In the new Sounds Good series "On the Money," Morning Edition host Daniel Hurt speaks to local community members about all things finance. In the latest installment of the series, Hurt spoke with Dr. Eran Guse, Murray State University Associate Professor of Economics and Finance, about the United States' relationship with China, including issues like trade and currency manipulation. Guse emphasized that free trade benefits both countries, but tariffs can be detrimental, leading to higher costs for American consumers. Hurt and Guse's conversation also highlighted the long-term financial strain China faces due to its debt-to-GDP ratio, which could be exacerbated by ongoing currency manipulation.
"Free trade suggests that we're all going to do as much trade as possible until we've got to the point where we've maximized that happiness that was created from trading with one country in another country," Guse began. "I think that limiting it or changing the rules can be bad for the entire population." Many politicians over the years have claimed that China is a currency manipulator and promised to hold them accountable. Guse said that while their claims are fair, the actions that any want to take can be harmful economically.
"Politics is about scaring your potential electors into voting for you," Guse said. "They are going to try and say, 'Okay, you need to vote for me or else.' In politics, as Thomas Sewell has said, the number one rule of economics is that we have scarcity, meaning that there's not enough for anything to go around. The number one rule of politics is to ignore the number one rule of economics. Typically, politicians don't understand trade-offs, and they ignore them. They typically look at costs or they look at benefits. They don't look at them both. They don't juggle the costs and the benefits. There's going to be winners and losers within this. If we have China producing more of our goods for us, that means there are fewer jobs available here—less American jobs. That's one of the things where people say we need to buy American. I think we should buy American goods that are created because we're the best at doing it."
Guse said the value of a nation's currency has a huge impact on the cost of production of goods and services. "It's a lot more expensive to pay an American to produce goods and services than for Chinese because average wages in the United States are much higher than average wages in China," Guse explained. "The Chinese have been keeping the value of the American currency up, which, when you're an American company, and you want to locate into China, you have to buy their currency, which is the yuan. And right now, American currency can buy a lot of yuan, and that means that it's really cheap to pay Chinese workers. So, China has what we call a comparative advantage on labor compared to us because the value of our currency is so much higher than theirs."
Along with the value of the currency, Guse says China’s manipulation of the yuan spells long term danger for the Chinese economy and is creating an extreme amount of debt that could impact the stability of the country.
“Basically, they're putting themselves in a hole. The reason why the American dollar has such value is because it is scarce. When something has more value, it means it's more scarce. What the Chinese are doing is they're buying up dollars. They're taking them out of the market, and they're holding onto them,” Guse said. “The government actually will take out loans from their own banks, and they will spend that yuan on Chinese dollars to bring the Chinese dollars out. Now, the problem is that their government has a larger debt problem in what we call debt-to-GDP ratio, which is a debt-to-income ratio for an individual. But they have a bigger debt-to-GDP ratio than we do here in the United States. We talk about the problem with our debt; their debt is a much bigger problem for them."
Guse used a hypothetical to explain the potential long-term consequences of Chinese trade policy: if there was free trade in its purest form, market forces would force an equilibrium in trade between the U.S. and China. This, he argued, would benefit both countries. "If we were to do that—we're saying, 'Go ahead, and buy up whatever you want or wherever it was produced,' we would be buying more Chinese goods. Now, if we were to do that, the demand for their currency, the yuan, would go up. When the demand of something goes up, the price of it goes up, and the value of it goes up. So, the value of the yuan will be going up, which will naturally lead to the value of our dollar going down, because it's relative."
"It's an inverse relation," he continued. "When their value goes up, our value goes down. So, if we do that, the Chinese government has to work harder to devalue their currency. They're going to have to borrow more. When the value of the yuan goes up, and the value of the dollar goes down, all of a sudden, nothing has changed. Maybe for their wages, but the wage prices in terms of dollars has now gone up substantially, and that makes the American worker able to compete better against those workers."
Guse said that under this circumstance, it would no longer be profitable for corporations to locate in China and could possibly be more profitable to locate in the United States.
“When the value of the dollar goes down, it means it's cheaper for foreign countries to buy our goods. When the value of the dollar goes down, it's good for exporters but bad for importers. If we want to see more U.S. production, that's exactly what we want to see. I want to see those goods being produced in the United States and sent elsewhere," Guse said.
“They can't continue borrowing from their banks there, and if we make them borrow faster and faster, because investors are going to see the difference between the yuan and the dollar, and they’ll know the dollar is going to lose value, and so they're going to start trying to sell their dollars. What's that going to do? China is going to have to have a choice: either go into a ton of debt or allow the market to adjust. At some point, they will have to make a decision to do that. When that happens, we'll see a big swing in relative wages.”
