On the yuan’s value
”I think it is correct that the Chinese government is keeping the yuan under-valued – estimates are anywhere from 15 to 40 percent undervalued. But I don’t think it’s as advantageous as many suggest. The first reason is somewhat theoretical: Who’s to say what the correct exchange rate is? Who’s to say that one U.S. Dollar is or isn’t worth eight yuans? The Chinese government has their hands in so many aspects of their economy that it’s impossible to tell how much their currency really is undervalued and so it’s not as if the market truly determines who gets what. The second reason is that if the yuan were to stay undervalued, then Chinese goods would be cheaper, increasing foreign demand for Chinese products, and inevitably, that would raise their prices. So in the long run, whatever advantage they have will disappear as the prices of their goods rise.”

On the development of the trade deficit
“It’s pretty straightforward why setting the yuan is a problem for us. What’s happened is that by keeping the yuan undervalued, Chinese goods tend to be cheaper. That has led to more imports coming from China than exports going to China. The difference is our trade deficit, to the tune of some $200 billion. A huge trade deficit may not be a big deal now, but if foreigners were to lose confidence in our economy, which it’s important to recognize is not very likely in the short run, then foreigners (including the Chinese) would not continue to finance our trade debt. Our economy would suffer greatly.”

On how jobs are affected
“That’s pretty simple too: When a company can make goods for cheaper abroad because the yuan is undervalued, they are going to take advantage of that opportunity by building goods overseas. That takes manufacturing jobs abroad.”

On the (bad) call for tariffs
“To even the playing field for U.S. companies, legislators have called for 25 to 30 percent tariffs on goods originating from China. I think it’s a bad idea for U.S. and Chinese interests. For us, the higher import prices are likely to trigger inflation – sustained higher prices is essentially what inflation is – and that will cause the Fed to bump up interest rates to curb inflation, which will in turn cause people to stop spending on durables, new homes, and other goods. That leads to a recession.”

On tariffs hurting China in other ways too
“In addition to the obvious affects of tariffs, their economy is so closely tied to ours that a downturn here will mean a downturn there.”

On Yavas’ solutions
“The root of the problem is the number of ways the Chinese government interferes with a free market. Setting the yuan to the dollar is just one example. They also have many state-owned companies that compete with the private sector, they give out huge subsidies, and they give major tax breaks to exporters. All of these affect the natural flow in an open market, so what needs to happen is for that government interference to be removed. It’s pretty ironic that we’re yelling at China for messing with open markets, and really, some politicians are suggesting remedying this with tariffs, which essentially impede on free markets themselves.”

On a good sign for free markets
”Last month, just before Chinese President Hu Jintau came to the U.S., China announced that they would let their citizens and businesses invest in foreign currencies for the first time. This was a very pleasant surprise because if they do invest abroad, it will help to balance out the yuan since demand for the yuan would fall relative to the supply, and domestic prices would rise. The adjustment would then help determine real value of the yuan. But there was a pretty low cap on how much they could invest abroad and it still remains to be seen whether Chinese citizens will jump at the chance to invest abroad. Even though it’s a step in the right direction, they think they can’t not remove the government restrictions all at once.”

On the problem with pulling all of the restrictions at once
“Even though the Chinese government should remove their influence from the market, they can’t do it all at once because that could drastically destabilize their economy. Their banks are riddled with non-performing loans, so a sharp spike in the value of the yuan could lead to banks failing, and worst case scenario: a banking crisis. The Chinese recognize this, which is why the foreign investment announcement is one baby step in the right direction.”

On what else we can do
“It’s not smart to impose tariffs, and really, we need to let the yuan develop a legitimate value over time since the Chinese are not going to do it all at once. Really, the only thing we can do that we control is lower our spending on imported products, save more, and simultaneously take measures to increase our exports. That’s not some message politicians are going to latch onto because it’s not what we want to do and it is a long-term solution – politicians typically do not have long-term horizons. The other thing is to continue to focus in areas where we have competitive advantage.”