August 13, 2015
Yes, I know oil is priced in dollars, not euros, but it doesn’t make one iota of difference. In an article on the meaning of the drop in the value of the yuan on people in the United States, USA Today told readers:
“China, the world’s second largest economy, consumes a lot of oil, second only to the U.S. However, oil prices are denominated in dollars, so a gutted yuan means China’s purchasing power is reduced, which could prompt the Chinese to spend less on oil-based products. That reduction in demand could lower prices, an upside for American drivers.”
Everything in this paragraph would be equally true if oil was priced in euros. The Chinese currency is now worth less measured in dollars, euros, yen, or oil. The loss of purchasing power will lead China to buy less of everything that is produced abroad, including oil. The fact that oil is priced in dollars matters not at all.
As a practical matter, anyone hoping to get super cheap gas due to less demand from China is likely to be disappointed. If we assume that the 2 percent drop in the value of the yuan leads to 2 percent higher gas prices in China, and we assume an elasticity of demand of 0.3, then China’s gas consumption will fall by roughly 0.6 percent as a result of the devaluation. This almost certainly has less impact on the demand for gas than even a one-year reduction in China’s growth rate by 2 percentage points. If the devaluation and other stimulatory policies speed growth in China, then we may see increased rather than decreased demand for oil from China.
The piece also gets the story of U.S. companies manufacturing in China somewhat confused. It tells readers:
“Many U.S. companies do a considerable amount of their business abroad, either selling directly to Chinese consumers, manufacturing or via overseas units that produce income in the local currency. Apple, for example, relies on China to make its iPhone and iPad. A stronger dollar compared to the yuan means any income generated in China loses value as it is repatriated back to America.”
Actually the impact is the opposite. The lower valued yuan increases the profits from manufacturing in China rather than the United States. Apple will likely still sell its iPhones and iPads at the same price in the United States and other countries, even though it now costs them less money to manufacture them because of the lower price of the yuan. This means greater profits.
This is an important point because the issue of currency values is often presented as one pitting the United States against China. That is not accurate. Many companies that manufacture in China or rely on importing low cost goods produced in China, like Walmart, have a real stake in keeping down the value of the yuan against the dollar. These powerful interests are a main reason that the United States has not made raising the value of the yuan a top priority in trade negotiations with China.
If it really was the case that the United States government considered it a top priority to raise the value of the yuan against the dollar, and was prepared to make concessions in other areas, like enforcement of Microsoft’s copyrights and Pfizer’s patents, then China would almost certainly have agreed to raise the value of the yuan by more than it has.
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