When I was a child my elementary school – Immaculate Conception School – held two fairs each year, one in the fall and one in the spring. At these fairs we students bought little red tickets that we could then exchange for food, trinkets, and game-playing offered for sale at the fair’s many booths. Of course, some items cost more than others. A giant stuffed panda bear might be priced at, say, 30 tickets, a hot dog at 3 tickets, and a pencil sporting the school logo at 1 ticket.

In order to purchase anything at the fair, we needed those tickets; we could not spend dollars directly at any of the fair’s booths. And so using dollars, each of us students bought as many or as few tickets as we pleased (or, more accurately, as many tickets as our parents allowed us to buy). Tickets in hand, we then entered the fairgrounds to spend them on whatever wonderful goodies caught our fancies.

The purpose of these fairs, obviously, was to raise money for the school. I’m sure that the school’s principal, Sister Quentin, was determined to raise as much money as possible.

What Is Seen and What Is Not Seen

But suppose that Sister Quentin reasoned in the following way: the school raises more money the greater the quantity of things students buy at the fair; students will buy a greater quantity of things at the fair the lower is the dollar price of the tickets used to buy things at the fair; therefore, the dollar price of these tickets should be set very low to encourage students to buy lots of them.

Sister Quentin triumphantly concludes that by keeping the dollar price of tickets especially low, the school ensures that the volume of fair sales will be especially high and, thus, the school will be enriched.

If Sister Quentin were to describe her plan to you, surely you’d point out its core flaw, which is this: if the dollar price of tickets is set below a level that enables the school to cover its costs of acquiring the goods and services sold at the fair, the school will lose money. While Sister Quentin’s scheme of undervaluing the tickets will indeed increase the volume of sales made at the fair, this scheme results in the school, on net, transferring economic value to the fair’s customers rather than the school getting net economic value from those customers.

So the students gain because the undervalued fair tickets subsidize their consumption. Further, because the fair does make more sales, also reaping benefits are the people paid to work at the fair, as well as the merchants who supply the food and trinkets sold at the fair. But without question the school itself is made poorer.

Think of Yuan as Tickets That Americans Use to Buy Chinese Goods

Although a school fund-raising fair differs in many ways from a country, the lesson above about the underpricing of fair tickets applies to undervalued currencies.

If a government manages to undervalue its currency in terms of foreign currencies, it subsidizes the consumption of foreigners who purchase its country’s exports. And while gains are reaped by those of its citizens who work to supply goods for export, currency undervaluation makes most of that country’s citizens poorer.

If, for example, Beijing successfully arranges for Americans to purchase Chinese yuan at below-market prices, Chinese exports to America will indeed rise, and American exports to China will fall. Chinese firms that sell more to Americans will reap artificial benefits while American firms whose sales fall as a result of the undervalued yuan will suffer. (For the record, I have real doubts that Beijing succeeds in keeping the value of the yuan against the dollar artificially low. But for my purpose here I take as true the claim of many protectionists that the yuan is indeed undervalued.)

Yet despite visible gains to Chinese exporters, the Chinese people as a whole will be made poorer by an undervalued yuan. After all, to produce additional goods to ship to America requires real resources. (These goods are not crafted literally out of money.) And these real resources must come from somewhere. These come from the Chinese people who, because of the undervalued yuan, can purchase for their own use fewer goods and services than otherwise.

Also, despite visible losses of some American firms, the American people as a whole will be made richer by an undervalued yuan. After all, American buyers – final consumers as well as American firms that use Chinese imports as inputs in production – are the lucky recipients of the additional resources that Beijing’s currency policy extracts from the Chinese people.

The real costs of goods exported to Americans by the Chinese people are not lowered simply because Beijing keeps artificially low the dollar price of the tickets – yuan – that Americans use to purchase goods and services in China. Indeed, because any “successful” undervaluation of the yuan relative to the dollar artificially drains real resources out of China and into America, such undervaluation impoverishes China as it enriches America.