Devaluation of Chinese yuan has implications for U.S. economy

Equity markets have been behaving like roller coasters lately, and one of the biggest reasons for the volatility is the devaluation of the Chinese currency, the yuan.

The decision by the Chinese authorities to take this surprising action reinforced fears that their economy could be in worse shape than the "official" data would indicate. It also shows that when it comes to free markets, the Chinese want nothing to do with them when it suits their purposes, and that has to change.

What are the implications for the U.S. economy of the devaluation of the yuan? A lower-valued Chinese currency means it takes fewer dollars to buy goods from China, so the price of Chinese products sold in the United States should decline. Consumers, businesses, even governments that purchase Chinese products would benefit, and sales of Chinese imports would rise, which is why the action was taken.

So what's the problem? Aren't lower prices good?

Unfortunately, a devalued yuan doesn't benefit everyone. If Chinese goods are cheaper here, that means U.S. goods are more expensive in China. That would lower the sales and exports of U.S companies that sell into China, hurting their earnings and slowing our job and economic growth. Rising imports and falling exports are not a good combination for the U.S. economy.

But the negative impact created by Chinese currency management doesn't end at our borders. One very major issue frequently overlooked is that by keeping Chinese products artificially low in the United States, China is creating unfair competition not only with American firms, but also with firms around the world.

Not every country will be able to, or even want to, match the Chinese devaluation. Therefore, Chinese companies will benefit by having lower export prices than their worldwide competitors. Firms outside China that export to the U.S., be they in Asia, the Americas, Europe or Africa, will become less competitive in our market because the prices of their goods would rise relative to Chinese products.

The real purpose for keeping currency value and export prices low is that the Chinese are attempting to keep their competitors out of U.S. markets. That allows the Chinese to exert greater control over the supply chain into our markets. Because we operate in a global economy and domestic firms and governments want to buy goods, materials and services at the lowest cost, China can underprice and thereby limit its competition in the U.S.

Should we be concerned that we have low Chinese goods prices but fewer suppliers because of currency manipulation? Of course. What firm wants its supply chain controlled by an individual, firm or country that is manipulating the market? And is it really OK that through currency manipulation the Chinese are growing faster while U.S. companies and firms around the world are being harmed? I don't think so.

Currency manipulation should be a cause of concern for everyone, especially business leaders. We need as many companies from as many countries as possible competing for sales in the United States. Only through that competitive environment can we be sure that firms and consumers have the lowest cost of goods, not just now but over time.

Having the second-largest economy in the world means that China must play a major role in making the global economy work smoothly. But this summer, its government has interfered in the workings of the equity markets by either restricting or requiring stock purchases. It has intervened in the currency markets by lowering the value of the yuan. It may be that the yuan is too high, but that is hard to know because the Chinese government manages its value so carefully.

Although free trade is good, currency manipulation is not free trade, and it creates real harm. China should allow its currency to adjust to market forces, instead of using it as a tool of economic warfare.