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CNN: Currency Confrontation

October 8, 2011

This week, the U.S. Senate considered a bill that threatens to impose broad-ranging sanctions on China unless it revalues its currency.  The Senate vote on the bill — which looks like it may have enough support to pass — had been planned for Thursday evening, but ran into partisan maneuvering, and is now expected to take place early next week.  If it does pass, attention would then shift to the House of Representatives, where there is mounting pressure to vote on the measure, and then on to President Obama, who would face the uncomfortable decision whether to veto the bill or sign it into law.

For those interested in exactly what the bill does, you can find a good summary here.   The bill the Senate is currently considering is the latest incarnation in a series of proposals put forward by Senator Chuck Schumer (D-NY) over the past several years, which have waxed and waned in support in line with the level of frustration felt in Washington with China’s on-again off-again moves to permit a stronger yuan.  (This time around, the situation is a little different.  China has actually been allowing the RMB to gradually appreciate, by 5.2% over the past 12 months, which along with mounting Chinese domestic inflation means that Chinese goods are at least 10% more expensive than they were a year ago.  The motivation in Congress this year has less to do with Chinese inaction than with growing election-year frustration over persistently high U.S. unemployment.) 

Although the current bill does not actually single out China, or impose any sanctions directly, its provisions would place significant pressure on the President to start sanctioning China in various ways or explain why he isn’t.  It also would set the stage for similar action against any other country with a fixed or semi-fixed exchange rate whose currency policy the U.S. doesn’t like.

Anyone who has heard my frequent calls for China to allow its currency to appreciate might be surprised to learn that I’m opposed to this bill (and was heartened to see that my old boss, House Speaker John Boehner, opposes it too, despite considerable political pressure to “get tough” on China).  If you want to understand my position on the subject, you can read my argument here, or watch me talk about it on Chinese TV here.

Yesterday, CNN’s Jaime FlorCruz interviewed me about the Senate debate, and the broader issue of what’s causing the trade imbalance and what China and America should be doing about it.  I’ve posted it here, and you can also access the original version here.  (You can also check out what I had to say in Thursday’s Washington Post.)

1) How serious is the U.S. trade deficit with China?

U.S. trade deficit with China has steadily grown over the past decade. In 2010, it reached $273 billion, over 40% of America’s global trade deficit, but still amounted to less than 2% of GDP. In fact, America’s global trade deficit peaked in 2006 and has declined substantially, largely due to expanding exports.

The real problem isn’t so much the absolute size of the U.S.-China trade imbalance, but the struggle to find sources of growth in a stagnant global economy.

2) The U.S. will hold a presidential election next year. How is the trade dispute with China playing out in America?

The number one election issue is going to be jobs, so every politician wants to show that they’re doing something about jobs. China’s trade imbalance with the U.S. is a real issue: If China’s markets were more open, if it was encouraging consumer demand instead of piling up reserves, it could help boost job growth in the U.S. So there’s a temptation to seize on China’s currency policy as a “silver bullet” that will solve this concern, by making U.S. goods cheaper and Chinese ones more expensive, even though the real problem is more complex than that.

3) What impact will the Senate bill have if passed?

The immediate concern would be retaliation, provoking a trade war with China. Even if China didn’t opt for actual retaliation, it could challenge the U.S. sanctions with the World Trade Organization, and China might very well win. One of the reasons the U.S. has always hesitated in slapping sanctions on China over currency is the fear that we might be shooting blanks.

4) Why so?

It’s far from clear that twisting China’s arm to strengthen its currency will have the effect we might hope. We’ve actually seen this movie before. In the Plaza Accord in 1985, Japan agreed, under considerable U.S. pressure, to strengthen its currency in order to combat the growing U.S. trade deficit. The yen doubled in value, but to everyone’s surprise, it had virtually no impact on the trade balance, because there were subsidies, trade barriers, and other policies in place in Japan that countered the stronger yen and prevented an adjustment from taking place. Back China into a corner and force it to accept a stronger yuan, without embracing the kind of economic adjustment that really requires, and I’m afraid we’ll see a replay of the Plaza Accord.

