China and the U.S. Housing Bubble

We often write about how China’s policy to devalue its currency, the yuan, has been a key factor in the U.S. trade deficit.

It’s not an easy issue to grasp. But economist Paul Krugman devotes an entire column to explaining why China’s devalued currency has such ramifications for our country. Here’s Krugman:

If supply and demand had been allowed to prevail, the value of China’s currency would have risen sharply. But Chinese authorities didn’t let it rise. They kept it down by selling vast quantities of the currency, acquiring in return an enormous hoard of foreign assets, mostly in dollars, currently worth about $2.1 trillion.

Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.

Read the entire column here [1].