You may have heard about the trade deficit with China. I’m going to explain the source of the deficit and why it has to stop.
Here’s how it works:
Let’s take cell phones as an example of something that’s made in China.
Say an American company like Apple wants to have phones manufactured. Apple finds out that china can do it for cheap. Apple sends the Chinese manufacturer US dollars to have cell phones made.
Now, the Chinese manufacturer can’t use USD to buy stuff in China. Business in China is conducted with Chinese currency, the yuan.
Under normal trading circumstances, the Chinese manufacturer would have to exchange those US dollars for yuan. This would increase the demand for the Yuan. This increase in demand would increase the yuan’s value and price.
Eventually, cellphones made in China would become more expensive. This would give manufacturers in other countries a chance to compete.
Unfortunately that doesn’t happen. I’ll explain why in just a minute.
First, I want to illustrate this example with numbers.
Say it costs an American manufacturer $100 to build a phone. China can do it for 80 bucks, so Apple chooses to have its phones made in China. Apple buys 10 million phones for a total price of 800 million. Now China has 800 million USD that it can’t really use.
In order to use the USD the Chinese manufacturer has to convert the USD into yuan. This increases demand for yuan an causes the currency to go up in value.
The increase in currency value makes everything more expensive in China, including phone components. The Chinese phone manufacturer therefore has to increase the cost of the phones it produces.
After enough trade, the prices difference between Chinese and American made phones would even out.
At this point, American manufacturers could make phones for the same price as the Chinese manufacturers, maybe even cheaper. American phone companies would then naturally choose to have their phones made in the US rather than in China. This would be great. It would create jobs in America and it would boost our economy.
This is free trade.
Unfortunately China prevents free trade from really happening. China cheats to keep its prices artificially low.
China prevents its currency from going up in value due to demand. It just prints more money to fulfill the demand.
This is how China devalues its currency. China keeps the Yuan cheap no matter how much demand there is. They simply make more of it. This keeps the price down and gives them a huge advantage in manufacturing. It makes it virtually impossible to compete with them.
This is what creates the deficit.
China manipulates its currency to keep their prices low. We then buy lots of stuff from them, and they don’t buy anything from us.
Here’s what else they do: Instead of exchanging their surplus USD for Yuan, they use those USD to buy our assets.
They buy our treasury bills and bonds (US debt), our companies (stocks) and other US assets like real estate.
They cheat and steal our manufacturing, our jobs, our country’s debt and our assets.
This has to stop.
We can stop it by negotiating better trade deals or by slapping them with tariffs.
Some ignorant pundits and newspaper writers oppose tariffs because they say it isn’t “free trade.” They don’t understand that we HAVE to tax Chinese goods to keep things free and fair, because China cheats.
China also rip us off by stealing our intellectual property, however that’s a story for another day. Stay tuned.