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Is Chinese Currency Policy a Form of Protectionism?

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The answer is clearly yes, as China interferes with the free exchange system by purchasing, hoarding foreign currencies to prevent an organic rise in the yuan's value.

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Editor's Note: This is Part 1 of a multi-part series. Click here to read Part 2 and here to read Part 3.

For the purposes of this article I define protectionism in the following manner: State-directed, sponsored, or sanctioned intervention in the system of free economic exchange which protects or promotes domestic industries against foreign competition in domestic markets and/or foreign markets.

The Chinese government, through its central bank and various other mechanisms, intervenes massively in the free exchange of global currencies. Nobody can deny this.

How do we know that the Chinese government massively intervenes in the global free exchange of currencies? This is a matter of public record. Over the course of only a few years China's massive net purchases of foreign currencies has caused an accumulation of foreign currency reserves currently valued at the equivalent of about $2.65 trillion USD. This level of currency intervention is historically unprecedented. The explicit goal of China's policy is to prevent the yuan from appreciating to levels that it otherwise would.

In a free and well-functioning market, the value of the yuan relative to the US dollar (as well as other global currencies) would have to be much higher than it is currently due to two factors. First, China runs a massive trade surplus with the US and the rest of the world. If Chinese exporters freely converted their foreign exchange earnings on the open market into yuan, the value of the yuan relative to these foreign currencies would naturally rise. Second, because of its abundant and inexpensive labor and other productive resources, China attracts massive amounts of foreign investment -- far exceeding the demand of Chinese investors for foreign investment assets. Thus, the surplus inflows of foreign exchange attracted by foreign investments in China should naturally be expected to increase the value of the yuan relative to the currencies employed by foreign investors.

Taken together, surplus trade inflows and surplus investment inflows create an excess quantity of USD (and other currencies) relative to yuan in the FX market. In a well-functioning market, the price of the yuan would rise until the trade and investment flows of USD versus yuan are equilibrated.

Exchange Hoarding and Fair Play: Past and Present


China doesn't allow the yuan to appreciate relative to foreign currencies in the manner that would occur in a free and well-functioning market. It does this essentially by taking US dollars off the market (or restricting their supply) -- a practice known in commodity markets as "hoarding." In commodity markets, hoarding is employed in order to cause an increase in the exchange value of the commodity being hoarded. In the case of China, the commodity being hoarded is the US dollar.

"Hoarding" is also the term that was historically applied to a practice by nations consisting of accumulating gold reserves (hoarding gold reserves was historically today's equivalent of hoarding reserve currencies such as the USD) via the promotion and perpetuation of persistent foreign trade surpluses.

The mercantilist policy of promoting persistent trade surpluses and the hoarding of gold reserves was widely attacked by classical economists in the 18th and early 19th centuries as unfair, exploitative, and prejudicial to global prosperity. Such practices have even been characterized by classically inclined historians as instruments of economic warfare and cited as prime instigators of international military conflicts.
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