saying that by pegging, China is ripping us off.

    What am I missing?


    How do we know the money that leaves the country due to imports will make its way back into the country?

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