"frenzy" on Congress, which is under pressure from uncompetitive American businesses and US workers seeking protection from cheap Chinese imports. The WSJ wants the Bush administration to focus instead on breaking down down the barriers shielding China's financial system from takeovers by US and other foreign banks eager to dominate the burgeoning Chinese home market.) ------------------------------ Feeding the China Frenzy Wall Street Journal May 20 2005
Treasury Secretary John Snow intoned some classic bureaucratic cant in saying Tuesday that the U.S. may someday charge China with unfair currency manipulation -- but not just yet. The markets breathed a huge sigh of relief. A currency/trade war with China at least has been postponed.
But back to Mr. Snow's statement, which demonstrates how decisions of huge importance to the global economy are so often founded on ill-judged premises. Said the Treasury Secretary: "Addressing imbalances in the global economy is a shared responsibility among the major economic regions of the world." We're all for global cooperation if it means reinforcing good policies. But this Treasury effort amounts to an ultimatum that if China doesn't revalue it will soon be cited as a "currency manipulator."
This U.S. quarrel with China has far more to do with U.S. politics than with any objective or scientifically based assessment of "imbalances" in the global economy or some shared "responsibility" of major nations to correct them. It has a great deal to do with the yammering about China that's coming from Senate protectionists like Democrat Chuck Schumer and Republican Lindsey Graham. The Treasury exchange rate report the Secretary was introducing is a requirement of U.S. law, the Omnibus Trade and Competitiveness Act of 1988, through which the U.S. Congress tasked Treasury with trying to decide what constitutes "fair" exchange rates.
Even if shifting exchange rates had a major bearing on terms of trade, a highly dubious proposition, there is no such thing as perfect "balance" in the global economy. If allowed to function freely, it is a dynamic system with constantly shifting patterns of trade and investment. Interference by political tinkerers always risks slowing it down and retarding its ability to produce new jobs and relieve global poverty.
As it happens, the dollar-yuan exchange rate has been an island of stability in this dynamic system, just as the euro serves that function for Europe. The yuan has been fixed at 8.28 to the dollar since 1995. This stability has given foreign investors the confidence to build factories in China, fueling its years of rapid growth. The U.S.-China relationship has contributed to global economic growth -- which reached nearly 5% last year -- and has increased the possibility that China will evolve into a responsible democratic nation.
But the U.S. has been ragging China for a year now to "revalue" the yuan on the presumption that this would raise the price of Chinese imports to the U.S. and "cure" the U.S. trade deficit with China. This is the triumph of politics over experience. Any reduction in the quantity of Chinese exports would be offset in part by their higher price. And while China's exports might fall, so would its imports as its economy slowed due to deflationary pressure caused by revaluation.
Stanford Economist Ron McKinnon recently reminded the world that this was precisely the experience of Japan as the yen was going to 80 to the dollar from 360 in the 25 years after 1971. "The ever-higher yen from 1971 to 1995 led to even bigger Japanese trade surpluses," Mr. McKinnon writes. Economists Steve Hanke and Michael Connolly have warned on this page that a revaluation or float of the yuan could do similar deflationary damage to China.
Rapid economic growth has created the superficial impression that China is some kind of "miracle" economy, much as Japan Inc. was similarly lauded in the 1980s. It is nothing of the sort. The stable connection to the dollar has brought in hundreds of billions in foreign investment, which has been put to good use by an industrious Chinese population and the business skills of the so-called overseas Chinese who have exploited this productivity.
But China still is a fragile economic and political system. The Chinese Communist Party has been unwilling, or unable, to reform the banking system because it is the party's means of bestowing political favors and thereby retaining support. Banks "loan" money without any expectation of ever being repaid. Because the banking system is so weak, China is making only small progress in removing controls on cross-border capital movements for fear of subjecting the banks to fatal foreign competition. Thus China piles up billions of U.S. dollar securities, sterilizing the inflationary pressures on the yuan by issuing bonds to Chinese banks. Until China frees up the capital account, it is in no position to float the yuan.
We have repeatedly urged China to move faster to eliminate the exchange controls on capital, and it will eventually have to do so in its own self-interest if it is to safely deconstruct the house of cards it has been building. The U.S. Treasury no doubt understands this, but feels it needs to do something to fend off Congress and therefore it shouts about the value of the yuan.
But far from deterring the protectionists, Treasury is only feeding them. By conceding their mistaken economic argument, it is forcing itself into a corner where it may end up damaging both the U.S. and Chinese economies. If you're worried about "imbalances," give some thought to the "imbalance" that would occur if China goes into the tank.