Yuan Revaluation unlikely to curb trade deficit

In response to mounting pressure from their constituents, American lawmakers are bullying China into revaluing the Yuan. China, they argue, is using its artificially cheap currency to 'steal' manufacturing jobs from the US. They cite the rising current account and trade deficits to buttress their claims. Logically, if China revalues its currency, American manufacturers will become more competitive and will not be forced to outsource their manufacturing to China. Alan Greenspan refuted such logic in a speech he delivered last week. The trade deficit, he said, us unlikely to improve if China allows the Yuan to appreciate. If anything, it will worsen.

The outsourcing of manufacturing to China typically involves large-scale, long-term commitments. Hundreds of millions of dollars are often spent to build plants and train new workers. As a result, American firms will not simply return their operations to the US following an appreciation in the Yuan. Suppose that the Yuan appreciates 40% against the dollar (unlikely) and manufacturing in China became uneconomical. Foreign firms will simply move production to other developing (Asian) economies, where labor costs are marginally more expensive than in China. The upshot is that American jobs which have already been outsourced are unlikely to return, and the twin deficits are unlikely to decline anytime soon.  Reuters reports:

But Greenspan poured cold water on the idea that a revaluation will shrink a record bilateral deficit with China that hit $162 billion last year. It will mean that suppliers will turn to other countries like Malaysia or Thailand for cheap textiles and other goods that China now supplies. "So essentially what we will find is we are importing from a different area but we'll be importing the same goods," Greenspan said.

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