Got an email from a client/friend yesterday with a link to an Industry Week Article and a note saying that I needed to give this “CLB’s dumbest article of the month award.” We do not actually have such an award (should we?) so for that reason alone, it is not in contention. Bad articles on China abound, but this one stands out because it is in a very influential magazine and because much of what it is wrong on has been repeated so often I fear it is beginning to pass for truth.

The article is in IndustryWeek Magazine and it is entitled, “Why Is China Cheaper?” It is written by Michele Nash-Hoff, President of ElectroFab Sales. She is also the author of the book, Can American Manufacturing Be Saved?

The main point of her article is that China manufacturing is cheaper than US manufacturing for reasons that go far beyond wage disparities. I do not dispute that point, but I do dispute much of what she says in support of that claim.

Her article starts out well by describing the costing differences between manufacturing a stuffed teddy bear and a Frisbee. Ms. Nash-Hoff points out that about 70% of the cost of manufacturing the teddy bear goes to labor, whereas the labor costs make up only around 20% of the cost of manufacturing the Frisbee. She then notes how because China deals in such massive quantities of the plastic resins that go into the Frisbee, its material costs for the Frisbee will be “as low as it could be.” I am not sure whether Ms Nash-Hoff is saying that the plastic resins will cost less in China than in the United States and I am not sure whether that is true or not.

Ms. Nash-Hof then tells us that labor is cheap in China because China has “one billion people living at the poverty level.” This is by far the highest number I have seen listed for those living at or below the poverty level in China but so be it.

As a result, wages have finally been rising by about 15% per year over the past four years. It took suicides by workers in the summer of 2010 to achieve additional improvement in wages and working conditions at plants that were more like prison camps with dormitories for workers to live on site and fences around the buildings so workers couldn’t leave the premises.

Okay.

This argument contains its own flaw. Wages in China have increased (fairly briskly) every year since the late 1980s and the average wage for workers in urban areas was four times higher in 2006 than in 1995. As Ms. Nash-Hof herself points out, wages have been rising “by about 15% per year” since 2006. With these statistics, is it really fair to claim that it took “suicides by workers in the summer of 2010” to achieve additional improvements in wages? Also, is she implicitly saying that it is not fair to the United States that China has so many poor people and that those people should not be employed? Or is she saying something else?

Ms. Nash-Hof’s third reason for China being cheaper is that China’s workers receive “nothing” when they are injured on the job:

Third, there are the costs of compliance to health and safety regulation and environmental regulations. These costs are less expensive in China than in the United States because the Chinese government imposes few health and safety or environmental regulations. China doesn’t provide workman’s compensation insurance for their workers so workers hurt on the job don’t receive any compensation when they are injured to the point that they are disabled.

Ms. Nash-Hof is both right and seriously wrong in this argument. Of course the cost to comply with health and safety and environmental regulations is way less in China than in the United States. I say “of course,” because even if China’s regulations were exactly the same as those in the United States and even if the enforcement of those regulations were exactly the same in China as in the United States, compliance would still be considerably cheaper in China. Compliance would be considerably cheaper in China because medical care and wages (and pretty much everything else) are considerably cheaper in China than in the United States.

But beyond that, Ms. Nash-Hof is right to claim that China does not enforce health and safety and environmental regulations nearly as rigorously as the United States, but she is flat out wrong to claim that China does not have workers compensation when it does and she is also flat out wrong to claim that “workers hurt on the job don’t receive any compensation when they are injured to the point that they are disabled” because they almost invariably do. Again though, a worker who loses a finger in China might get $500 while a worker who loses a finger in the United States might get $50,000. I wonder if Ms. Nash-Hof is seeking an increase in workers compensation in China or a decrease of it in the United States?

Ms. Nash-Hof then argues that China’s VAT law works in its favor as against U.S. manufacturing:

Next, there is the cost of taxes and duties. China is one of over 150 countries that utilize a Value Added Tax (VAT) system. It is a tax only on the “value added” to a product, material, or service at every state of its manufacture or distribution. The VAT rate is generally 17%, or 13% for some goods. Chinese companies receive a VAT refund from the government for materials of products produced for export. American imports to China are charged a VAT, but the U. S. doesn’t have a VAT to charge Chinese imports.

