Should the US Retaliate against China’s Currency Manipulation?
By Michael Bush and Steve Suranovic
Republican presidential nominee, Mitt Romney, focused much of his attention last week connecting the decade-long skid of the U.S. manufacturing sector with President Obama’s trade policy on China, specifically Obama’s failure to apply the currency manipulator label. The large trade deficit with China, presumably the result of the undervalued yuan, provides voters with a visual manifestation of high unemployment and stagnant incomes. China is an easy target. Trade sanctions against our largest trading partner, the argument goes, would reduce the trade deficit, level the playing field for U.S. producers, and create American jobs. This message plays especially well in manufacturing?heavy cities like Cleveland, OH, where recently reinforcements arrived with a provocative documentary titled “Death by China.” However, labeling China’s monetary policy currency manipulation is not only misleading, but the recommended trade remedies that would follow are likely to hurt, more than help Americans.
For starters, China has not actively lowered its currency value. Like many other U.S. trading partners, China has adhered to a fixed currency regime for over two decades. To maintain that fixed rate, and because of high demand for the yuan during the past decade, China’s central bank has purchased over a trillion dollars of currency reserves that are invested mostly in U.S. treasuries. These actions by China’s central bank are what Romney and others refer to as currency “manipulation”. However, this characterization overlooks three important things: first, a fixed currency regime is not unique to China; second, the yuan has been appreciating against the dollar for almost a decade; and third, currency appreciation does not automatically eliminate trade deficits.
According to the International Monetary Fund (IMF), over 100 countries have some form of a fixed exchange regime. Thus, it is misleading to single out China as a currency manipulator when other U.S. trading partners engage in the same practice. Regardless, China has adopted a crawling peg system, which permits the central bank to periodically adjust the yuan with respect to the dollar. Since 2005, the yuan has appreciated by 23 percent in nominal terms. Taking into account inflation, that number increases to almost 50 percent.
To put a nearly 50 percent appreciation into context, as well as provide a historical touchstone, Congress proposed legislation back in 2005 that would slap a 27.5 percent tariff on all Chinese imports. Why 27.5 percent? At the time, this was estimated to be the amount the yuan was undervalued. Fast-forward to today, the Chinese yuan has appreciated by almost twice that amount and the U.S. still has a trade deficit with China! One might argue that a 50 percent increase in the value of the yuan simply wasn’t enough to do the job. In this case, consider the 1980s when the U.S. faced worrisome trade deficits with Japan. Since the 1980s the yen has appreciated by 220 percent to the dollar and yet this has not prevented a sizeable US trade deficit with Japan in every year since.
This evidence alone should give hesitation to anyone who thinks a simple currency adjustment will eliminate the trade deficit and create U.S. jobs. Trade deficits are influenced by much more than just the currency value; notably low U.S. savings and high consumption levels.
In addition, while changes in currency values would probably have a negligible impact on the trade deficit, sanctions against China would hurt more Americans than they would help. U.S. consumers who buy Chinese clothing, furniture, toys, appliances, electronics and many other products would have to pay more for these items. Holidays would become much more expensive! And, it would likely be the less wealthy who will suffer the greatest reduction in purchasing power. Moreover, the retaliatory tariffs that China would most certainly pursue would harm U.S. companies that export to China, as well as the U.S. affiliates in China that ship goods back to the U.S. So, who will benefit from the tariffs? The U.S. industries and associated workers that compete with Chinese imports will prosper most, but this represents only a small fraction of U.S. stakeholders.
Thus, while politicians claim that America will gain from getting tough on China, the reality is that a subset of influential U.S. producers will benefit at the expense of most American consumers. This should hardly be surprising given the perennial accusations that powerful lobbies have commandeered international trade negotiations. Rather than blaming China for the turbulent economy, Americans would be much better served by looking internally and addressing its savings problem while simultaneously reining in its own spending. Unfortunately, this does not play well on the campaign trail. To be fair, President Obama’s position on China, though not as strident, is not markedly divergent. Regardless of what side of the aisle it originates from, public censure of China is more political maneuvering than sound economic policy.
Michael Bush is an MA student in the Elliott School of International Affairs at the George Washington University. Steve Suranovic teaches international trade, international finance and microeconomics at the George Washington University. This is cross posted from The International Economic Policy Blog.