5) What is the fundamental reason causing the trade deficit?

The cheap yuan is one factor, but it’s only one piece of the puzzle. Other factors include obstacles to market access, China’s failure to protect intellectual property rights, export tax rebates, subsidized inputs, subsidized credit, and soft budget constraints for Chinese state-owned companies.

There are a whole host of factors in the Chinese economy besides currency that distort price signals in favor of exports and discourage imports. To their credit, American negotiators have been placing more and more emphasis on these issues lately, rather than focusing exclusively on currency as some kind of “silver bullet.”

6) Why should China revalue the renminbi?

When China intervenes to keep the yuan from rising, in order to protect export growth, it ends up accumulating trillions of dollars in official reserves that it has to somehow invest, leaving it exposed to losses. It also injects trillions of yuan into its domestic economy, fueling inflation and asset bubbles. The fact is, when you run massive trade and investment imbalances, as China is doing, you’re going to get an adjustment, one way or the other. It’s either going to take place through external prices (exchange rates) or internal prices (inflation).

7) What will be the pros and cons for China?

There will be losers. Some Chinese exporters, especially those with razor-thin margins and no reliable competitive advantage, may lose their markets and go out of business. But there will be winners too. A stronger yuan would give the average Chinese citizen greater buying power and an improved standard of living.

8) Some observers argue that, if the renminbi revalues and the Chinese exports to the U.S. become expensive, the American consumers will have to pay more for them — and thus will be hurt too. Your view?

That’s absolutely true. Just as a stronger yuan will mean that Chinese consumers will enjoy greater buying power, American consumers will lose some of the buying power they’ve enjoyed over Chinese goods. Their dollars will buy less. But the focus in America right now is on jobs, not buying power. The problem this past decade is that Americans’ buying power has led us to consume more than we produce, which means more than we could ultimately afford, and as we’ve all come to learn, that’s just not sustainable.

9) Will further revaluation of the renminbi help stop the loss of jobs in the U.S.?

A stronger yuan is not going to bring back jobs in labor-intensive, low-tech industries where the U.S. has no real competitive advantage. Those jobs will go to Bangladesh or Vietnam before they come back to the U.S. But a Chinese consumer with greater buying power — if accompanied by greater openness and fairer treatment for American companies in the Chinese market — will translate into more opportunities and more jobs in sectors where the U.S. has a real advantage. Twisting China’s tail won’t get us there, however. A market-based exchange rate has to be part of a more comprehensive win-win solution.

9 Comments leave one →
  1. October 8, 2011 10:11 pm

    What do you think of this?
    And about the chances that China will in fact address the various issues you name (hidden subsidies, IP theft, etc.) any time soon?

  2. PlayFair permalink
    October 9, 2011 9:44 am

    Revaluing the yuan wont help the US.

    This is just some noise.

    The US lacks the system to create the goods that China makes.

  3. Hua Qiao permalink
    October 9, 2011 9:57 am


    I agree. The problem is much more than just exchange rate. If forced to allow the RMB to appreciate faster, China will just find other ways to achieve their purposes. The nuanced regulations and requirements are easy ways to block western imports. Althought the Norwegian salmon issue was politically motivated, it is a classic example.

    The challenge is that this kind of blocking and control is so endemic in China (also penalizing privately owned mainland firms), this will reduce to a kind of hand to hand combat over rules that achieve dual purposes, i.e. ostensibly enacted to achieve some legitimate purpose but also carefully crafted to tilt the plaing field towards firms in favor.

  4. Wang Xi permalink
    October 9, 2011 11:04 am

    COMMENT DELETED. Wang Xi, if you wish to make a substantive contribution on any of the issues discussed on this blog, I will wholeheartedly welcome it, even (perhaps especially) if you disagree with me. But personal attacks and untrue statements about me will simply be deleted, without apology. This is not your platform for slander.

