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The Law of One Price

Thomas Shelton, CPA

“The Law of One Price states that in competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency”. (Global Business Today 6e, Hill p. 316)  Based upon this principle, if the Chinese currency is pegged to the dollar, similar products in China and the United States would have the same value in the terms of dollars.

Even though the Chinese has allowed it currency to peg against the dollar in recent years it has changed its philosophy somewhat by allowing the Yuan to be valued with respect to a basket of several other currencies.  This policy has had a direct effect on the import and export of products from the perspective of producers and consumers with who trade is carried on.

If the Yuan is weaker than the dollar then it will take more Chinese currencies to buy goods imported from the United States whether it is used in Chinese production or consumed by the Chinese People. On the other hand, if the dollar is weaker then the Chinese could by more goods. If China uses these goods in production that is exported to other countries, then depending on the strength of the Yuan at the time of their purchase, the costs to the developing countries would be affected by price volatility.

The same economic factors will affect the United States in similar ways.  If the dollar is stronger than the Yuan, then the price of the exports to China will generate greater revenue for the producers located in the United States.  The imports from China will be bought at a cheaper price because the dollar can buy more goods to use for personal consumption or in production.  If the imports are used in production, then the cost to the consumer should be lower, again because of the price volatility.

Producers in developing countries are directly affected by the values of currency, as it would directly be related to their costs of imports unless the currency they use is the same currency as the exporting country.

Overall, when we look at just the Chinese currency, some feel that “the effect on individual companies will depend largely on how much product they get out of China”. (Russell, “Importers, retailers mixed on China’s currency change No longer tied to U. S. Dollar, Furniture Today, July 21, 2005.  Others may see things a little different as Eric deCorbonnel related in his article “Hyperinflation will begin in China and destroy the dollar when he states “The media overwhelmingly presents China’s dollar peg as a win-win situation: Americans get cheap imports and low interest rates while China gets a strong manufacturing sector”.

In the end, careful detail should be given to all trading between countries to assure that the citizens are protected from unfair practices that can become available because of international trade.

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