Help me out here readers because I am just not seeing it. Maybe I am missing something here, but I do not see how China’s VAT has anything to do with its manufacturers being able to produce for less. I just do not understand how charging the VAT for domestic sales, but refunding it for exports reduces Chinese manufacturing costs. Could I not argue that the VAT actually increases manufacturing costs by reducing domestic sales and thereby making it tougher to achieve economies of scale? Is not this exactly what pretty much every country does with its VAT and exactly what U.S. states do with their sales tax?

Ms. Nash-Hof then makes a completely off-base factual argument that I am seeing and hearing much more frequently of late, which is that foreign companies cannot go into China without a Chinese partner:

In addition, the Chinese government requires foreign firms to have a Chinese “partner” company, who maintains the majority interest, takes most of the profits, and has the real control of the company.

This is just false. Completely 100% false. When I wrote a Wall Street Journal article on China Joint Ventures back in 2007, “only 27% of new foreign-invested businesses used this legal mechanism [Joint Ventures] in 2006, compared to well over 50% in 2001.” I would guess that percentage is less than 20% today. China allows foreign companies to go into China alone in just about all industries other than media, military and mining.

Ms. Nash-Hof also gets it wrong when it comes to China R&D and technology sharing:

More seriously, China now requires U. S. companies to share their technology and relocate their R&D centers to China if they want to have access to Chinese markets.

This statement is just so wrong I hardly even know how to attack it. First off, there are hundreds of thousands of U.S. companies that have “access to Chinese markets” without having any presence in China at all. Every U.S. company that sells a product or a service to China has “access to Chinese markets” and many (most?) of those companies are not even in China, much less sharing their technology and relocating their R&D centers there. Then there are the foreign companies in China that do no R&D there and zealously protect their technology. China does not require U.S. companies set up an R&D facility in China or share their technology with China to have access to China’s markets. Apple Computer, KFC, The Gap, McDonalds, Price Waterhouse, and an endless list of other American companies that are thriving in China give lie to this bizarre claim. There have been instances of what Ms. Nash-Hof describes (see the Chevy Volt), but fortunately, that it is not the norm.

Unsurprisingly, Ms. Nash-Hof also attributes the China Price to China’s undervalued currency:

Above all, there is the ever-present currency manipulation, where China undervalues their currency by an estimated 30%-40%, which simply makes every product that China ships out 30-40% cheaper than those of a potential American competitor.

I am not going to dispute that the Yuan is undervalued, but 30-40% seems high to me. Is it?

Lastly, Ms. Nash-Hof talks about dumping and I am not going to fight her on that.

What do you think? Am I being too harsh on Ms. Nash-Hof? Is she right?

I just think that with election season upon us, it is more important than ever that we get our facts right.

  • Bill Graham

    I think picking on other peoples opinions when you’ve not called her to clarify is poor behavior to be honest. You’re not going to do your reputation much good by continuing down that road. How about you write something original for a change instead of constantly commenting on others?

  • The percentage by which a currency is undervalued is not well-defined for large percentages. It depends on which currency you’re using as the denominator.
    Example: suppose the yuan-dollar exchange rate is 2 yuan per dollar but that the equilibrium exchange rate would be 1 yuan per dollar. Is the yuan 50% undervalued or 100%? Most people say “50%”, and yet it would take a 100% appreciation of the yuan (in this fictional example) to reach equilibrium.
    So, people should be careful of that.

  • Cristi Kennedy

    This article is a joke but it is just what a publication like Industry Week wants. Unabashed China bashing and damn the facts.