  5. lark permalink
    October 9, 2011 11:09 am

    I don’t understand the argument that we should do nothing because China might respond to our move in some way.

    Let’s get on with it. China has been acting in bad faith on the currency front for years, as well as in other areas: IP, export tax rebates, subsidized inputs, subsidized credit, and soft budget constraints for Chinese state-owned companies.

    If you negotiate (for over a decade now) with a partner who bargains in bad faith, it is time to move to tougher tactics. Will your first tougher tactic fix all the outstanding problems? Of course not. That is not a reason to choose inaction. Have you heard of the game chess? With your approach, it would be impossible to play chess. Your preferred policy isn’t a policy. It is paralysis. That is unacceptable in an era of 9.1 per cent unemployment.

  6. susian permalink
    October 9, 2011 5:44 pm

    Hi there. I like your blog a lot – don’t always agree with it but it certainly provides a lot of food for thought – and in this post, the historical context from US trade issues with Japan in the 80s does feel like an injection of balanced thinking to an emotional debate. The other area which seems never to come up in the US coverage is the relative silence of China’s other trade partners. Do they find China’s currency and trade policies less detrimental to their pursuit of higher growth/ job creation ? Or is it that their political audience less responsive to the noise which plays well to US voters ? Obviously commodity exporters enjoy very favourable terms of trade with China but so do some large EU members (Germany, France) – how does this come about and what makes the US different ?

    • prchovanec permalink*
      October 9, 2011 8:26 pm

      You know, this is a very interesting point. When I was in Brussels last year, I spoke at a joint event with the EU Commissioner for Trade, who is a very outspoken critic of Chinese trade policy. One of the audience members asked a question, why should Europeans care about China’s peg to the dollar, isn’t this just an American problem? Judging from the approving noises around the room, and the Commissioner’s reaction, this seemed to reflect the European consensus. As I pointed out, though, this really depends on which way the dollar is heading. If the dollar is rising relative to the Euro, the yuan rises with it and, from a European perspective, has appreciated. Last year, the weaker Euro due to the PIIGS debt crisis gave German exporters a real boost in supplying machinery to feed China’s ongoing investment boom, particularly compared to their Japanese competitors who were suffering from a strong yen. So the Germans ended up being a lot more concerned with market access and technology transfer demands than with currency. But if the dollar drops, and the Chinese maintain the peg, the yuan actually depreciates against the Euro, and then you hear a lot more screaming. In that case, Chinese currency policy hits the Europeans a lot harder than the Americans.

      I’d be curious to hear a European perspective on this, if anybody wants to comment.

      • X. Liu permalink
        October 12, 2011 2:33 am

        Would love to see a post on how a banking crisis in the Euro-zone would affect China’s “crisis” moment. A banking crisis would presumably hit the EUR/USD pair hard and cause a change the “it’s an American problem” attitude.

        Thanks in advance.

  7. Hua Qiao permalink
    October 10, 2011 3:12 pm

    Here’s another example of tilting the playing field. While I do not have an opinion on whether Walmart knowingly did or didn’t sell non-organic pork, I am reasonably certain that Walmart stores are not the only established retailers that would engage in such a practice. Of course, the authorities will claim that their interest is solely protecting the safety of the public. Going after the foreign firm is good press as well as it helps the sales of local retailers. (Excerpt from the WSJ.)

    “A dozen stores operated by Wal-Mart Stores Inc. in the southwestern Chinese city of Chongqing have been shut down by local authorities after having been accused of falsely labeling regular pork as higher-priced organic pork, according to Wal-Mart spokeswoman Christina Lee.

    Chongqing officials closed 10 Wal-Mart stores and two Wal-Mart-owned Trust Mart stores on Sunday and is requiring Wal-Mart to shutter them for a total of 15 days, Ms. Lee said.

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