The Wrong Fight

People who want to sell more American-made goods to China keep prodding Beijing to raise the value of the yuan against the dollar. The rationale is simple: The higher China's currency climbs in relation to the greenback, the more competitive American products will be in China -- and the pricier Chinese goods will be in the United States.

In short order, the Chinese will buy more American products, and Americans will buy fewer Chinese-made goods, the scenario goes. U.S. manufacturers will start exporting more to China. The trade imbalance between the two countries will narrow. And U.S. workers will have more jobs. What's not to like about that?

The problem is, proponents might be worrying about the wrong set of exchange-rates, economists say. What really counts in determining how much the U.S. exports to China -- or to any other market -- is not whether the dollar's value appreciates against the Chinese yuan, but rather how the dollar fares against the euro and the Japanese yen.

"We don't compete with China; we compete against goods from Europe and Japan," says Robert Z. Lawrence, a Harvard University economist who specializes in trade issues. If the yen and euro are low in relation to the dollar, it gives Japan and Europe an advantage over American goods, Lawrence says. "If the dollar is lower, it gives American firms an edge."

Indeed, all three rich trading partners make essentially the same things for export -- from capital goods, such as aircraft and engines, to food and agricultural products, chemicals and scrap. China doesn't make most of these, so it buys them from the United States, Europe or Japan, whichever seller has the best price and quality. America doesn't make what China sells.

"So people who focus on the yuan are worrying about the wrong thing," Lawrence says.

Indeed, we've just gotten through a period that has tested that assertion -- and found it very much on target. Over the past two years, the euro has declined sharply against the dollar. European exports to China have risen significantly, and Chinese direct investment in Europe has soared. Meanwhile, American export sales to China haven't kept pace.

Although the United States imports far more from China than it exports to that country, China had been America's third-largest export market -- and its fastest-growing customer for exports -- before the recession hit. The euro was higher against the dollar before the current slump; more recently, it has declined sharply. So has the yen, after inflation is taken into account.

The decline of the euro also may have been a factor in making China's leadership hesitant to let the yuan rise more rapidly against the dollar following its announcement on June 21 that China would cut the link between the dollar and the yuan. China feared that too fast a rise might crimp its exports to Europe, a finance ministry official hinted last month.

That isn't an imagined risk, says Kenneth Lieberthal, director of the John L. Thornton China Center at the Brookings Institution in Washington. Under the new exchange-rate rules that China adopted in late June, the yuan will be measured against a basket of currencies -- presumably including the euro -- not just against the dollar, as was the case before.

While that makes sense from an economic viewpoint, it means that letting the yuan appreciate against the dollar could hurt China's exports to Europe. China also has some $2 billion worth of dollar-denominated holdings, Lieberthal points out. When the yuan appreciates against the dollar, its portfolio loses some of its value.

Some analysts believe that the sharp fluctuations between the euro and the dollar over the past few years may have contributed to Europe's on-again, off-again support for America's periodic efforts to pressure China into making more trade concessions.

During 2006 and 2007, when the euro was low in relation to the dollar, the Europeans were silent while the United States stepped up its pressure on China to eliminate "unfair trade practices." By mid-2008, that changed: The euro had risen against the dollar, and top EU officials were sounding much like U.S. lawmakers, berating China much as America was.

To be sure, it's more difficult to do anything about the euro -- or even the more stable yen -- than it is to complain about the yuan. To begin with, the exchange rates for the euro and the yen are determined by the foreign-exchange markets, not by arbitrarily pegging them to the dollar, the way the yuan has been. Governments have little power there.

Harvard's Lawrence says there are some things the United States could do. Helping the Europeans resolve their current banking crisis, for example, would raise the value of the euro against the dollar, and restore some of the advantage that America had in the Chinese market.

But prodding China to let the yuan appreciate won't help much. Americans won't buy fewer Chinese imports if the yuan appreciates. China won't buy more American products. And any jobs that China "loses" will go to lower-wage countries such as India or Vietnam, not to the United States.

"Focusing on the yuan is the wrong fight," Lawrence says.