Why China Wants to Dump the Dollar

By Chriss W. Street 

www.dailypaul.com

China’s Dagong credit rating agency on October 17^th downgraded its United States sovereign credit rating to A- and maintained its negative outlook on America’s solvency. Dagong warned that despite Washington's last-minute resolution of the debt ceiling deadlock, “The fundamental situation that the debt growth rate significantly outpaces that of fiscal income and gross domestic product remains unchanged.” 

China's official state-run news agency, Xinhua, reiterated its statements that because of the continuing risk of a U.S. debt default, it is “a good time for the befuddled world to start considering building a de-Americanized world.” This language is code for China wanting to abandon the U.S. dollar as the world’s “reserve currency” and move international financial transactions to the renminbi, the currency of the People's Republic of China. 

Having benefited for twenty years from their under-valued currency, importing manufacturing jobs, and exporting lower priced products, China’s comparative advantage is being destroyed by America’s oil and natural gas fracking boom. The Chinese communist authorities are terrified their loss of competitiveness will cause unemployment and the social consequences that flow from it. But with the terms of trade now substantially against China, convincing the world to dump the U.S. dollar as reserve currency and switch to the Chinese “renminbi” is their best hope to try to save tens of millions of manufacturing jobs. 

When the Soviet Union collapsed in the early 1990s, China’s economy began to implode and inflation skyrocketed from 10% to 25%. The United States, Europe, and Japan saved the Chinese economy by allowing China to devalue their currency by 68% and gain tariff free export to the world’s largest markets. Under this new communist form of capitalism from 1993 to 2008, China’s economy quadrupled, the U.S. economy doubled, Europe's rose by half, and Japan's stagnated.

Contract manufacturing is a very competitive business and historically had an average profit margin of only 3.5%. This assumes uncontrollable costs of about 75-80% for purchased inputs and 13.5% for energy. The companies primarily compete over managements’ ability to get more or less productivity from an average of 8.5% in labor cost, but China’s labor rates were initially 75% cheaper than the U.S. By moving production to China, manufacturers could often double their profit margins to 7% of sales. Once in China, manufacturers could also discount their sales prices to wipe out U.S. competition.

U.S. trade “experts” in 1993 expected Chinese workers’ total factor productivity (TFP) would be less than a quarter of American workers’ 1.25% annual productivity gain. This may not sound like allot, but over a 15 year period Chinese manufacturers would produce a unit for 95% of original cost and U.S. manufacturers would be producing the same unit for 82% of cost. The “experts” predicted few jobs would be lost to China, and America would gain new markets for high tech manufactured goods. 

Over the next 15 years, China grew the number of assembly workers involved in manufacturing for export to over 200 million workers. America lost about eight million manufacturing jobs to China, 40% of our 20 million production jobs. But even more damaging, every manufacturing job also lost four service jobs and another 1.58 manufacturing jobs from sub-assembly manufacturers who locate near their customer.

China understood that as it sucked manufacturing jobs out of the U.S., the Chinese renminbi currency would be expected to rise in value and destroy their “cheap” labor advantage. As a communist nation, they adopted a national policy of recycling a portion of their export sales revenue into the purchase of U.S. Treasury bonds to drive up the value of the U.S. dollar versus the Chinese renminbi.

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