Reading the headlines of the news this week and last, you’d think the US suddenly found itself in imminent peril of economic collapse because of the bad old Chinese. “Goodbye Free Trade?” a Wall Street Journal editorial asked. “Americans Sour on Trade” another Journal editorial lamented. “Americans Are Turning against Trade” The New Republic chortled.
Huh? The Chinese are in the third decade of currency-driven economic growth. Where have these commentators been?
Apparently they don’t understand that all countries try to exploit their domestic economic system, as well as the international economic system, to their advantage. Doing so has given China exceptional growth as a developing economy – recently passing Japan as the second largest economy in the world. As one of their major trading partners, we might not like their tactics but the impact of those tactics on the American economy, in my opinion, is overblown.
Here’s why.
Since Mao Zedong died 35 years ago, the government of the People’s Republic of China has walked a tightrope to continue the ideological vision of its single-party Communist regime in power while gradually introducing capitalist ideals that are imperative to maintaining social order – i.e. jobs and a more equitable distribution of wealth, even among the poorest villages. So far, Beijing has been able to pull this off even though their rickety state-owned enterprises can’t be absorbed easily into the capitalist system. A high rate of year over year GDP growth is required to produce the capitalist transition.
Since China didn’t have the domestic infrastructure to support a consumer-driven economy like ours, and it didn’t have the money or time to create one, it chose to grow as an exporting nation, requiring that it keep its currency low against foreign currencies. A cheap currency allows China to achieve its domestic goal of alleviating poverty and potential social unrest by moving large numbers of poor people out of the fields and the interior and into the factories for export production that populate the industrial zone along China’s east coast.
Beijing's currency is called renminbi, which translates as “the people’s currency” and it is denominated in yuan – pronounced like saying UN fast in one syllable. There is no American equivalent to the Chinese currency system, but the British currency is called sterling and is denominated in pounds. The Chinese government pegs the yuan to the dollar, and currently it trades in a narrow range around 6.7 yuan per dollar. To keep the yuan from appreciating, the central bank buys dollars brought into China by foreign investors and Chinese exporters. Then the bank issues bonds to scoop up the yuan it has paid for those dollars, thus warding off inflation.
Because the yuan is cheap against the dollar, their products – our imports – are inexpensive and our products – exports – are expensive to the Chinese market. This causes a trade deficit and (allegedly) the loss, if not the export, of jobs.
During difficult economic periods, people look for villains and as of late China has replaced Wall Street as the villain de jour. It’s not surprising, therefore, that the Demagogue in Chief has tried to deflect attention away from his failed stimulus and unemployment numbers by attacking the trade deficit. He recently warned US global companies that they should not expect to be treated the same "if you create a job in Bangalore, than if you create one in Buffalo." Nevertheless, two weeks ago the Senate failed to muster enough votes to begin debate on the laughably named Creating American Jobs and Ending Offshoring Act. Perhaps a few sober minded Senators realized that this sword cuts both ways and our trading partners might retaliate in kind and repatriate all of the jobs they create in the US.
Even though the trade deficit with China has been going on for decades, some candidates – mostly Democrats – have tried to make it a political football in the fall elections. In northern Illinois, Democrat US Representative Debbie Halvorson is running ads slamming her opponent, Adam Kinzinger, for backing trade pacts that "ship our jobs overseas." "China is cheating," she said in an interview. "We need to send a message that they need to play by the rules." I wonder if she knows what she is talking about.
Kinzinger countered that 95% of the world’s consumers are outside of the US and therefore Illinois’ top manufacturers "say that in order to be successful and to hire people in Illinois to manufacture and put our stuff together, we've got to have trade." Well, yeah. If you refuse to buy low tech goods from China they have no way to pay for high tech American goods like computers, drugs, software, and airplanes.
Apparently the House of Representatives didn’t get the word. Skipping town like a bunch of juvenile delinquents, they couldn't find the time to pass a budget or keep the Bush tax cuts from expiring. But they did find time to start a senseless trade war with China by passing the Currency Reform for Fair Trade Act, which will do nothing its name implies. It won't make trade any fairer and it won't "reform" China's currency. Passing by a hefty 348-79 margin in the House, including 99 Republican votes, it's unlikely to ever become US law, but if it does, the WTO will declare it illegal.
Even so, it's a dangerous bill, reflecting the ugly mood in Congress more than anything else. The bill is nothing short of a return to protectionism. It amends Smoot-Hawley (yes, that awful law is still on the books) empowering the Commerce Department to slap tariffs on Chinese goods as punishment for keeping its currency artificially low against the dollar. Forcing such a currency realignment on China would be a blunder of historic proportions.
