The United States Democrat-controlled Senate has postponed a vote on a bill investigating whether China is illegally manipulating its currency until Tuesday. If passed, the bill will then be put to the Republican-controlled Lower House. If it gets through the House, the Currency Rate Exchange Oversight Act 2011 will compel the Treasury to determine whether China is manipulating its currency. If the yuan is found to be artificially low, the Commerce Department will be obligated to levy taxes on some Chinese imports, potentially sparking a trade war between the world’s two largest economies.
The first thing to note is that the prospect of the bill (in its present form) passing both houses of Congress is slight. Even though the Barack Obama administration, in addition to Democratic and Republican lawmakers, all believe that China is indeed manipulating its currency (and they would be correct,) few of the president’s advisers and officials in the Treasury and Commerce Departments want to risk a trade war with China and will be quietly advising undecided Congressmen accordingly.
Additionally, the Republican leader and Speaker in the House, John Boehner, has publicly gone on record questioning the wisdom of such an action, arguing that a trade war would be disastrous. Despite a growing number of Republicans supporting action against China, it is probable that Boehner will prevent the bill being formally introduced into the House for a vote. At the very least, only a significantly watered-down bill will be acceptable to Boehner.
However, many in Washington are searching for a scapegoat in light of the country’s stubbornly high unemployment rate. Democrats—the most vociferous China-bashers on this issue—are behind in the polls and presidential elections are due in 2012. In the fluid world of American politics, strong momentum to ‘punish’ China can be built over the next few days – making passage of the bill more likely. So what happens if I am wrong and the bill is passed into law by Congress?
First, Treasury would be asked to review China’s currency policies. The reality is that Beijing very clearly suppresses the value of the yuan (relative to the dollar) through a combination of massive ‘market intervention’ by the People’s Bank of China and a closed capital account. In short, the non-convertibility of the yuan severs the normal market mechanism of exchange rate determination, while the PBoC uses its massive foreign currency reserves gained from its enormous trade surplus with the US to buy American dollar assets in order to inflate the greenback relative to the yuan.
Incidentally, this is one important reason the US is able to keep treasury yields absurdly low despite widespread concern about the longer-term value of the American dollar. China has to keep buying US-dollar assets in order to sustain its currency policy and currently holds around $US1.5 trillion in T-bills.
While there is still some question whether Chinese practices are actually illegal under World Trade Organisation rules, the US Treasury would only have to find that Beijing is manipulating its currency—which it is certainly doing. The US Department of Commerce would then be forced to consider retaliatory levies against selective Chinese imports.
No doubt, American trade lawyers would warn Commerce officials that the US still has obligations under WTO rules and an indiscriminate range of retaliatory tariffs would be illegal. Consequently, the range and extent of retaliatory levies would most likely be limited, hence preventing an all-out trade-war between the US and China.
Despite the anti-China sentiment surrounding this debate, US economists also realise that many American firms are amongst the big winners of China’s currency policy. Around 84 per cent of the country’s vibrant export manufacturing sector are comprised of foreign owned or invested companies. In a world of globalised manufacturing, between 50-70 per cent of all Chinese exports are processed goods: that is, parts of products shipped into China for assembly and shipped out again to mainly American and European markets. This means that if China’s currency was to dramatically rise against the greenback, the cost of ‘made in China’ products would become more expensive for the American consumer.
In the event of rapid yuan appreciation, firms would eventually find other cheaper places to assemble products, such as Vietnam and Indonesia. The primary value add to products would still be done by workers in America, Europe, Japan etc. Once the high-technology components are produced, few American or foreign firms would choose to relocate to America to do the grunt work of assembly due to higher labour costs, and more onerous standards and regulations. This means that successfully forcing China to change its currency policies will not lead to the creation of many new American jobs. Foreign firms will do their best to remind America lawmakers about this fact.
Any final action by the US Department of Commerce will therefore be watered-down and a full-blown trade-war will be avoided. But regardless of whether the Currency Rate Exchange Oversight Act 2011 comes into force or not, the currency issue will not help already strained diplomatic relations between the US and China.
Even if the Act does not come into force, the currency issue will remain since smaller American firms not tapped into the globalised production network are actually suffering from Chinese suppression of the yuan to some extent. But rather than the blunt instrument of the Currency Rate Exchange Oversight Act 2011, Congress and the White House will take a product-by-product approach to tariffs without formally labelling China a ‘currency manipulator’. This will help minimise any major political fall-out vis-à-vis China. It will also avoid the prospect of America violating its WTO obligations should the Commerce department be forced to issue broad-based retaliatory tariffs from the successful passage of the proposed Act.
So yes, China is a currency manipulator. But if anything, its policies discriminate against its own citizens since China is a net importer of many basic staples such as grain, soy and fuel. Only through subsidies and price controls can Beijing keep these products affordable for its people. The more pertinent point here is that punishing Beijing will not help America solve its economic woes.