Trade and Globalization
On Wednesday, Senator Orrin Hatch claimed that the Currency Exchange Rate and Oversight Reform Act of 2011 (S 1619) (the Currency Reform Act) could cause “a huge trade war … with China.” Nothing could be further from the truth. A large share of our exports to China are intermediate products that are used to produce exports to the United States. If China raised tariffs or otherwise restricted imports of those products, it would simply raise the cost of their own exports to the United States. Furthermore, U.S. imports from China exceed our exports to that country by a ratio of more than 4 to 1. So every dollar in tariffs imposed by China would, in theory, be matched by four dollars in U.S. tariffs on their exports, if China ever tried to engage us in a trade war. But history shows us that they will not.
Senator Hatch also disparaged my latest report on China trade and U.S. employment, but I’ll save that argument for another post. We appreciate his use of our research, and are glad that he felt it necessary to respond.
In Aug. 2005, the Senate passed much a much tougher currency bill sponsored by Senators Chuck Schumer and Lindsey Graham (S. 295) that would have imposed a 27.5 percent tariff on all imports from China if it failed to revalue within 180 days. That bill never passed the House and never become law. Nonetheless, shortly after the bill was approved in the Senate (by a veto-proof majority), China began to revalue, for the first time in more than seven years, ultimately allowing the yuan (or RMB) to rise by 18.6 percent over the next three years. China did not retaliate.
China will not retaliate if the Currency Reform Act becomes law because it will hurt its own exporters if it does, and because China will benefit if it does revalue. If the yuan is allowed to appreciate, it will lower the cost of oil, food and other imported commodities in China. This will put downward pressure on inflation, which has been accelerating rapidly in China this year. Lower fuel and food prices will be particularly helpful to low-income families in China, who are very dependent on these basic commodities.
As shown in my most recent report on China trade and U.S. employment (Table 2), some of the most important U.S. exports to China are basic commodities used in producing exports such as chemicals ($11.6 billion, 13.5 percent of total U.S. exports to China), scrap and second hand goods ($8.5 billion, 10.0 percent) and semiconductors ($6.1 billion, 7.1 percent). Agricultural products ($15.4, 18.0 percent) could be vulnerable, but U.S. imports from China, which could be subject to some trade restrictions, were $363.6 billion and exceeded agricultural exports by a ratio of 23:1 in 2010.
When Senator Hatch referred to a “huge trade war,” most people think of the Smoot-Hawley Act of 1930, which raised tariffs on about one-third of U.S. imports to a peak of 59.1 percent. However, average tariff rates rose to only 19.8 percent in 1933. Canada, our largest trading partner retaliated with higher tariffs on about 30 percent of U.S. imports, and Germany developed a system of autarky (little or no trade).
The Currency Reform Act of 2011 would not impose sweeping, across-the-board tariff increases (as did the Smoot-Hawley Act). It defines a new process for determining which currencies are “fundamentally misaligned,” and defines new procedures for conducting negotiations with such countries including new consequences, especially when a country persistently fails to revalue despite continuing negotiations. These measures are intended to spur negotiated solutions to currency manipulation, not to spark a trade war.
The Currency Reform Act also authorizes the Commerce department to take currency manipulation into account in anti-dumping and countervailing duty investigations. But these changes will affect a small share of total U.S. trade with currency manipulators. Again, there is nothing similar in these proposals to the broad, across-the-board tariffs imposed in the Smoot-Hawley act.
“Trade war” is a term that is easily thrown around in legislative debate and by political commentators. As Fred Bergsten has noted, China’s currency manipulation “is by far the largest protectionist measure adopted by any country since the Second World War – and probably in all of history.” The Currency Reform Act is a measured response designed to bring about a negotiated end to China’s predatory economic policies. China has launched a trade war on the rest of the world. It is important to stand up to the bully, to restore balance to the global trading system and world demand.
On Monday, the Senate agreed to move ahead with debate on the China currency bill, approving a petition to proceed on the measure by a 79-19 margin; this morning they voted to proceed to a final vote, also by a strong margin. Predictably, the People’s Bank of China responded by claiming that the yuan (or RMB) has appreciated “greatly” and is close to a balanced level. The best indicator that China is manipulating its currency is simply that it must buy hundreds of billions of dollar in U.S. assets each year to keep it from moving ever higher. That’s how we know that they haven’t done enough.