  • lpc1998

    Before you allege that China “manipulates” the RMB or when you echo such allegation, pause and ask yourself in what ways precisely has China “manipulated” the RMB, bearing in mind that the RMB is not freely traded in the foreign exchange markets. So even if it wanted to, the Chinese Central Bank cannot buy or sell RMB in the markets.
    What actually happens is that China has used the dollars for her international trade settlements and investments, reinforcing the dollar’s role as the primary international trade settlement and reserve currency. Because of this, the Chinese Central Bank has to exchange the dollars deposited in the Chinese banks for RMB at a stable rate so that businesses in China that sell products and services in dollars could pay for their expenses in RMB in China.
    Exploiting Sinophobia may be irresistible for politicians desperate for votes and harms the country’s relations with China. However, nothing is more damaging to the US economy than to compel China to stop “manipulating” the RMB. When that happens, businesses in China would not be able to accept the dollar as payment for goods sold and services rendered when the Chinese Central Bank stops exchanging the dollars deposited in the Chinese banks for RMB (the act of China “manipulating” the RMB). These businesses need to convert their dollar revenue into RMB to pay for expenses in China.
    On that day, the RMB may “float” freely in the foreign change markets as wished for by so many Americans and others and the value of the dollar plummets as the RMB no longer acts as the anchor for the dollar which has already become junk currency because of the very excessive “printing” by the US authority. Together with the rapid loss of value, the dollar would also lose its status as the international trade settlement and reserve currency as nobody would want to hold to an asset that is fast depreciating in value. Businesses which have sold their goods and services in dollars would be wiped out.
    When the dollar collapses, the consequences would be global, unprecedented and enormous.
    *********
    The inevitable collapse of the dollar
    http://www.youtube.com/watch?v=4n3g5lUgkWk&feature=youtu.be
    The Dollar is DEAD
    http://www.youtube.com/watch?v=O-tRivbrYGk&NR=1
    Economic Collapse : Some Amazing And Frightening Facts
    http://www.youtube.com/watch?v=d2tgHW1w1lE&feature=youtu.be
    The Day the Dollar Died
    http://www.youtube.com/watch?v=2N8gJSMoOJc

  • Maya K.

    There are a number of blatant falsehoods in this article, all of which I have heard far too many times before. We are all going to be counting on you (and others of course) to maintain the fort in terms of monitoring this sort of stuff which is going to no doubt become prevalent as elections draw nearer. Thanks for this one.

  • Loren

    I’m reading the book Death By China and it makes the very same mistake of claiming that foreign companies cannot go into China on their own. How is it that in 2011 people are writing about China without having a clue about WFOEs?

  • Hi

    I don’t get why you’re confused about the VAT issue. it’s been beaten to death elsewhere.
    Take two hypothetical countries, let’s call them US and Germany. US has a payroll tax, Germany a VAT. Labor, material, and other production costs are otherwise identical. Say a Chevy made by GM in the US costs GM $10,000 to make–$9,000 in various non-tax costs, and $1,000 in payroll tax baked into the product. If GM exports that Chevy to Germany, at zero profit it will retail for $11,000 (the German VAT is added to the price). That Chevy will have US payroll tax and German VAT baked into its price. Take now that the same Chevy built in Germany. It costs GM $9,000 to make. At zero profit It will retail in Germany for $10,000 (9,900 actually) after you add the VAT. The VAT is rebated on export, so that same Chevy can retail for $9,000 in the US. A Chevy built in Germany and sold in the US will have neither US nor German taxes baked into its price. $9,000 one way, $11,000 the other way. Germany gets its tax revenue by taxing consumption, while the US gets its tax revenue by taxing production. Which do you think will have more of each?

  • nulle

    China doesn’t have unemployment insurance, nor paying into social security, nor property taxes to state and local governments (lower cost of production).
    Chinese children have limited (in slots for) free education (translates lower tax rates and lower cost of production.)
    Chinese labor unions are different translates to lower wages since strikes and protests are frowned upon and usually disrupted or stopped.
    Separately, Chinese CCP limited market access via other ways:
    – like using high tariffs on imported (luxury) goods (explains why people cross borders to buy luxury good and sometimes everyday items)
    – requiring JV with local companies
    – won’t (or very slowly) issue the ‘required’ business license sometimes without explanation
    – requiring government purchases from chinese companies, essentially limiting foreign firms to SMEs since most large firms are partial or total state controlled
    – tight capital inflows (investment) and outflows (conversion of RMB to other currencies)
    – using other forces to disrupt competitors of companies owned by current and former CCP members and their families
    – lower IP protection compared to other countries

  • Me Guste

    Thanks for calling her out on her inaccuracies. I have been living here in China for six years and the China she described may have once existed but it certainly does not exist now, nor has it for the last six years. She should run for President.

  • Nick Olesund

    What is she talking about? You have already done a great job pointing out her inaccuracies as they relate to the law (the fact that joint ventures are not required and that injured workers receive compensation) so I am going to address the economics. The numbers I have seen for those living in poverty in China is around 400 million and the extent to which the RMB is overvalued is usually listed at between 10 and 15% and with the way prices keep rising in China, those numbers may already be too high. I’m with you on the VAT too. I do not see how China’s handling of its VAT is at all unfair or any different from how just about every country in the world handles it.