Smoot-Hawley became law in 1930 just as the U.S. economy was slipping into a recession. Some say it caused the Great Depression. It set off a round of retaliatory reactions around the world and shrank the global market for goods and services at the very time nations needed trade to boost their growth. Over three years, U.S. trade with its major trading partners fell 68%. That helped turn what might have been a normal recession into the Great Depression, with a 30% drop in GDP and joblessness of 25%.
Democrats – all but five of whom voted in favor of the currency reform bill last week – would do well to remember that in 1932 their hero, FDR, ran as a free-trader, pledging to lower Smoot-Hawley's tariff walls. The 99 Republicans who voted aye should likewise remember that Herbert Hoover's name lives in infamy for erecting those walls. Wednesday's vote was a bipartisan display of stupidity to build Smoot-Hawley’s tariff walls even higher.
China has already reacted angrily that it is justly torqued by the bill, hinting that it would retaliate. That makes the bill a nuclear threat of mutually assured economic destruction. If it becomes law and, notwithstanding a WTO ruling on its illegality, if it is implemented, the cost basis of Chinese imports could be jacked up as much as 40%, crushing trade between China and the US, which are huge export markets for each other. One of every six human beings on the planet today is Chinese. China is our third largest export market. In short, China is our partner and our rival.
But let’s suppose China blinks and revalues the yuan to avert the impending nuclear threat. Even if doing so creates some American jobs, which is unlikely because of China’s low-end manufacturing economy, it would make Chinese goods more expensive in the US – an immediate inflationary tax on American consumers.
Concurrently, goods priced in dollars would become cheaper for China to import, supposedly boosting US exports. (That assumes there is a Chinese market for the cheaper American goods. Remember that there’s not a large consumer market in China.) A stronger yuan will make China an even more dangerous competitor for oil on the world market because oil is priced in dollars. A stronger yuan-to-dollar makes a barrel of oil cheaper to China. Look at any currency conversion chart and you’ll see that the yuan fell from about 8.2 per dollar to about 6.8 per dollar between 2005 to 2008 as political pressure from the US forced a revaluing of the renminbi. Not surprisingly, oil prices shot up from $60 to $147 per barrel, translating into pump prices of $5 per gallon in some US cities. If this were to happen again, the gas price inflation is a tax on American citizens and businesses.
The large appreciation in the value of the yuan demanded by exporting nations would cause Chinese exports to fall, setting off widespread plant closures and layoffs among marginal producers. Chinese companies would shift low-wage manufacturing to countries like Sri Lanka and Vietnam to regain profitability. The industrial belt along the China’s east coast might be able to absorb some of the layoffs, but the less developed interior of the country would have few options.
On balance, no nation benefits if China’s economy falls on hard times. The revaluation during 2005 to 2008 was accompanied by improvements in productivity that lowered the costs that the more expensive yuan started pushing up. Even in a developing country like China, however, there is a limit to offsetting a stronger currency with efficiency increases.
Rather than demanding that China let the yuan float, which it won’t and shouldn’t do, or revalue the renminbi by some arbitrary amount, Western nations would be better served if China began building a consumer economy, increasing the renminbi as part of its economic rebalancing. It would have to do so over a long period to avoid creating a financial bubble of too much cash chasing too few products and to avoid large scale unemployment as it reduces reliance on exports.
Rebalancing will shift income from producers to households because a more valuable renminbi increases Chinese household income by reducing the cost of imports. It balances this by lowering the profitability of exporters. If done carefully and over a long period, China’s household income share of it GDP would rise as the renminbi is revalued and consumption would rise also. Since China exports what it produces but doesn’t consume, raising the value of the renminbi will reduce China’s trade surplus.
But as noted earlier, an increase in the renminbi too quickly might placate Western politicians but it would cause export profitability to decline so quickly that Chinese exporters would be forced either into bankruptcy or into moving their facilities abroad to lower-wage countries. Layoffs would be inevitable. Unemployment would cause Chinese household income to fall and with it, household consumption. Rebalancing would fail, and Chinese society might destabilize. The US could lose one of it largest trading partners. Americans would lose a supplier of low cost products.
Smoot-Hawley was one of many mistakes committed by Depression-era policy-makers who had never held a real job in the real economy and therefore had little understanding of the law’s likely impact. The Currency Reform for Fair Trade Act has all of the marks of being the ghost of Smoot-Hawley at a time when our economy is weak. If we are to avoid the destructive, beggar-thy-neighbor trade wars that contributed to bringing down the world economy in the 1930s, we had best admit the obvious: no one wins a currency war.
