Why China’s currency announcement is hokum

China is oriented to production, not consumption. It is unlikely then, that US companies will continue to make big profits from sales in China.

By , Guest blogger

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    A Chinese roadside seller holds tens of Yuan while dealing with a customer in Beijing, China, Tuesday, June, 22. The Chinese yuan edged lower against the U.S. dollar in spot trading Tuesday, a day after surging to a new high following the central bank's decision to let the currency trade in a wider range. But with Chinese consumers still reluctant to spend, will a stronger Yuan really make a difference?
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The stock market is euphoric over China’s apparent decision to allow its currency to rise against the dollar.

Watch your wallets.

China isn’t really changing anything. It’s only doing the minimum to prevent Congress from listing China as a currency manipulator, leading to a squeeze on Chinese imports.

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Over time – and I’m talking about months if not years – China will raise its currency to where it was before the global meltdown in 2008. Big deal.

Even then, a stronger yuan won’t generate lots of new jobs in the United States

That’s because most of the gains of China’s meteoric growth are still not finding their way into the hands of Chinese consumers, whose spending is growing far more slowly than China’s overall economy. In 2009, total personal consumption in China amounted to only 35 percent of the economy; ten years ago it was almost 50 percent.

Why are Chinese consumers so reluctant to spend? First, social safety nets are still inadequate there, so Chinese families have to cover the costs of health care, education, and retirement. (China recently doubled its spending on these services but the total is still low by international standards – around 6 percent of the Chinese economy, compared with an average of around 25 percent in most developed nations.)

Second, young Chinese men outnumber young Chinese women by a wide margin, so households with sons have to save and accumulate enough assets to compete successfully in the marriage market.

Third, Chinese society is aging quickly because the government has kept a tight lid on population growth for three decades. That means households are supporting lots of elderly dependents and must save in anticipation of supporting even more.

But most fundamentally, China is oriented to production, not consumption. It wants to become the world’s preeminent producer nation. While keeping the yuan artificially low is costly to China — it pushes up the prices of everything China imports — China is willing to bear these costs because its currency policy is really an industrial policy.

We think the basic purpose of an economy is to consume, not to produce. So we only grudgingly support industrial policy. We think of government efforts to rebuild our infrastructure as a “stimulus.” We approve of government investments in basic research and development mainly to make America more secure through advanced military technologies. And we give American companies tax credits for R&D wherever they do it around the world.

Don’t be fooled into thinking that US companies will continue to make big profits from sales in China. China allows big U.S. and foreign companies to sell in China on condition that production takes place in China – often in joint ventures with Chinese companies. It wasn’t American know-how, so it can eventually replace the US firms with China firms.

GM’s China sales are soaring but it’s making those cars there. It’s even designing and developing a new subcompact for China, in China. Proctor & Gamble is so well-established in China that many Chinese think its products (such as green-tea-flavored Crest toothpaste) are local brands. They might as well be. P&G makes most of them there.

Other American are helping China build a “smart” infrastructure, tackle pollution with clean technologies, develop a new generation of photovoltaics that convert solar radiation into electricity and wind turbines, find new applications for “nanotechologies,” and build commercial jets and jet engines. GE was producing wind turbine components in China.

Even if some of this enhances the profits of American-based companies, it doesn’t translate into more jobs in the United States. And it doesn’t build know-how here. It builds it there.

China’s currency policy also doubles as a social policy designed to maintain order. Each year, tens of millions of poor Chinese pour into China’s large cities from the countryside in pursuit of better-paying work. If they don’t find it, China risks riots and other upheaval. Massive disorder is one of the greatest risks facing China’s governing elite. That elite would much rather create export jobs, even at the high cost of subsidizing foreign buyers, than allow the yuan to rise much against the dollar and thereby risk job shortages at home.

Here’s the awkward truth that’s not openly discussed on either side of the Pacific: Both the United States and China are capable of producing far more than their own consumers are capable of buying. In the United States, the root of the problem is a growing share of total income going to the richest Americans.

Inequality is also widening in China, but the root of the problem there is a declining share of fruits of economy growth going to average Chinese and increasing share going to capital investment.

Both our societies are threatened by the disconnect between production and consumption. In China, the threat is civil unrest. In the United States, it is a prolonged jobs and earnings recession which, when combined with widening inequality, could create a political backlash.

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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. This post originally ran on www.robertreich.org.

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