  • Twofish

    nulle: China doesn’t have unemployment insurance, nor paying into social security, nor property taxes to state and local governments (lower cost of production).
    Factually not true.
    nulle: Chinese children have limited (in slots for) free education (translates lower tax rates and lower cost of production.)
    Also factually not true.
    nulle: Chinese labor unions are different translates to lower wages since strikes and protests are frowned upon and usually disrupted or stopped.
    Factually misleading. It turns out that Guangdong is a hot bed of work stoppages and strikes, and the authorities will generally not intervene in a strike. You don’t hear about strikes, because it’s in both sides interests to have the employer quietly increase wages.

  • China Scholar

    This is no doubt not going to be the last of these such articles as the elections approach. I will say though that articles like this used to be commonplace and they are less so now. It is a lot harder now to write something like this with a straight face because correct information on China is so much more available now than it was even five years ago. I am hoping she addresses your comments. I would love to see that.

  • “. . . fences around the buildings so workers couldn’t leave the premises.
    Since I used to work at the factory she’s apparently referring to here (i.e., the Foxconn plant in Longhua, Shenzhen) let me just say what total baloney this is. Go anywhere in Longhua or Shenzhen and you will run into people who work at Foxconn. They are not forced to stay on premises during their off hours, the fences, guards etc. are there to keep people out, not in.
    @Nulle – Sheesh, where do we start? How about reading what Dan wrote first?

  • Hua Qiao

    Ipc,
    You don’t know what you are talking about. China runs a trade surplus to support employment and therefore must constantly buy dollars to maintain its exchange rate. Every month it has a current account surplus, it must buy those dollars. If they want to keep exports going, they have to keep buying and recycling those dollars.
    If you want a lesson on what is really going on, go read patrick chovanec or michael pettis. They both have excellent blogs to ‘splain it to you.

  • credzba

    nulle,
    your facts are incorrect.
    just recently foreigners working in China had to begin paying into the Chinese social retirement system and are complaining, while everyone has to pay ss in america. I assure you there is a social retirement and medical system in China.
    The education system promotes studying in students, and those that don’t want to study, get moved out of the educational system. if we did this in American perhaps more students would study instead of being disruptive in class.
    Having 20 years of work experience in China and 20 in America I can guarantee you that my job security in China was higher than in America. Company in America can “lay off” people for no reason, in China this would never happen.
    I cannot speak to your international business claims. I do suspect there is a fair amount of protectionism in China, but I WISH America would protect our jobs!

  • elemental

    Her article is polemical and not even worthy of a serious response.

  • Lawrence

    I see your point about her article and it is good to see the healthy and constructive comments this is engendering.

  • lpc1998

    @ Hua Qiao – September 12, 2011 3:30 AM
    Can you keep an open mind and try to understand my post?
    “…… China runs a trade surplus to support employment and therefore must constantly buy dollars to maintain its exchange rate. Every month it has a current account surplus, it must buy those dollars. If they want to keep exports going, they have to keep buying and recycling those dollars.”
    This is an interpretation by western economists and politicians of China’s economic data. It is so far from the facts on the ground that is mythology, pure and simple.
    China does not run a trade surplus to support employment. To create employment, China encourages manufacturing investments in China for exports to rich countries at very competitive prices. The huge trade surplus is the consequence of insufficient imports relative to exports. If China has bought lots of raw materials for stockpiling and imports more of other things, then China would even have a trade deficit without losing the manufacturing jobs. So China does need a trade surplus to support employment.
    When China sells goods overseas for dollars, the entire value of the goods (costs + profits) would be received in China in dollars. China would have so many dollars already. So why does China need to buy more dollars. Rather China needs to buy dollars when she has a trade deficit, not trade surplus.
    Why must China constantly buy dollars to maintain the exchange rate when there is NO market rate to maintain as the RMB is NOT freely traded in the foreign exchange market? The RMB-US$ exchange rate used by the Chinese Central Bank to exchange the dollars deposited in the Chinese banks for yuan is set by the Chinese Central Bank, and NOT set by the foreign exchange market. So there is absolutely no need to buy dollars to maintain this rate.
    Don’t imagine that the RMB is traded freely in foreign exchange markets where the Chinese Central Bank buy dollars for the yuan when, in fact, it does not. O.K?