Huh? The Chinese are in the third decade of currency-driven economic growth. Where have these commentators been?
Apparently they don’t understand that all countries try to exploit their domestic economic system, as well as the international economic system, to their advantage. Doing so has given China exceptional growth as a developing economy – recently passing Japan as the second largest economy in the world. As one of their major trading partners, we might not like their tactics but the impact of those tactics on the American economy, in my opinion, is overblown.
Here’s why.
Since Mao Zedong died 35 years ago, the government of the People’s Republic of China has walked a tightrope to continue the ideological vision of its single-party Communist regime in power while gradually introducing capitalist ideals that are imperative to maintaining social order – i.e. jobs and a more equitable distribution of wealth, even among the poorest villages. So far, Beijing has been able to pull this off even though their rickety state-owned enterprises can’t be absorbed easily into the capitalist system. A high rate of year over year GDP growth is required to produce the capitalist transition.
Since China didn’t have the domestic infrastructure to support a consumer-driven economy like ours, and it didn’t have the money or time to create one, it chose to grow as an exporting nation, requiring that it keep its currency low against foreign currencies. A cheap currency allows China to achieve its domestic goal of alleviating poverty and potential social unrest by moving large numbers of poor people out of the fields and the interior and into the factories for export production that populate the industrial zone along China’s east coast.
Beijing's currency is called renminbi, which translates as “the people’s currency” and it is denominated in yuan – pronounced like saying UN fast in one syllable. There is no American equivalent to the Chinese currency system, but the British currency is called sterling and is denominated in pounds. The Chinese government pegs the yuan to the dollar, and currently it trades in a narrow range around 6.7 yuan per dollar. To keep the yuan from appreciating, the central bank buys dollars brought into China by foreign investors and Chinese exporters. Then the bank issues bonds to scoop up the yuan it has paid for those dollars, thus warding off inflation.
Because the yuan is cheap against the dollar, their products – our imports – are inexpensive and our products – exports – are expensive to the Chinese market. This causes a trade deficit and (allegedly) the loss, if not the export, of jobs.
During difficult economic periods, people look for villains and as of late China has replaced Wall Street as the villain de jour. It’s not surprising, therefore, that the Demagogue in Chief has tried to deflect attention away from his failed stimulus and unemployment numbers by attacking the trade deficit. He recently warned US global companies that they should not expect to be treated the same "if you create a job in Bangalore, than if you create one in Buffalo." Nevertheless, two weeks ago the Senate failed to muster enough votes to begin debate on the laughably named Creating American Jobs and Ending Offshoring Act. Perhaps a few sober minded Senators realized that this sword cuts both ways and our trading partners might retaliate in kind and repatriate all of the jobs they create in the US.
Even though the trade deficit with China has been going on for decades, some candidates – mostly Democrats – have tried to make it a political football in the fall elections. In northern Illinois, Democrat US Representative Debbie Halvorson is running ads slamming her opponent, Adam Kinzinger, for backing trade pacts that "ship our jobs overseas." "China is cheating," she said in an interview. "We need to send a message that they need to play by the rules." I wonder if she knows what she is talking about.
Kinzinger countered that 95% of the world’s consumers are outside of the US and therefore Illinois’ top manufacturers "say that in order to be successful and to hire people in Illinois to manufacture and put our stuff together, we've got to have trade." Well, yeah. If you refuse to buy low tech goods from China they have no way to pay for high tech American goods like computers, drugs, software, and airplanes.
Apparently the House of Representatives didn’t get the word. Skipping town like a bunch of juvenile delinquents, they couldn't find the time to pass a budget or keep the Bush tax cuts from expiring. But they did find time to start a senseless trade war with China by passing the Currency Reform for Fair Trade Act, which will do nothing its name implies. It won't make trade any fairer and it won't "reform" China's currency. Passing by a hefty 348-79 margin in the House, including 99 Republican votes, it's unlikely to ever become US law, but if it does, the WTO will declare it illegal.
Even so, it's a dangerous bill, reflecting the ugly mood in Congress more than anything else. The bill is nothing short of a return to protectionism. It amends Smoot-Hawley (yes, that awful law is still on the books) empowering the Commerce Department to slap tariffs on Chinese goods as punishment for keeping its currency artificially low against the dollar. Forcing such a currency realignment on China would be a blunder of historic proportions.