China’s purchases of Treasury bills and other types of foreign exchange reserves have accelerated in the past year, as I showed on Monday. In the past 12 months (ending June 30, 2011), they acquired nearly $730 billion in additional reserves. Between 2005 and 2010 their reserve acquisitions averaged between $400 and $450 billion, which indicates that the yuan is even more undervalued than it was a year ago. This is true despite the yuan’s real, inflation-adjusted appreciation of 7.4 percent in the past year.
William R. Cline and John Williamson of the Peterson Institute have produced some of the best estimates of China’s currency manipulation. In a series of annual reports on fundamental equilibrium exchange rates (FEERs), they have estimated that China’s currency manipulation increased from 24.2 percent in 2010 to 28.5 percent in 2011, despite the fact that China’s real exchange rate appreciated over the past year. Three factors explain why China’s estimated FEERs increased in 2011.
First, the International Monetary Fund has estimated that China’s global current account surplus (the broadest measure of its trade balance) will more than double from $305 billion in 2010 to $852 billion in 2016 (an increase of 179 percent), as shown in the graph below. There is widespread agreement among the G-20 leaders (including China) that global trade flows must be rebalanced to help end mass unemployment around the world. These IMF predictions show that unless China sharply revalues, world trade flows will become even more distorted than they are today. Among the top five currency manipulators identified by Cline and Williamson (China, Malaysia, Hong Kong, Singapore, and Taiwan), China is responsible for the vast majority (83 percent) of the estimated global surpluses of these currency manipulators in 2016.
Second, the IMF predicts that China’s current account surplus will rise from 5.2 percent of GDP in 2011 to 7.2 percent in 2016. Cline and Williamson project in their latest research China’s that current account will rise even faster, to 7.8 percent of GDP in 2016. China’s rapidly growing GDP, combined with a rapidly growing trade surplus as a share of its GDP, and its stubborn addiction to currency manipulation will, if unchallenged, destabilize both the U.S. and global recoveries, as suggested by the IMF’s own forecast of global trade imbalances shown above.
The final nail in the case against the People’s Bank is its own massive and growing accumulation of foreign exchange reserves, as noted above. China has invested trillions of dollars to prevent the appreciation of their currency to a fair market value. China’s currency manipulation is a fundamental threat to the U.S. and world manufacturing system. It artificially suppresses the value of the yuan, subsidizing China’s exports to the United States and raising the cost of U.S. exports – both to China and to every country where U.S. exports compete with Chinese products. Enough is enough. It’s time to get tough with China and other currency manipulators.
In light of this afternoon’s cloture vote in the Senate on China’s currency bill, I think it would be helpful to go over why the bill is so important. Simply put, unlike most bills that proponents claim are about “job creation,” this one actually is. Since it entered the World Trade Organization in 2001, China has engaged in massive intervention in currency markets, buying U.S. dollar-denominated assets to boost the value of the dollar and keep their own currency artificially cheap. This acts as a subsidy to U.S. imports from China, and it raises the cost of U.S. exports — both to China and to every country where U.S. exports compete with goods coming from there.
Between 2007 and 2010, China invested nearly $450 billion per year in Treasury bills and other foreign exchange reserves to keep its own currency cheap. In the year ending June 30, 2011, China’s purchases of foreign exchange surged to nearly $730 billion, and its total holdings reached $3.2 trillion, as shown in the figure below. Roughly $2.2 trillion (70 percent) of China’s foreign exchange reserves are held in Treasury Securities and other dollar denominated assets.
The best estimates arethat the Chinese currency, known as the yuan (also known as the Renminbi, or RMB), is undervalued by approximately 28.5 percent, relative to the dollar. China’s currency manipulation has compelled others to follow similar policies in order to protect their relative competitiveness and to promote their own exports. Hong Kong, Malaysia, Taiwan, and Singapore have currencies that are undervalued by 27.5 percent to 38.5 percent against the dollar.
In The Benefits of Currency Revaluation I showed that full revaluation of the yuan and other undervalued Asian currencies would improve the U.S. current account balance by up to $190.5 billion, increasing U.S. GDP by as much as $285.7 billion, adding up to 2.25 million U.S. jobs over the next 18-to-24 months, and reducing the federal budget deficit by up to $857 billion over 10 years. This change to the current account balance would also help workers in China and other Asian countries by reducing inflationary overheating and increasing workers’ purchasing power. Revaluation is a “win-win” for the global economy.