  • Hua Qiao

    @ipc
    That’s my point. The PBOC and SAFE administer the exchange rate. They set the rate because they are the only ones allowed to exchange dollars and RMB.
    By buying dollars, i am referring to the exchange that the PBOC engages in when a mainland exporter wants to take the dollars to the bank and convert it to RMB.
    ” The huge trade surplus is the consequence of insufficient imports relative to exports.” Exactlyy. Market exchange rates adjust to equalize this imbalance by making exports more expensive and imports cheaper. But since there is no RMB market because China wants to control the RMB, the surplus continues. And China must re-cycle those dollars by lending them back to the west.
    If China buys lots of raw materials or other things, equalizing the imbalance, that would be great. Seems to me, China ought to want to do this in the absence of the employment impact to its export industry. So why don’t they let the RMB float or at least appreciate to the point of balance? I think we all know the reason.
    Remember what Wen Jiao Bao said last year: “a drastic re-evaluation of the yuan and a 20 to 30 percent rise would cause the bankruptcy of numerous enterprises and severe unemployment. Many migrant workers would have to return to the countryside.” He clearly ties the RMB level to mainland employment.
    By the way, those rich countries aren’t so rich. China has lent them the money because it chooses not to adjust its exchange rate or purchase goods in the world market. So now the US government is more leveraged by trying to maintain demand over the last 2 years as the US consumer deleverages. Meanwhile, China chides the US for its profligate ways at a time when it should be hopeful that world demand can continue to buy its exports.

  • slim

    Hua Qiao is entirely correct on the RMB/$ mechanism. None of it is mythology; it is more textbook econ. applied to China’s extreme version of mercantilism.
    Read Michael Pettis or Derek Scissors for clear, easy-to-understand explanations of how this works.

  • Andeli

    I would argue that when all is added together good Chinese employees are more expensive, and those that placed their factories in China must have a long term goal of selling products or else its is a bad investment.
    “I just do not understand how charging the VAT for domestic sales, but refunding it for exports reduces Chinese manufacturing costs.”
    A VAT refund is a production increase. This means that for some products the manufacturing company can produce more for the same money (100 unites for USD 100 with VAT or 118 unites for USD without VAT). More products mean you can have a lower margin and thus your products are cheaper.
    Your argument is correct if the products made could be attractive in the home market, but Chinese still have a very low consumption rate. VAT on foreign goods is created to hold down domestic consumption of these products.
    The rest of her arguments are no good….
    The question of the Yuans value can only be answered by another question “does the Chinese government want the Yuan to be a reserve currency? if so then it is undervalued by how much other other countries are willing to trade in yuan and how much debt the Chinese market is willing to sell. That can be between 1 and 1000 %.

