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MCDOWELL: Dragons, not scapegoats
China could make U.S. pay in a currency-based trade war
Question of the Day
Earlier this month, the House Ways and Means Committee voted to broaden the powers of the Commerce Department, which will allow it to impose tariffs when another country is deemed to be a “currency manipulator.” The move was aimed explicitly at China, which keeps the value of its currency, the yuan, artificially lower than markets would dictate.
Beijing’s currency policy is a thorn in the side of the American economy, making Chinese goods more competitive here and disadvantaging U.S. goods in China’s growing consumer market. Still, moving to impose trade sanctions on America’s No. 2 trading partner is bad foreign economic policy for two reasons. First, even if China allowed the yuan to appreciate rapidly, that would not fix the ailing U.S. economy. Second, imposing tariffs on China is unlikely to induce a change in Beijing’s currency policy because a significant revaluation of the yuan in the near term is simply not in China’s interests. Trade sanctions more than likely would produce the opposite of their intended effect. Rather than applying pressure, Congress should show patience with China and, in time, the yuan will rise.
Yuan appreciation is not a panacea for U.S. economic woes. Even if the yuan did climb significantly against the dollar, this is no assurance that the U.S. trade deficit with China would improve. In fact,the last time the yuan was allowed to appreciate, between 2005 and 2008, it climbed more than 20 percent against the dollar. But the U.S. trade deficit with China actually increased during this period, from $201 billion in 2005 to $268 billion in 2008. Furthermore, even if yuan appreciation could cut into the U.S. trade deficit with China, other Asian economies likely would fill the void by producing the cheap foreign goods U.S. consumers demand. The notion that U.S. manufacturing would suddenly return to its heyday because of yuan appreciation is silly. Chinese monetary policy is not to blame for America’s economic struggles; it is, however, a convenient scapegoat.
Tariffs or not, China has shown few signs it will bend to U.S. pressure. The reason for this is quite obvious: The U.S. is asking China to do something obviously contrary to its own interests.First, a quick and significant jump in the exchange rate could create serious dislocations in the Chinese labor market by throwing a wrench in the Chinese manufacturing sector and cut growth rates by as much as 2 percent, according to some estimates. Second, because China is the world’s top holder of dollar assets, a steep appreciation of the yuan would directly translate into a financial loss for Beijing by diminishing the value of those holdings. Finally, as pointed out recently by a People’s Bank of China (PBC) official, Beijing is well aware of the potential medium- to long-term consequences of rapid revaluation, citing Japan’s experience when it bowed to U.S. pressure in the mid-1980s and allowed the yen to rise. What followed was an inflow of capital, loose monetary policy and the creation of an asset bubble, which ultimately popped. Japan’s economy has never fully recovered.
Yet, though a rapid rise in the yuan is not in China’s interests, a gradual, orderly rise is. First, China discovered during the financial crisis that relying on exports to the United States and other Western economies is not the safest long-term growth strategy. As exports to those markets collapsed, factory production slowed, which forced millions of migrants back to the countryside. An orderly rise in the yuan should boost domestic consumption of Chinese goods and allow industry time to adapt to the changing playing field. Second, inflation continues to be a real threat in China. In order to stabilize the yuan’s value, the PBC has to buy up all the dollars that enter the country, paying in yuan, which effectively pumps more of the currency into the economy, causing it to overheat. A steady revaluation should bring this under control. Finally, it absolutely is in China’s long-term economic and geopolitical interests to allow the yuan to develop into a free-floating, internationalized currency. Just as the United States enjoys significant benefits from the status of the dollar, an internationalized yuan would significantly increase Chinese economic policymakers’ flexibility.
The bottom line is this: Over the medium term, if the United States does nothing, the yuan will rise slowly, but steadily, as it has recently. But if the United States chooses to go down the road of trade sanctions, this progress may be halted because Beijing will not want to appear as if it is acquiescing to U.S. pressure. Tariffs could cause the United States to trade gradual appreciation for no appreciation - at least for a time - until China made its point. Alternatively, China might choose to fight back with its own retaliatory trade sanctions or even could employ the nuclear option of dumping U.S. treasuries, as Stephen Roach, chairman of Morgan Stanley Asia, warned recently.
Daniel McDowell has written for Foreign Policy magazine and is a regular contributor to World Politics Review.
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