The Overwhelming Case for Ending Chinese Currency Manipulation Now

Global Geopolitics & Political Economy

Originally published on the American Economic Alert, May 21, 2010
Read the article in its original form.

Alan Tonelson

Although you couldn’t tell from the angry, impatient mood that’s seizing so many American voters, easy answers to most of the nation’s policy challenges are few and far between.  Problems linger and even fester so often because many alleged solutions create more and worse difficulties than they eliminate, or because many legitimate but competing or conflicting goals need to be balanced.

Luckily for domestic manufacturers, their employees, and others determined to restore America’s economic health by reviving production and real wealth creation, dealing with China’s currency manipulation isn’t one of these agonizingly complex issues.  Only two significant sets of obstacles are blocking effective U.S. responses.  First – powerful offshoring and importing corporate interests – whose obsession with the short-term benefits of manufacturing in China and other super low-cost foreign production sites rather than at home helped spark the ongoing three-year old national and global economic crisis.  The second is a series of myths spread by these interests and holding that Chinese currency manipulation is basically irrelevant to U.S. growth, employment, and wage levels.

With senior U.S. officials heading to Beijing for yet another round of a sham bilateral dialogue aimed mainly at fooling voters into thinking their government is effectively dealing with China’s economic predation, it’s a good time to expose some of the biggest such myths for the drivel they are.

Myth Number One: A major Chinese revaluation, or tariffs on Chinese goods are pointless because Chinese and foreign-owned exporters will simply start supplying the U.S. market from other countries. Therefore, the scale of U.S. trade deficits will remain unchanged.

In fact, many such expectations about revaluation in particular assume that an increase in the yuan’s value will spur revaluations by other Asian currency manipulators as well – including many countries to which China-based production would supposedly migrate.  Why?  These Asian exporters are getting worried that their currency policies are encouraging inflation and the growth of asset bubbles, but have needed to match Chinese manipulation for fear of getting priced out of valuable export markets. 

Outsourcing businesses will of course try to end run the effects of a big Chinese revaluation or U.S. tariffs on Chinese goods.  So will China’s Asian neighbors if they revalue.  But this is simply another way of saying that there are no panaceas in trade policy.  America’s competitors will remain formidable and determined to protect their gains.  As a result, U.S. trade — and especially tariff — policies will simply need to be agile-enough to counter these moves.  In other words, American trade policymakers will finally need to start earning their pay!

At the same time, it’s easy to over-estimate likely production shifts from China.  For example, an excellent recent paper by University of Maryland engineering professor Michael Pecht and a colleague explain cogently how so much of the world’s electronics production — and comparably complex and extensive supply infrastructure — have been lured to China by hook or by crook, that significant relocation would be prohibitively expensive.

Myth Number Two:  Revaluation or tariffs would be pointless because differences in national savings rates are what really determine national trade balances.   It’s hard to think of a maxim of modern economics that’s so widely misunderstood – even apparently by leading economists.  The relationship between savings rates and trade and broader economic balances is actually nothing more than a mathematical identity.  And mathematical identities by definition says nothing about the flow of causality. 

Therefore, insisting that low U.S. savings rates and high Chinese savings rates are responsible for America’s huge trade deficit with China amounts to saying that “A equals B” has the same meaning as “A caused B.”  And it’s just as incorrect.

In addition, the insistence that higher U.S. savings or lower Chinese savings will eventually eliminate the bilateral trade deficit completely ignores the inevitable effects of the massive purchases of even very low-yielding U.S. debt by China and other surplus countries:  U.S. consumption is subsidized, and U.S. savings are penalized.  So the trade imbalances could be driving the savings rates, not the other way around. 

Further, there’s another compelling reason for blaming low U.S. savings on the trade deficit.   Economists widely agree that low-income earners save much less of their incomes than their wealthier counterparts.  Simple common sense suggests why:  The greater the share of their incomes individuals and families need to spend on necessities, the less will be left over to salt away.  As a result, if America’s outsourcing-focused trade policies have indeed driven down U.S. workers’ wages by sending millions of high-paying manufacturing jobs and thus prime income-earning opportunities to places like China, then these policies have indirectly but substantially contributed to a lower U.S. personal savings rate.   
Myth Number Three: The 20 percent 2005-2008 Chinese revaluation failed to boost U.S. manufacturing employment.  Therefore, even a larger Chinese revaluation, or comparably high tariffs, would have only minor effects at best.  The fatal flaw in this argument, however, is its assumption that a single type of predatory Chinese trade behavior has been the only driver of American manufacturing job creation or destruction.  No intelligent critic of U.S. trade policy takes such a narrow-minded view.  China’s currency manipulation, after all, is hardly its only predatory trade practice.  And China is hardly America’s only problem trade competitor. 

In addition, the 20 percent argument completely overlooks the cumulative effects on U.S. manufacturing output and employment levels of more than a decades-worth of outsourcing-focused trade agreements aimed at exporting production and jobs, not goods and services.  Their major effects on the trade balance are clear from Commerce Department data showing that U.S. multinationals are responsible for a big chunk of America’s trade deficits.  Nor should anyone  forget about the importance of purely domestic influences on manufacturing output and employment.

So dealing with currency manipulation alone – as even many supporters of strong anti-manipulation moves seem to favor – is only a necessary but not sufficient step for reviving domestic U.S. manufacturing and rebalancing the U.S. and global economies.  Much more sweeping trade policy changes in particular will be needed. 

Finally on this score, the 20 percent revaluation figure is only a nominal figure.  Given the skyrocketing of China’s international surpluses during this period, and other developments that should have made the yuan an all-but-irresistible magnet for currency traders, the real level of revaluation surely was far lower.

Myth Number Four:  Many Chinese products sold in the United States (and around the world) contain high levels of U.S. and other foreign content.  Moreover, much of this non-Chinese content consists of extremely high-value goods, like the U.S.-made microprocessors and specialty computer chips found in so many PCs and consumer electronics products made in China.  Consequently, the myth continues, economic damage allegedly done to the United States by importing from China is much less serious than widely charged, and restricting such imports from China would backfire on the American workers that make these key inputs.

This U.S. content unmistakably exists. Yet the Chinese content levels of these goods also have been rising steadily, especially in capital- and technology-intensive industries.  What’s the exact measure?  No one knows for sure but the outsourcing multinationals themselves.  And thanks to U.S. government coddling, they’ve never been required to make public their foreign sourcing/procurement data.  But capital- and technology-intensive goods — many of which are industrial intermediates — represent the fastest-growing category of Chinese exports to the United States.  And no knowledgeable observer would dispute that Chinese manufacturing is rapidly moving up the food/value chain. Therefore, it stands to reason that the many of these sophisticated inputs are also increasingly finding their way into the finished goods China sends to America.  That is to say, don’t look at the snapshot.  Look at the trend.

None of this analysis should tempt anyone to think that vigorous responses to China’s trade cheating will be cost and pain-free.  But that’s not because these steps are ill-conceived.  It’s because the roots of the crisis and recession have been neglected – and even nurtured – for so long, and have grown so deep, that pain and cost-free solutions are no longer possible.  But timely actions will prevent far more pain and greater expenses down the road.

So as they watch their leaders chit-chat with their Chinese counterparts in Beijing this week, Americans should understand that the economic case for immediate U.S. tariffs against China – and similar steps to offset predatory trade practices by other competitors – is overwhelming.  And if President Obama keeps dithering, it’s simply because he’s more interested in supporting the outsourcing and importing interests than the domestic industries that form the U.S. economy’s productive core.

Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).

©1999-2010 United States Business & Industry Council

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