  • lpc1998

    @ Hua Qiao – September 12, 2011 5:36 PM
    “That’s my point. The PBOC and SAFE administer the exchange rate. They set the rate because they are the only ones allowed to exchange dollars and RMB.”
    The PBOC set the exchange rate simply because there is no market rate for the US$-RMB exchange. It is responding to a need in the natural cause of things. There is nothing sinister about it. The PBOC is the best entity to set the rate as it is ultimate source of the RMB.
    “By buying dollars, i am referring to the exchange that the PBOC engages in when a mainland exporter wants to take the dollars to the bank and convert it to RMB.”
    The mainland exporters and others exchange their dollars for the RMB at an ordinary bank which then exchanges the dollars accumulated with the PBOC. Do note here that it is the banks that go to the PBOC to exchange their accumulated dollars for RMB unlike currency interventions by other central banks when they go to the foreign exchange markets to buy and sell their currencies. The PBOC does not buy or sell RMB in the foreign exchange markets.
    “” The huge trade surplus is the consequence of insufficient imports relative to exports.”
    Exactlyy. Market exchange rates adjust to equalize this imbalance by making exports more expensive and imports cheaper. But since there is no RMB market because China wants to control the RMB, the surplus continues. And China must re-cycle those dollars by lending them back to the west.”
    No, in real world, currency market exchange rates are determined by the supply and demand of the currencies involved. Since the supply of a fiat currency is infinite as it could be “printed” by the central bank concerned, the upper end of the market exchange rate of a currency in a normal functioning market is actually determined by the central bank printing the right amount of the currency needed. So currency market exchange rate moving upwards caused by a trade surplus is not only limited, but also temporary. On the other hand, a currency market exchange rate moving downwards or even plunging is often caused by the “overprinting” of the currency by the central bank. Wild currency exchange rates fluctuations, which are very damaging to ordinary businesses, are the results of the currency speculations, especially by the hedge funds.
    The reason why there is no RMB market is because China decided at the beginning of “Opening Up and Reform Policy” to use the dollar for her foreign trade settlements and investments. So the RMB needs not have a market rate as it was mainly for domestic use. At the time, what the PBOC did was to set US$-RMB rate for domestic banking purposes and there was no compliant from anyone about China’s US$-RMB domestic rate.
    “If China buys lots of raw materials or other things, equalizing the imbalance, that would be great. Seems to me, China ought to want to do this in the absence of the employment impact to its export industry. ….”
    China has been buying lots of raw materials and other things in the last few years. That is why commodities prices remain very elevated even during the years following the 2008 Great Financial Crisis. Commodity exporting countries across the globe have all benefited substantially directly or indirectly from such purchases. That is also why China’s trade surpluses have been declining sharply in the last few years.
    On hindsight, only if she has started to do so earlier when her exports started to accelerate, she would not have such a huge foreign currency reserves headache today and those raw materials and other real assets would worth far more today than the costs of purchasing them.
    “…… So why don’t they let the RMB float or at least appreciate to the point of balance? I think we all know the reason.”
    China cannot let the RMB “float” at the moment simply because the foreign currency markets are not functioning normally. The dollar is now junk currency; the euro is not much better off and the yen is sick. Are you sure you want the RMB to appreciate against the dollar to the point of balance? Do you know what that point of balance would be? If you are thinking that it is between 20% to 50% appreciation, you are going to get a very nasty shock. You don’t know how junk the dollar has become. Have you seen the 4 videos in the first post?
    Have you ever wonder why so many US Administrations have refrained from naming China a “currency manipulator”? Have you wonder why legislations that seek to penalize China seriously for “currency manipulation” somehow die in the US Congress before it could become law? If you have considered the consequences of China stopping “manipulating” the RMB on the value of dollar as discussed in my 1st post here, you would have known why.
    Anyway, the day when the RMB floats freely in the foreign exchange market as desired by so many Americans and others is not very far away (say, within 10 years) as China, under threat of trade or currency war, is seriously divesting herself from the use of the dollar for her foreign trade settlements and investments. She is promoting the use of the RMB and her trade partners’ currencies for such purposes, instead. And she has made excellent progress in this direction in the last two years. The US could hasten this day by actually taking actions against the alleged “RMB Manipulation” by China.
    “Remember what Wen Jiao Bao said last year: “a drastic re-evaluation of the yuan and a 20 to 30 percent rise would cause the bankruptcy of numerous enterprises and severe unemployment. Many migrant workers would have to return to the countryside.” He clearly ties the RMB level to mainland employment.”
    Premier Wen was talking about the effects of “a drastic re-evaluation of the yuan” of 20 to 30 percent. The RMB has, in fact, already appreciated in real terms more than 30% against the dollar since 2005 and the disaster he mentioned has not happened. You can do an experiment here: go and demand a business owner nearby your place to increase his prices immediately by 20% and find out what he would think of you.
    “By the way, those rich countries aren’t so rich. China has lent them the money because it chooses not to adjust its exchange rate or purchase goods in the world market. So now the US government is more leveraged by trying to maintain demand over the last 2 years as the US consumer deleverages. Meanwhile, China chides the US for its profligate ways at a time when it should be hopeful that world demand can continue to buy its exports.”
    From China’s perspective, countries with a GDP per capita of more than 10 times China’s, they are rich countries.
    Generally, China has not lent money to these countries. She has invested in the sovereign bonds which are purchased in the open markets. So China is neither their banker nor creditor. She is an investor in these bonds.
    The US is indebted heavily because her elected leaders borrow massively from the future and present generations and sell many trillions of dollars of bonds to foreigners, to buy the votes of the present generations and to maintain a monstrous military that she cannot afford.
    Don’t get the Chinese message wrong. China was yelling that another tidal wave of dollar flooding massively into China may compel her to stop “manipulating” the RMB and causing it to float freely in foreign exchange market. That would also be the end of the Chinese support for the value of the immensely overprinted dollar. Read my first post again.