Smoot-Hawley became law in 1930 just as the U.S. economy was slipping into a recession. Some say it caused the Great Depression. It set off a round of retaliatory reactions around the world and shrank the global market for goods and services at the very time nations needed trade to boost their growth. Over three years, U.S. trade with its major trading partners fell 68%. That helped turn what might have been a normal recession into the Great Depression, with a 30% drop in GDP and joblessness of 25%.
Democrats – all but five of whom voted in favor of the currency reform bill last week – would do well to remember that in 1932 their hero, FDR, ran as a free-trader, pledging to lower Smoot-Hawley's tariff walls. The 99 Republicans who voted aye should likewise remember that Herbert Hoover's name lives in infamy for erecting those walls. Wednesday's vote was a bipartisan display of stupidity to build Smoot-Hawley’s tariff walls even higher.
China has already reacted angrily that it is justly torqued by the bill, hinting that it would retaliate. That makes the bill a nuclear threat of mutually assured economic destruction. If it becomes law and, notwithstanding a WTO ruling on its illegality, if it is implemented, the cost basis of Chinese imports could be jacked up as much as 40%, crushing trade between China and the US, which are huge export markets for each other. One of every six human beings on the planet today is Chinese. China is our third largest export market. In short, China is our partner and our rival.
But let’s suppose China blinks and revalues the yuan to avert the impending nuclear threat. Even if doing so creates some American jobs, which is unlikely because of China’s low-end manufacturing economy, it would make Chinese goods more expensive in the US – an immediate inflationary tax on American consumers.
Concurrently, goods priced in dollars would become cheaper for China to import, supposedly boosting US exports. (That assumes there is a Chinese market for the cheaper American goods. Remember that there’s not a large consumer market in China.) A stronger yuan will make China an even more dangerous competitor for oil on the world market because oil is priced in dollars. A stronger yuan-to-dollar makes a barrel of oil cheaper to China. Look at any currency conversion chart and you’ll see that the yuan fell from about 8.2 per dollar to about 6.8 per dollar between 2005 to 2008 as political pressure from the US forced a revaluing of the renminbi. Not surprisingly, oil prices shot up from $60 to $147 per barrel, translating into pump prices of $5 per gallon in some US cities. If this were to happen again, the gas price inflation is a tax on American citizens and businesses.
The large appreciation in the value of the yuan demanded by exporting nations would cause Chinese exports to fall, setting off widespread plant closures and layoffs among marginal producers. Chinese companies would shift low-wage manufacturing to countries like Sri Lanka and Vietnam to regain profitability. The industrial belt along the China’s east coast might be able to absorb some of the layoffs, but the less developed interior of the country would have few options.
On balance, no nation benefits if China’s economy falls on hard times. The revaluation during 2005 to 2008 was accompanied by improvements in productivity that lowered the costs that the more expensive yuan started pushing up. Even in a developing country like China, however, there is a limit to offsetting a stronger currency with efficiency increases.
Rather than demanding that China let the yuan float, which it won’t and shouldn’t do, or revalue the renminbi by some arbitrary amount, Western nations would be better served if China began building a consumer economy, increasing the renminbi as part of its economic rebalancing. It would have to do so over a long period to avoid creating a financial bubble of too much cash chasing too few products and to avoid large scale unemployment as it reduces reliance on exports.
Rebalancing will shift income from producers to households because a more valuable renminbi increases Chinese household income by reducing the cost of imports. It balances this by lowering the profitability of exporters. If done carefully and over a long period, China’s household income share of it GDP would rise as the renminbi is revalued and consumption would rise also. Since China exports what it produces but doesn’t consume, raising the value of the renminbi will reduce China’s trade surplus.
But as noted earlier, an increase in the renminbi too quickly might placate Western politicians but it would cause export profitability to decline so quickly that Chinese exporters would be forced either into bankruptcy or into moving their facilities abroad to lower-wage countries. Layoffs would be inevitable. Unemployment would cause Chinese household income to fall and with it, household consumption. Rebalancing would fail, and Chinese society might destabilize. The US could lose one of it largest trading partners. Americans would lose a supplier of low cost products.
Smoot-Hawley was one of many mistakes committed by Depression-era policy-makers who had never held a real job in the real economy and therefore had little understanding of the law’s likely impact. The Currency Reform for Fair Trade Act has all of the marks of being the ghost of Smoot-Hawley at a time when our economy is weak. If we are to avoid the destructive, beggar-thy-neighbor trade wars that contributed to bringing down the world economy in the 1930s, we had best admit the obvious: no one wins a currency war.
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