I just read this article http://mises.org/daily/4256 I understand most everything in it and it makes sense but I am stuck on one spot and it might just be my brain jumping around on too many other things.
"By making Chinese goods cheaper through inflation, the People's Bank of China is effectively subsidizing the American importer. Think of it this way. The Chinese producer fabricates Widget X, which before inflation is on the market for eight yuan. Let us assume that at this point the natural, market dollar–yuan exchange rate is one to four, which means that Widget X effectively costs two dollars (one dollar buys four yuan, and the widget costs eight yuan).
However, China's central bank steps in and inflates the yuan, causing the exchange rate to change to one to eight (one dollar to eight yuan). Now Widget X will cost the American consumer only one dollar. The winner is clearly the American, who purchased the good for half of the original price. The loser is the Chinese producer, despite now having eight yuan; each yuan is really worth half as much as before inflation. In effect, inflation cheated the Chinese producer out of half of the value of the good being sold. Although this example does not represent real-world changes in the exchange rate, the point stands. Over the long run, it becomes clear just how injurious currency devaluation is to the Chinese economy."
I can see how initially widgets might be half the price in dollars as they were before the yuan was devalued but as the devaluation leads to price inflation in china wouldnt the price of widgets soon rise to 16 yuan esentially nullifying the effect of the perceived purpose of the devaluation and end up costing the same 2 dollars as it did before? what am I missing? or can someone givee me another example.
It's an example. It's meant to make a point obvious, otherwise it would be hard to follow.
Yes, the price of Chinese goods rises. This is important for my point to remain true. Whoever receives new money first will benefit the most from it, because it will be them who begin the process of bidding up prices. As such, the original American importer is subsidized.
The price of the good is equal to 8 yuan. Widget X = Y8.
Originally, Y8 = $2 (4:1)
The money supply is inflated, and now the exchange rate is 8:1. So, th American can buy the same good for $1, even if in yuan the amount being paid is the same. It costs the American half as much. But, with double the money supply once prices are inflated the new cost of widge X is Y16. Yet, the Chinese producer was only paid Y8, so his earned yuan are effectively worth half as much.
Yes, ultimately the exchange rate will even back out. That's why these type of currency peggings require constant inflation to maintain the exchange disparity.
The example is not terribly well written.
The People's Bank of China doesn't simply pump money into the system at will. They keep a very close eye on the value of the dollar and the euro and have adopteded an inflation rate to keep yuan-priced exports palatable. They don't just double the money supply overnight as the example may lead to believe. Also exporters get huge benefits in the form of sizeable tax returns: until recently some categories of exporters were entitled to massive returns, up to 25%, effectively making economically feasible to export their goods at bare-naked costs or even at a loss since they were making money through tax returns. As part of the measures to "cool down" the economy these subsidies have been slashed two years ago and again this year.
But you are right: there is massive price inflation in China and, together with raising standards of living and low capital investment per worker are starting to cause issues. By 2016 it will be just cheaper to manufacture some goods in the South instead of importing them from China. Ironically the world's largest chopstick manufacturing hub right now is good old Georgia...
I see that makes sense. I missed the assumption (which I guess is more of a standard practice and should have been assumed on my part) that this would be an ongoing practice.
and thanks for the article. I had always wondered how the same people could right;y say that artificial inflation is bad for us it is good for another country.