Most currencies in the world trade at their market value.  This fluctuates due to political/fiscal policies, budgets, relative strength of the domestic economy and many other factors.  Sometimes, it is healthy for an emerging market to peg their currency to a stronger currency like the dollar.  This saves them the hardship of inflation and investor speculation until they can raise their industries out of infancy and stand on their own two feet.

This is a valid argument for an emerging market.  However, in terms of a robust nation like China, there is no reason to keep their currency from fluctuating at market rates.  Let me rephrase that, the only reason for China to keep their exchange rate constant is a selfish one intended to greedily draw in as much growth/wealth as possible while other nations struggle to recover.

Estimates range about how undervalued the yuan is.  My best guess is a solid 25-30%.  If this is true, it represents an enormous cost advantage over other nations that produce goods.  The fact that this is anticompetitive and hurtful to other nations is not up for debate, the next step for the United States, however, is a point of disagreement.

There is a growing contingent in the United States that believes China needs to be met head on regarding their currency policies, strength on strength.  Unfortunately, there are several things that stand in the way of the United States convincing China to do anything.

First, the current state of the dollar makes for a weak bargaining chip.  Without some hard nosed budget cuts and fiscal reform, the dollar could lose status as the most reliable source of value in the world.  In terms of telling China what to do about their policy on currency, we may not be best equipped for a persuasive argument.

Also, try to remember that China owns a large portion of our national debt.  Now, take into account that the last thing China will ever do is sell a large portion of this debt.  It is in their worst interest to do so, but they will still use it to convince the United States that they hold power.  This is a compelling argument to most politicians, who do not understand the complexities of divesting such a large sum of treasury securities in the current markets.

The most pressing issue, however, is that of political relations.  China is struggling to become the peer of the United States, and being bullied will only further strengthen their resolve.  The right approach is crucial when dealing with China right now.  A trade war would hurt the United States more than it would hurt China, especially if they remain steadfast on their currency policies.

Representative Michael Michaud, a Democrat, recently said that, ”if the administration fails to act on this issue it will hold back our economic recovery and hurt the ability of American small businesses and manufacturers to increase their production, keep their doors open, and create jobs.”

Unfortunately, if the response from the US is too strong and combative, it could create a situation even worse than the one we currently face.  Although the currency is creating issues economically, those issues pale in comparison to the political fallout that could result from making China an enemy.

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