What Does China's 'Currency Manipulation' mean for the Dollar?

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In last night's US Presidential Debate, Mitt Romney labeled China "a currency manipulator" when speaking about foreign policy and how to improve the manufacturing atmosphere in America. Is China a currency manipulator, and what would it mean for the US Dollar if Romney were elected?

China's Yuan is in a "controlled peg" relative to a basket of currencies. They control the exchange rate of their currency by purchasing the currencies of other countries, including the US Dollar, and many argue that the Chinese are buying a disproportional amount of dollars in order to keep their currency at a rate lower than it would be in a free market. This would allow them to produce (and sell) products cheaper as exports.

If this is true, then there prevailing reason would say that China (NYSEARCA:FXI) could be "stealing" manufacturing jobs from the United States by attracting companies with cheaper costs than would otherwise be available under freer market circumstances. However, prevailing wisdom may be wrong.

Is the Yuan being manipulated?

As with most economic debates there are two or more differing opinions on the topic, but the majority of opinions is that the Chinese currency is undervalued. Some measurements that support such claims are the popular "Big Mac Index", the International Monetary Fund's analysis, as well as academia's purchasing power parity studies.

The Big Mac Index, which was popularized by The Economist magazine, measures the prices of a Big Mac burger in McDonalds ( MCD ) around the world adjusted for exchange rates. A Big Mac in China in July 2012 costs an equivalent of only $2.45. The average price in the United States is $4.33. This implies that the Chinese Yuan is undervalued by a little over 40% based on purchasing power parity.

The IMF as well as some academic studies also support that the Yuan is being undervalued between 30 and 50%.

Who is Correct, Romney or Obama?

President Obama rebutted Romney's accusation that he was soft on China claiming, "as far as currency manipulation, the currency has actually gone up 11 percent since I've been president because we have pushed them hard. And we've put unprecedented trade pressure on China (NYSEARCA:GXC). That's why exports have significantly increased under my presidency. That's going to help to create jobs here."

The chart below shows that Obama is correct in the short term and Romney is correct over the long term. China's pegged currency has devalued significantly since its lows just above 1Yuan/Dollar in the early 80's to a high of above 8 Yuan/Dollar in 2006.

Since 2006 the Yuan has strengthened about 26%, and since Obama took office in 2009, the Yuan has increased in value around 11% from just over 7 Yuan to just over 6 Yuan per Dollar. Currencies (NYSEARCA:FXE) are always measured relatively, so a strengthening Yuan implies a weakening US Dollar (NYSEARCA:UUP).

Election Potentials

If Governor Romney is elected it sounds like he will pressure the Chinese to continue to strengthen their currency. If China's currency strengthens, prevailing wisdom is that the US Dollar will be a beneficiary by devaluing. If theUS Dollar devalues then US goods become cheaper relative to other countries and manufacturing picks up as other countries demand our goods, or at least economic theory would teach.

If Obama is re-elected it sounds like a similar outcome is expected as Obama debated that the 11% strengthening of the Yuan was a result of his policies. He also likely will continue to pressure the Chinese to strengthen their currency.

To take advantage of a devaluing dollar, the bearish PowerShares DB ETP (NYSEARCA:UDN) moves inversely to the US Dollar. The Wisdom Tree Dreyfus Chinese Yuan Fund (NYSEARCA:CYB) takes advantage of a strengthening Yuan.

But will a devaluing US dollar really help jobs?

Currency Devaluation does not Drive Manufacturing Jobs

Against prevailing thought, academia theory, and economic studies, a declining US currency is not correlated with an increase in manufacturing jobs, at least not in the last 30 years. In fact quite the contrary.

The below chart shows the US dollar since 1980 along with the St. Louis Fed's Manufacturing Employment Data since 1980. Together they sum up the manufacturing jobs debate quite nicely.

Both candidates are wrong in their assumptions about the US Dollar and manufacturing jobs. Since 1980 the US Dollar has been in a long-term devaluation. Based on the candidate's logic, that would imply manufacturing jobs should be increasing in America. That simply has not been the case.

Even more so, since around 2002 (red shaded boxes), that decline in the dollar's value has picked up speed, yet manufacturing jobs still continued to decline, significantly.

There is very little support that a declining US currency amounts to more manufacturing jobs. If anything, the analysis shows that a stronger dollar actually may be a better policy for attracting manufacturing jobs. In the 90's the dollar strengthened and so did manufacturing jobs. More recently since 2009, the dollar also has stabilized and so have manufacturing jobs.

Both Obama and Romney are wrong when it comes to China's currency manipulation and its role in the loss of manufacturing jobs in America. For the past 30 years a declining dollar value has not increased the amount of manufacturing jobs in the United States. What makes them think it would work this time?

The latest ETF Strategy Newsletter includes a detailed analysis of various market forecasting tools, along with a short, mid, and long-term outlook for t he US stock, bond, and foreign exchange markets. We monitor global events and formulate profit strategies based on fundamental, technical, and sentiment research.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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