It was great to see President Obama challenge congressional Republicans to do something real about jobs. His jobs bill, submitted to Congress Monday, would support 2.3 million new jobs and provide continuing support for another 1.6 million jobs. But his plan requires congressional approval, which is about as likely as a World Series appearance for Washington’s sub-.500 Nationals this year.
With unemployment at 9.1 percent, our economy desperately needs at least 11 million new jobs now just to get the unemployment rate down to pre-recession levels. We cannot allow the political stalemate in Washington to stand in the way of a full set of bold job creation initiatives. The president should take immediate, executive action that will directly support the creation of up to 2.25 million export jobs by eliminating unfair currency manipulation by China and other countries.
The administration wants to stimulate exports, and that’s a good idea, but if and only if it improves the trade balance. Growing exports support domestic employment but growing imports displace domestic jobs; meaning that we need policy changes to boost net exports. The president included an oft-repeated promise in his speech last week that he will soon send legislation to Congress to implement Bush-negotiated free trade agreements with South Korea, Colombia and Panama. Passage of those FTAs would be a terrible idea because all past evidence indicates that FTAs are not an effective tool for improving the U.S. trade balance and stimulating net job creation.
If the president was serious about boosting net exports he would take significant action to stop the currency management of our trading partners that has hamstrung the competitiveness of U.S. producers. He has the authority to do this without Congress – and swift and independent action could help to create millions of new jobs over the next 18 to 24 months.
The best estimates are that currency intervention by our trading partners (i.e., buying U.S. dollar-denominated assets to boost the value of the dollar and keep their own currency artificially cheap) raises the cost of U.S. exports – both to the intervening countries (China is the most important one) as well as to every country where U.S. exports compete with goods coming from there. China’s currency intervention has also compelled Hong Kong, Singapore, Malaysia and Taiwan to follow similar policies in order to protect their relative competitiveness and to promote their own exports.
In a recent report on the benefits of revaluation, I showed that full revaluation (28.5%) of the yuan and other undervalued Asian currencies would improve the U.S. current account balance by up to $190.5 billion, increasing U.S. gross domestic product by as much as $285.7 billion, adding up to 2.25 million U.S. jobs, and reducing the federal budget deficit by up to $857 billion over 10 years.
This revaluation done quickly would be a win-win – it would help workers in China and other Asian countries by reducing inflationary overheating and increasing workers’ purchasing power in those countries.
There are several different actions that can be taken by the Obama administration to put pressure on China. First, it can and should identify China and the other countries listed above as currency manipulators when the Treasury releases its Semiannual Report on International Economic and Exchange Rate Policies in mid-October. This would trigger mandatory negotiations which could result in sanctions if the issues are not resolved. Secretary Tim Geithner has consistently refused to name China or any other country as a currency manipulator, despite all available evidence to the contrary. The administration could also file complaints with the World Trade Organization (WTO) about China’s currency manipulation and request dispute resolution.
The administration could also endorse China currency legislation that has been introduced in both the House and the Senate. The Currency Reform for Fair Trade Act (HR 639, S 328) was passed by an overwhelming majority of both Democrats and Republicans in the House in 2010, but the bill died in the Senate. The scope of the bill is a bit limited – only 3 percent of Chinese imports would be affected – making it something of a rifle shot; larger artillery may be needed to persuade China that it’s in its own interests to revalue.
The mere threat of a large, across-the-board tariff on imports from China may be sufficient to persuade China that the time has come for a major revaluation that would benefit both countries. In 2005, Senators Charles Schumer and Lindsey Graham introduced legislation (S. 295) that would have imposed a 27.5 percent tariﬀ on all imports from China if it failed to revalue within 180 days. This legislation was approved by the Senate (by a veto-proof margin of 67-33) but not by the House. Even so, shortly after its passage, China allowed its currency to rise for the first time in more than a decade. The currency ultimately appreciated by 20 percent, until the onset of the great recession in late 2007, when it was again tied to the dollar. China will respond to the threat of severe external pressure – especially since their policy of intervention has clear downsides for them as well.
The U.S. needs at least 11 million jobs to eliminate excess unemployment. Fiscal policy, if it can be enacted, is a good start, but the task before us is huge. We need a job strategy that pulls every available policy lever. The best place to start is with exchange rates—a lever that can be pulled by President Obama even if Congress refuses to help.