Gold, More Relevant Than Ever
When Chinese President Hu Jintao visited the White House Wednesday, President Obama made sure to raise the contentious issue of currency values and press the Chinese leader to allow the renminbi to rise against the dollar. Not least among the reasons given was China’s $226 billion trade surplus with the US.
The problem: The Obama administration’s weak dollar policy is based on official trade data that grossly misrepresent the bilateral trade balance between two countries. According to the World Trade Organization (WTO), the actual US trade deficit with China is less than half the official number, or less than $115 billion.
The official trade data are based on a 19th-century world in which it was reasonable to assume that goods, from wine to machinery, were produced in a single country. If a bottle of French wine were imported to the US, the entire cost of the wine was credited to France in the calculation of the US-France trade balance.
While that simplified view of trade generally still holds for trade in agricultural products such as wine, it no longer reflects the 21st-century reality of global supply chains in all things manufactured.
Take, for example, the case of the Apple iPhone. Using the 19th-century approach, the entire $178 estimated wholesale cost of the iPhone is credited to China, because that is the place of final assembly. As a consequence, imports of the iPhone in 2009 contributed $1.9 billion to the US trade deficit with China.
In other words, official trade data imply that the invention of the iPhone has cost the US jobs, reduced our competitive position and made us poorer relative to the Chinese. That alone should cause any policy-maker to question the use of trade data in the development of international economic policies.
Here is what they would find: What the 19th-century approach ignores is that Chinese workers contribute only $6.50 to the value of the phone. According to a study by Yuqing Xing and Neal Detert of the Asian Development Bank Institute (ADBI), this is far less than the value add provided by Japan ($60.60), Germany ($28.85), South Korea ($22.96) or the US ($10.75).
When the value add from the US is taken into account, every iPhone imported into the US in 2009 actually contributed $4.25 to the US trade balance with China – the difference between the $10.75 of parts China imported from the US and the $6.50 in payments received for assembling the iPhone. That turns the $1.9 billion iPhone trade deficit with China using official trade data into a $48 million trade surplus.
Although this example is extreme, it does reveal how absurdly misleading current trade data are. In a speech last October that explored this issue, WTO Director General Pascal Lamy reported that “a series of estimates based on true domestic content cuts the [US-China trade] deficit by half, if not more.”
Moreover, the focus on the bilateral trade with China ignores that the overall US trade deficit with Asia has remained “at something like 2% to 3%” of US GDP for the past 25 years.
Lamy goes on to point out that the current methodology for measuring the bilateral trade also misleads policy-makers with regard to the impact of trade on employment and income. Of 41,000 jobs associated with the manufacture of the iPhone, 14,000 were located in the US. However, those American workers earned $750 million, while less than half that amount–$320 million–went to non-US workers.
Current bilateral trade data are simply not a reliable basis for understanding the competitive position of various countries, nor for the development of trade or exchange-rate policies.
Imagine, for example, the Obama administration got its wish and the Chinese renminbi rose relative to the dollar and all other currencies by 20% in the year ahead. Using the example of the iPhone, such an appreciation in the value of the Chinese currency would reduce the price of all of the imported components by 20%. As a result, only the cost of final assembly in China would be affected, rising 20% to $7.20. Assuming a full pass-through, that would increase the imported price of the iPhone by a mere 70 cents, or less than 0.5%. Hardly enough to alter trade flows.
In addition, such an appreciation of the renminbi would reduce the price of all raw material imports, including oil, iron ore, scrap metal and agricultural products, as well as all other imported materials necessary to feed its manufacturing base, thereby enhancing China’s competitive position relative to the rest of the world.
There may be valid reasons for the Chinese to allow the value of the renminbi to rise against the dollar, but attempting to reduce the bilateral trade account with the US is not one of them. A strong Chinese currency, however, would offset the inflationary forces that have been unleashed in its economy by the Federal Reserve’s pursuit of an inflationary monetary policy. Reducing US soft power in Asia by offering a more reliable currency than the dollar would also be consistent with China’s long-term strategic interests.
The results of the research at the WTO and the ADBI mean that the entire US approach to international monetary reform needs to be rethought. In a global economy with integrated international supply chains, the underlying assumption that changes in exchange rates can ameliorate trade imbalances no longer makes sense.
An approach far more coherent with the actual world in which we live would be to seek arrangements that lead to increased stability in exchange rates. Such an approach would reduce the disruptions, financial risks, and windfall gains and losses associated with the current system of gyrating currency values, leading to increased growth and employment in the US and the rest of the world.
Such a system would need a neutral reference point that would provide both an anchor of price stability to the entire international monetary system and a reliable indicator of which governments need to take action to adjust the value of their respective currencies. In that regard, World Bank President Robert Zoellick’s suggestion that gold be restored as a critical reference point in the international monetary system appears more relevant than ever.