  • Jamar

    @lpc1998
    “There is no market rate for the US$-RMB exchange”
    So tell me, what’s going on when I go to a bank in Japan, hand them RMB, and they give me yen? Or a booth in Hong Kong where I do the same but receive HK$ instead? Heck, I can go to a Bank of America back home, deposit RMB, and watch it be exchanged to US$ before hitting my American account. It’s being traded already to some degree (unless you think all of that goes back to China; more likely it gets sold to someone going to China at a certain rate which makes them more profit); that’s where one would draw the “market rate” from.

  • CanuckinCT

    Dan – you might not completely understand how the VAT works (understandable for most Americans). While the VAT is levied on the business inputs in China, most VAT registered businesses in China would recover the input VAT paid on purchases, by way of the credit that is available under the VAT system. This ensures that the VAT paid by a business is not a cost to the business. When the goods are sold to the final customer they are levied with the VAT at the prevailing rate, which for customers in China is at the 17% or 13% (reduced rate) and for customers outside of China where the goods are exported at the 0% (zero-rate). It is inaccurate to call this a rebate, as the input VAT which the chinese manufacturer incurrs is refunded via the input tax credit (ITC) and is equally available to the manufacturer regardless of where their customers are (domestic or export).
    This of course is completely contrary to how sales taxes work and why sales tax in the US harms business and is a cost to US business. Were the states to gravitate their sales taxes towards VAT systems, businesses would see their costs go down as the tax burden shifts to the final customer. More importantly, were the US to adopt a federal VAT, this would answer the question of “unfair, low cost, untaxed imports” entering the US by creating a level-playing field wherein a US VAT would be imposed on all imports into the US. There are many reasons that more than 140+ countries around the world have the VAT and many questions why the US is one of the few outliers (along with places such as Malaysia, Burma, Hong Kong and the Middle Eastern countries).

  • slim

    Work through this to clear up confusion sewn by lpc1998:
    http://mpettis.com/2011/08/foreign-capital-go-home/

  • lpc1998

    @ Jamar – September 13, 2011 7:23 PM
    “@lpc1998
    “There is no market rate for the US$-RMB exchange”
    So tell me, what’s going on when I go to a bank in Japan, hand them RMB, and they give me yen? Or a booth in Hong Kong where I do the same but receive HK$ instead? Heck, I can go to a Bank of America back home, deposit RMB, and watch it be exchanged to US$ before hitting my American account. It’s being traded already to some degree (unless you think all of that goes back to China; more likely it gets sold to someone going to China at a certain rate which makes them more profit); that’s where one would draw the “market rate” from.”
    The “market rate” in the context of my post refers to the foreign exchange market rate:
    http://en.wikipedia.org/wiki/Foreign_exchange_market#Market_Size_and_liquidity
    Do note who are the usual market participants in foreign exchange market listed in the link and that the amounts of currency trades done by them are in the trillions of dollars.
    What you have done at the various countries and places is no difference from those bank customers in China. They exchange (not trade) foreign currencies for yuan or vice versa for personal or business use. These banks including the foreign ones in reality act as service centres for the PBOC which sets the daily currency exchange rate for the RMB and the price you pay for the currency exchange is that rate varied by the service charges.
    As the RMB is not freely traded in the foreign exchange market like the dollar, euro or yen, there is no market rate for it.

  • Hua Qiao

    @ipc
    Most of your rebuttal points are nonsense. Doesn’t matter if the an exporter goes to a bank or the pboc, it is the pboc that sets the exchange rate. Why doesn’t the pboc vary the rate to allow the market to clear and the current account to balance?
    As for the inflationary effect to the US of an appreciating RMB, bring it on. We don’t mind a little inflation. This would also protect China from inflation and those junk dollars you talk about. Why is it that China keeps accumulating these if they are junk? The reason is that they must. It is an arithmetic certainty if they run a current account surplus.
    You cannot simultaneously 1. Control cross border capital flows 2 . Control the exchange rate and 3. control the money supply.
    As for your assertion that investing in US sovereign bonds (i presume you mean treasuries) is not leniding to the US, well, that is nonsense. If you own a treasury bill or bond, you are a creditor of the US Treasury. Hard stop.

