Why China Undervalues Its Currency

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Yesterday, Brad DeLong described what he believes to be the primary Chinese rationale for its weak renminbi policy:

China has 900 million rural dwellers who are still living at a standard of living not that far above subsistence. The pressure to migrate from the countryside to the coastal cities is enormous. China needs to grow at more than 8% per year in order to avoid mass unemployment in the coastal cities. And mass unemployment in the coastal cities is likely to be followed by political collapse and turmoil on a gigantic scale.

Part of growing at 8% per year is to continue to rapidly expand exports to the North Atlantic core of the world economy. But in order to expand exports Chinese-produced goods must look like good values. And if demand for dollar-denominated assets falls and the value of the dollar falls, Chinese-produced goods will no longer look like good values.[i]

The U.S. policy problem is that the undervalued renminbi is leading to weak demand for U.S. goods and services in China.  The U.S. needs to reduce its trade deficit with China.

To reiterate, the five causes of high unemployment in the United States are:

  1. Inadequate aggregate demand.
  2. Migration of jobs to other countries, especially China.
  3. Increased productivity of employed workers.
  4. Inadequate credit for small businesses.
  5. Uncertainty about future taxes and regulations.

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