If China were to let its currency float, commodity prices would soar

But this would be a good thing.

Krugman says China's currency is clearly undervalued.  Clearly, he's right.  And this is hurting China, hurting the US, and hurting the whole world's economy.  China could solve their inflation problems without curbing growth by simply letting their currency float.  And their proposed price controls could make things a lot worse.

Now, if China were to abandon these destructive policies, I think it's also clear that commodity prices would soar, at least as measured in dollars.  (Prices would fall in Renminbi, and perhaps other currencies.)  This would likely elicit howls from some who might fear that rising oil prices would stifle domestic recovery.

But I think those fears would be misplaced.  Because while oil and other commodity prices would rise, so would foreign and domestic demand for goods produced in the U.S.  This would stimulate our economy and push us back toward full employment and capacity utilization.  That is, commodity prices would rise due to a demand shock, which is quite unlike the supply shocks prevalent in our history.

The phenomenon would be much like some of commodity price increases we've seen recently with QE2 and a falling dollar.

Anyway, I'm just trying to emphasize that not all commodity price shocks are the same, and I think we currently have little to worry about--in terms of impacts on inflation or broader economic activity--from commodity price increases stemming from a weakening dollar.

Comments

  1. That is why I advocate a hedge in metals: APMEX has one of the lowest premiums around for Gold and Silver: http://bit.ly/anCEr0

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  2. so what you're saying is, we should have our real terms of trade trashed so that we can put our populace to work making things for foreigners. how is this better then putting our populace to work making things Americans need (like installing green technology, building public infrastructure and transportation, rebuilding our neighborhoods etc)?

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  3. Nathan:

    I think our trade terms are currently highly distorted (trashed?) and I would like to see them aligned more closely with real values.

    All the things you mention:"like installing green technology, building public infrastructure and transportation, rebuilding our neighborhoods" are likely to happen faster if China were to stop pegging its currency to the dollar.

    There would be some downsides to the transition (we wouldn't like higher gas prices), but overall demand of US-made things would go up, which help to increase income, employment and reduce debt.

    It would be good for China too. They don't have debt but they have rapidly increasing inflation. A higher-valued currency would quell inflation and increase domestic demand relative to export demand, which is what they really need to sustain their growth going forward. A correctly valued currency would also quell the need to for higher interest rates and price controls, which will curb their growth.

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  4. @ Nathan: "...so that we can put our populace to work making things for foreigners."

    All of the things you mentioned in your comment are important and should be implemented immediately. But here in East Asia, countries and companies learned long ago that "making things for foreigners" pays the bills and makes for full employment, positive trade and current account balances, and full foreign reserve holdings; in short, vibrant economies. But, hey, if you're satisfied with a dysfunctional economy and a national unemployment rate of 9.6%, be my guest.

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  5. A higher Remimbi would doubtless help exports, but with some caveats: 1) the nominal effect (higher ag and industrial materials prices) might be stronger than the real effect; 2) the export sector is relatively small; and 3) higher commodity AND consumer goods prices would hurt the middle class and seniors; 4) in the absence of QE, a Chinese trade deficit would raise U.S. l.t. interest rates and harm housing.

    Yes, manufacturing employment would benefit, but consumer confidence might plunge. Why should we expect the former effect to be stronger than the latter?

    One thing to consider is that a shift to consumption in the Chinese economy would require relatively little real import growth from the U.S.. Ag would benefit, but consumption of consumer goods would proceed through "export substitution" -- diversion of TV, shoe, etc. production to internal demand.

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