  • lpc1998

    @ Hua Qiao – September 15, 2011 6:46 AM
    “Most of your rebuttal points are nonsense. …..”
    You are obviously a mythology lover. My posts mainly deal with the facts regarding the RMB. And facts, being “rebuttal points” to you, are nonsense.
    “…… Doesn’t matter if the an exporter goes to a bank or the pboc, it is the pboc that sets the exchange rate. Why doesn’t the pboc vary the rate to allow the market to clear and the current account to balance?”
    The fact here is the PBOC could not and does not intervene in the foreign exchange market unlike the other central banks that do. This is because the RMB is not freely traded in the foreign exchange market. Any talk of China selling the yuan to keep the RMB substantially undervalued is mythology. So any talk that in doing so, China derives big trade advantages is mythology. Do note that the US$-RMB exchange rate is an administrative exchange rate mainly for China’s domestic banking purposes determined at discretion of the PBOC. There is absolutely no need to buy or sell the yuan for the dollar to maintain the US$-RMB exchange rate.
    The talk that trade surplus MUST lead to higher exchange rate to an even freely traded currency in the foreign exchange market is mythology. This is because all or most currencies traded in the foreign exchange market are fiat currencies without intrinsic values and with infinite supply as they are “printed” by their respective central banks. In other words, central banks could and do print the necessary amount of currencies to maintain the desired exchange rate in the upper range of a traded currency. The exchange rate of the currency is ultimately determined by supply and demand of that currency in the foreign exchange market and as pointed out earlier on, fiat currencies could have infinite supply.
    Any talk that China runs a trade surplus to support employment is mythology. A lot of employment in China is generated by investments in the manufacturing sector of the economy for exports. Trade surplus is caused by a deficit of import over export. The US buys lots of things from China, but refuses to sell many high-value things to China on national security grounds. As a result, she suffers massive trade deficits with China. The US is not doing her best to sell to China. Do note that countries like Germany, Japan, South Korea and even tiny Singapore are selling proportionally more manufactured goods to China than the US.
    “…. Why is it that China keeps accumulating these if they are junk? The reason is that they must. It is an arithmetic certainty if they run a current account surplus.”
    It is not an arithmetic certainty. It is practical reality. Current account surplus can be eliminated by increasing import. Enormous inflows of dollars into China owing to dollar dumping by the dollar holders by means legal or otherwise, cause huge surge in the increase of China’s foreign currency reserves even during the months when there are trade deficits. In view of the situation, now and in the future, the floating of the RMB in the foreign exchange market is inevitable. The root problem holding back the floating of the RMB is the use of the dollar by China as the primary currency for her foreign trade settlements and investments. From the current trend, this problem would be substantially resolved within the next 10 years. Just have a bit more patience and your wish will for a freely floating RMB come true, but your desire for elimination of China’s trade surplus will not for a very long period of time.

  • Hua Qiao

    The pboc doesn’t need to intervene in the currency market because it makes the market. It is the market and, as you point out, it sets the rate administratively. I presume there are a lot of lawyers, skilled in logic argumentation, who read this blog and will find your arguments specious.
    As to supply and demand of currency, the consequence of China’s accumulation of dollars is a huge growth in domestic money supply (all the RMB that goes into exporters accounts). The pboc is desperately trying to offset this thru reserve requirement adjustments in order to reduce velocity and slow the inflationary effect. The pboc, while “printing the money” is taking it back in the form of reserve requirements and other sterilization techniques.
    As to the hot money flowing into China, it is because everyone knows the rmb in undervalued and they are betting it will appreciate
    As to your point about the US choosing not to sell sensitive technology, well, i would only point out that this very blog is, to a great extent, about the IP issue. I’d like to ask the Russians about the sale of the SU33 fighter to China. Or how about kawasaki or the French with their high speed train technology. I’d ask them “How’d that work out for you?”
    As to true free floating, convertible currency of the RMB, i look forward to it. We’ll see. Relying on the market means you lose control. Not sure if China policy makers are comfortable with that.

  • Tim

    Feel like I must have missed half my Int’l Finance and Trade class when I read ipc’s take on rmb exchange rates.