Understanding Why The China Currency Issue Matters

China has been very smart about looking out for its own interests.

As a developing country China had natural advantages in selling goods made in China and in attracting manufacturing from other countries. A significant advantage was that their currency was valued very "low" or "weak." There was not a lot of demand for Chinese currency so they had to offer more of their own currency to acquire the currency of other countries in order to import goods. This low currency rate meant that Chinese resources and labor were inexpensive compared to countries with stronger currencies, so goods made in China cost less.

Over time the Chinese government and Western countries invested in developing China's manufacturing infrastructure, helping to bring people out of poverty and frankly to channel potential conflict pressures into the marketplace. So China was able to put resources into industrial investment instead of military. This was generally good for China and the world.

There came a point where China had developed sufficiently to be competitive in its own right. Natural market forces should have brought balance, but those forces were instead interfered with. The best example of this is the value of their currency. As China developed demand should have increased for its currency, raising its price or making it "stronger." A stronger currency would have caused goods made in China to rise in price, allowing goods made in other countries to compete in the world, and in China. And it would have enabled China to buy more from the rest of the world. This is balance. This is how a true free market can be beneficial for all involved.

But China does not want to lose the advantage that a very cheap currency brings them (and to companies from other countries that are benefiting from this arrangement) so they interfered with this market process. They use the proceeds from their manufacturing to buy up currency from competing countries, changing the supply and demand equation to keep their currency low. (If China is willing to pay more to buy your dollars or pounds, why accept less?) Meanwhile this pricing advantage brings even more sales of Chinese-made goods, increasing their manufacturing advantage even more.

The result of this currency manipulation is that goods made in China today enjoy a price advantage of up to 40%! And that advantage is increasing, which means even if China allows its currency to appreciate 5% in the next year, while their advantage also increases by 5%, they start up and end up with a 40% advantage!

The world is unable to compete with this 40% advantage. At the same time China now controls enough of the world's manufacturing that they are starting to change the terms of deals for companies trying to do business in China.

The Chinese currency problem certainly is not going to go away. And it is really just one piece of a larger problem involving government subsidies, labor suppression, environmental degradation, theft of intellectual property and other violations of trade rules. It is a huge bubble, that is expanding rapidly. It cost 2.4 million American jobs between 2001 and 2008.

The sooner this is dealt with the better. Bringing the trade relationship back into balance will help American workers, American manufacturers, Chinese workers, Chinese importers and the rest of the world. Letting the problems grow and grow until it all breaks down -- and it will -- is a recipe for disaster.

Views expressed on this page are those of the authors and not necessarily those of Campaign for America's Future or Institute for America's Future