China trade crosscurrents

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After several months of relative calm on Capitol Hill about U.S.-China trade relations, leading House Democrats are calling on the Bush administration to employ "all available tools at its disposal to address China's protracted, large-scale intervention in the foreign exchange markets to maintain an undervalued currency."

In a five-page letter on March 26, House Ways and Means Committee Chairman Charles B. Rangel of New York and Trade Subcommittee Chairman Sander M. Levin of Michigan called for denying China a larger governance role at the International Monetary Fund unless China stops intervening in the foreign exchange market. The letter was signed by 15 of the 24 Democratic members of the Ways and Means Committee.

House Democrats see the IMF as an ally in pressuring China to allow faster appreciation of the yuan. They are encouraged, no doubt, by the IMF's June 2007 decision to monitor members' exchange rate policies with an eye toward achieving external stability and preventing fundamentally misaligned exchange rates.

Under this rubric, China's persistent and large current account surplus, massive foreign exchange reserves, and capital controls imply a "fundamentally misaligned" exchange rate, which would compel China to consult with the IMF. Mr. Rangel wants concrete action to penalize China if it fails to comply with requests for realigning of its currency.

By a vote of to 20-to-1 last summer, the Senate Finance Committee passed the Currency Exchange Rate Oversight Reform Act, hoping to counteract the "unfair trade" practice of maintaining a misaligned currency to gain a competitive advantage. Sen. Lindsey Graham, South Carolina Republican, crowed: "No longer will the United States sit on the sidelines and allow other nations to gain an unfair advantage. ... For too long the game has been rigged against American business."

Under the act, if China took no corrective action, the Treasury could more easily label it a "currency manipulator" and take account of the undervalued yuan in determining duties under anti-dumping law. Treasury officials would have to consult with the IMF, but could recommend changes in governance to penalize China. If Beijing continued to disregard the request for realigning its currency, the U.S. Trade Representative would be required to bring the case to the World Trade Organization for dispute settlement consultations.

Though this legislation has not passed Congress, it points to the path the United States is likely to take in confronting China — especially the increased role of the IMF. Yet, the IMF has already lost much of its credibility, and countries with large foreign exchange reserves can safely ignore its advice. It's also unlikely the WTO would discipline a member for its exchange rate policies.

The U.S. cannot use the IMF to discipline members for failing to revalue their currencies in line with some unknowable "fundamental equilibrium exchange rate." Moreover, the U.S. current account deficit is not the result of China's undervalued currency, although that may be a contributing factor. The major reason is that U.S. domestic private investment exceeds domestic saving, and a bloated federal government is absorbing domestic saving for redistribution rather than productive investment. Unless the savings-investment gap is closed and the U.S. budget deficit reduced — by constraining the growth of government and reforming the tax code — U.S. and global imbalances will persist.

Congress ought to be more concerned with excessive government spending and the massive imbalances in Social Security and Medicare than with the U.S.-Sino bilateral trade deficit and the dollar-yuan exchange rate. The federal budget deficit is expected to grow to more than $500 billion in the next fiscal year, and the present value of the unfunded liabilities in Social Security and Medicare now amount to nearly $43 trillion.

House Democrats have conveniently ignored these problems and chosen to use China as a scapegoat in an election year. China faces increasing inflation, and thus has an incentive to allow faster appreciation of the yuan, without being pressured by the U.S. and IMF.

China's growth is an opportunity for American growth, as well, so Congress would accomplish more by correcting its protectionist drift than trying vainly to reduce China's influence at the IMF and manipulate exchange rates to its liking.

If a new trade strategy is needed, it should recognize the wisdom of David Hume's statement in 1742: "Where an open communication is preserved among nations, it is impossible but that the domestic industry of every one must receive an increase from the improvements of the others."

James A. Dorn is a China specialist at the Cato Institute and editor of the Cato Journal.